Next-Gen DVDs: Advantage, Sony
Sony-led backers of Blu-ray seem to have pulled ahead of rivals in the race for a single high-def DVD standard

by Ronald Grover and Cliff Edwards

It's a fight with more plot twists and intrigue than a Hollywood thriller. For two years now, rival camps have been battling over which new DVD format will prevail: Blu-ray, which is backed by Sony (SNE) and a consortium of 170 other companies, or HD DVD, which is being championed by Toshiba (TOSBF), Microsoft (MSFT), and others. Both technologies promise crisper video that looks better on the new generation of flat-panel, high-definition TVs. And the winner stands to control a lucrative new market worth billions. Each side has been competing to win the backing of the major movie studios. Only Warner Bros. (TWX), which currently uses both formats, is still playing hard to get.

Now, with the Jan. 7 International Consumer Electronics Show fast approaching, Sony and Toshiba are keen to announce they have won over Hollywood's last holdout. In the meantime, they are falling over themselves to woo Warner. While either side could prevail, the Sony group has suddenly emerged as the front-runner.

Why? Because despite a setback this summer when the HD DVD companies signed up Paramount Pictures (VIA) and DreamWorks Animation (DWA), the Blu-ray forces have still lined up more studios than the HD DVD side. Plus this year, the Sony team has sold more than twice as many discs. "The rumor is that Warner is coming aboard soon," says Michael Burns, vice-chairman of studio Lionsgate (LGF), which makes its movies available on the Sony-backed format. "That will make it awfully tough for HD DVD to stay in this game." (Sony declined to comment, and Toshiba only would say it is "in regular contact with the studios.")

From the beginning, the two camps' overarching strategy has been the same: getting access to as many movies as possible. It isn't hard to see why. Consumers will buy the new technology only if they believe most of the films they want will be available.

Right now the Blu-ray team has enough studios on board—among them Disney (DIS), Fox (NWS), and, of course, Sony—to account for about 49% of current DVD market share. Warner is a prolific film factory, releasing as many as 30 pictures a year, including those produced by sister studio New Line Cinema. Persuading it to sign an exclusive deal would give the Sony crowd about 70% of DVD market share. That could prompt the other studios to abandon HD DVD.

On the other hand, if Toshiba were to win Warner's hand, the two forces would divide the market between them. That could create mass consumer confusion and potentially strangle a new technology that the studios hope will give a lift to flagging DVD sales. That's exactly why Warner has long pushed for a single format.
WOOING WARNER

The battle has heated up since HD DVD got Paramount and DreamWorks Animation. Both sides have been beating a path to Warner's Burbank (Calif.) doorstep. Yoshihide Fujii, the head of Toshiba's HD DVD business in Japan, has made three trips to the U.S. since the summer, say those with knowledge of the situation. And while Andrew House, Sony's chief marketing officer, has been pressing the Blu-ray case, the stakes are sufficiently high that Sony CEO Howard Stringer has been making personal appeals to Richard Parsons and Jeffrey Bewkes, the two top executives at Warner parent Time Warner (TWX).

Toshiba is pressing the case that because its technology is cheaper, it will more quickly become a mass-market product. According to the DVD Release Report, an industry newsletter, the suggested retail price of an HD DVD is $31.74, nearly $2 less than Blu-ray's suggested price. (Retailers traditionally cut the price to less than $29.) Toshiba also has been cutting the price of its players, slashing its entry-level machine to $299 earlier this year.

It was price that prompted DreamWorks Animation and Paramount to throw in their lot with HD DVD earlier this summer. (Like Warner, Paramount had previously backed both formats.) "The game-changer for us was the hardware costs dramatically coming down to where it could succeed broadly for the consumer," says DreamWorks Animation CEO Jeffrey Katzenberg. "In addition, the software manufacturing costs in the future would be significantly lower than Blu-ray." Of course, it didn't hurt that Toshiba agreed to pay Paramount and DreamWorks Animation a combined $150 million in incentives, including money to license DreamWorks' Shrek character for marketing purposes.

The Blu-ray faction insists there is no burning reason for it to match HD DVD's prices. "We think Warner will respond to the fact that our greater number of titles gives us a greater likelihood of being the single standard," says Andy Parsons, who leads the Blu-ray lobbying effort. But another executive backing Blu-ray, who didn't want to be identified, expects the imminent arrival of a sub-$300 Blu-ray machine.

What's more, Hollywood insiders say the $150 million that the Toshiba group showered on Paramount and DreamWorks Animation radically changed the game. These people suggest the Blu-ray team is so determined to win that it will throw hundreds of millions of dollars of marketing support behind Blu-ray equipment if Warner gets on board.

Warner isn't talking, but people close to the situation say the studio is waiting to see which group sells more of the new-fangled DVD players this holiday season. "Warner wants one of the two sides to make a commitment to getting this format into as many hands as possible," says a studio executive with knowledge of its thinking.

So far Toshiba has eked out a lead. According to industry tracker Adams Media Research, by the end of this year as many as 578,000 U.S. households will own HD DVD players, compared with 370,000 that have Blu-ray players. Adams also estimates there are 300,000 more HD DVD players in circulation inside Microsoft Xbox game consoles. But that still pales in comparison to the estimated 4 million Blu-ray-equipped Sony PlayStation 3 consoles sold in the U.S.

The Blu-ray side has another advantage. Disney caters to families, who buy lots of older films for their kids. That could help the format build critical mass. "The Blu-ray customer is more likely to build a new library," says market researcher Richard Doherty. "Studios live for [that]."

That leaves one question. If the Sony camp wins Warner, will the other studios ditch HD DVD? They're not saying. But Dreamworks Animation and Paramount only signed on with the Toshiba side for 18 months. So then they could take the money and run.