The Blu-ray Gamble


The format war between Blu-ray and HD DVD heated up last month with news that Paramount and Dreamworks Animation had decided to drop support for Blu-ray and back HD DVD exclusively.[1] Rumors about a $150 million deal brokered by Paramount parent company Viacom were confirmed by the New York Times, which spoke on condition of anonymity to two Viacom executives with knowledge of the agreement.[2] The deal is expected to last for 18 months, although Paramount executive vice president and chief technology officer Alan Bell asserts that “at this moment in time, it’s an indefinite commitment.”[3]Up until this point, HD DVD had been in a tough spot. In terms of movie studio support, it was lagging far behind its competition, with Disney, MGM/Columbia Tristar, Fox, and Lions Gate solely backing Blu-ray, while only Universal supported HD DVD exclusively (Paramount and Warner released for both formats).[4]Recent news that Blockbuster had decided to side with the Blu-ray camp as well as sales reports showing Blu-ray outselling HD DVD 2-to-1 for the first half of 2007 signaled the cessation of the format war.[5]The end of the match was in sight: HD DVD had its back against the ropes, and Blu-ray was winding up for that final haymaker that would seal the deal.

[1] http://thegamereviews.com/story-466-Paramount-goes-HD-DVD-Exclusive.html
[2] New York Times
[3] http://www.pcworld.com/article/id,136253/article.html
[4] http://reviews.cnet.com/4520-6463_7-6462511-2.html
[5] http://uk.reuters.com/article/technologyNews/idUKN1419176920070815

Unfortunately for the Blu-ray camp, Paramount’s announcement effectively blocked any chance of a quick victory, and opened up an opportunity for Toshiba and its allies to launch a counterattack against the Sony-backed format. Whether or not Toshiba will capitalize on this opportunity remains to be seen. But what does all this format warring mean for the game industry? And does the struggle between the Blu-ray camp and the HD DVD camp shed any light on the intentions and strategies of Sony and Microsoft in the current console war?

As a matter of fact, the console war and the format war are closely related, and by no means accidentally. Sony’s intention from the outset was to win both wars, and its strategy was to put its full weight behind the symbiotic expansion of Blu-ray and the Playstation 3. The plan was to allow the PS3 to stimulate rapid growth of Blu-ray’s install base, and once Blu-ray became the next-generation home video industry’s standard, the format would in turn drive sales of Playstation 3 as consumers came to realize the tremendous value of a game console and high-definition DVD player bundled into one electronic device. Thus, the future success of the Playstation 3 depends in large part upon the ability of Blu-ray to defeat HD DVD. As long as there is no standard format in the high-definition DVD industry, the value proposition of the Playstation 3 remains unfulfilled because consumers continue to wonder: “why spend $499 on a game console which mandatorily includes a disc drive of an unproven format?”

Hence, for Sony, Blu-ray is an all-or-nothing gamble. If the format succeeds, Sony reaps all the benefits from its research, development, and marketing investments, and fulfills the value proposition of the Playstation 3. If the format fails, it will be the Betamax nightmare all over again, albeit with an added crippling effect—Sony will have to support an expensive-to-produce disc drive that will keep the price of Playstation 3 higher than its competition without providing the promised value of high-definition DVD playback. Hence, it is imperative for Sony that Blu-ray overpowers HD DVD, and does so relatively quickly.

On the other hand, Microsoft has been backing HD DVD since September 2005. The company’s official reasons for supporting the format are that it is cheaper to produce and that it allows consumers to copy data from the disc.[1] But is Microsoft supporting Toshiba’s disc because it honestlybelieves that the format is going to win? In my view, no. As opposed to Sony, Microsoft has played it relatively safe in regard to the format war. Whereas Sony built a Blu-ray drive into every Playstation 3, Microsoft chose to release a peripheral HD DVD player for the Xbox 360. This way, if the HD DVD ship sinks, Microsoft can just cut the ropes and float to safety. Ex-Microsoft Corporate Vice President Peter Moore once even mentioned the possibility of releasing an add-on Blu-ray player in the event that Blu-ray emerges the victor, although this is unlikely given that Sony is the primary developer and owner of the format.[2]

[1] http://arstechnica.com/news.ars/post/20050927-5355.html

[2] Microsoft and Sony do cooperate in some business ventures, but only when it is profitable for both corporations and harmful to neither. An Xbox 360 add-on Blu-ray player would compete directly against Playstation 3’s built-in drive, so Sony faces strong economic disincentive to allow Microsoft to develop such a device.

If Microsoft does not honestly believe in HD DVD’s ability to triumph over Blu-ray, why does it continue to support the format exclusively? In my assessment, a large part of the reason is that where Sony stands to gain or lose in a big way in the context of the console war, Microsoft has a vested interest. If Blu-ray succeeds, and as a consequence propels the adoption of Playstation 3, it will no doubt harm the competitiveness of Microsoft’s console. Consumers may be confused now as to why they should shell out $500 for a game console with an unproven high-definition DVD format, but if Blu-ray became the industry standard, the perceived value of the Playstation 3 would be greatly enhanced.

The sensible strategy for Microsoft, then, is to deny or delay this possible outcome for as long as possible, even if it means supporting a format with a higher likelihood of failure than its rival. It’s thus apparent that Microsoft’s outward enthusiasm for HD DVD is no more than a guise for a war of attrition with Sony to delay the fulfillment of the Playstation 3’s value proposition as an all-in-one game machine and high-definition DVD player. If Microsoft can prolong the format war for long enough, it can develop a strong enough portfolio and capture sufficient market share that by the time Blu-ray emerges the victor, the beneficial effect it would produce for Playstation 3 sales would be too little, too late to make much of a difference for Sony.

In light of these observations, it’s clear who gained the most from the Paramount announcement. Not Sony, because it lost a valuable business partner to a rival company. Not necessarily Toshiba either, because HD DVD still has a steep hill to climb before it can actually defeat Blu-ray (and if it loses nonetheless, the $150 million spent brokering the deal would simply be additional sunk cost). The greatest benefactor from Paramount’s decision was Microsoft, because the action delayed—perhaps significantly—the emergence of a clear victor in the high-definition format war. So long as HD DVD and Blu-ray are locked in a stalemate, the Playstation 3’s value proposition remains suppressed; and this has a directly advantageous effect on the competitiveness of the Xbox 360.

If Microsoft can continue to play Sony and Toshiba off one another, by the time a definite format winner emerges, the videogame and home video industries may have dropped the physical disc altogether in favor of digital distribution. Indeed, both Microsoft and Sony executives have predicted the inevitable demise of the disc after the Blu-ray/HD DVD generation.[1] Will Sony be able to reap the rewards of its big gamble in time? It’s too soon to say, but for the moment, it seems that Paramount has thwarted any efforts on Sony’s part to finish the fight quickly.

[1] In October of 2005, Microsoft Chairman Bill Gates predicted: “The format that’s under discussion right now, HD versus Blu-ray, that’s simply the last physical format we’ll ever have.” And in August 2006 SCE Worldwide Studios President Phil Harrison said that digital distribution “will be the business model for the future of games. I’d be amazed if the PS4 had a physical disc drive” (http://www.gamesindustry.biz/content_page.php?aid=12398; http://www.gamesindustry.biz/content_page.php?aid=18802).

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