Even if you don’t care one bit — and this probably describes the vast majority of Americans — you have probably heard by now that a Great Format War has been fought, and apparently won. The HD-DVD format for DVDs, backed by Toshiba, has lost out to Sony’s Blu-ray format. To be sure, there are some caveats. In this Computerworld article, for instance, Lucas Mearian writes that Blu-ray’s victory may not be remotely as meaningful as it seems. Having recently spent a cold, rainy, but thrilling afternoon walking the Freedom Trail in Boston, I would put it this way: the Blu-ray victory may end up being as expensive, and as predictive of ultimate victory, as was the British victory of Bunker Hill. (This is not to say that HD-DVD will come back and win the war; it likely won’t. Still, the Blu-ray victory is hardly unqualified.)
So what are we to make of this format skirmish? We gathered up a group of smart people who think about such things — Shane Greenstein, Andrei Hagiu, Michael Santo, and Pai-Ling Yin — and asked them the following:
Is the battle between HD-DVD and Blu-ray really over? What can we learn from it?
Here are their answers. Thanks much for their participation and insights.
Shane Greenstein, professor of management and strategy at the Kellogg School of Management at Northwestern University:
While the history of format wars teaches analysts not to infer lessons too hastily, it is much more fun to throw such caution to the wind. So here goes. I see three lessons from this recent battle, one for vendors and two for buyers.
The lesson for vendors: a format victory does not guarantee profitability. Neither side in this fight committed a strategic error. Each hardware vendor lined up a large coalition, launched a sophisticated campaign, and fully funded their marketing efforts. Such sophistication led to large sunk expenses. That put both sides in a position to lose money unless the war settled quickly. It did not. HD-DVD had its best chance when it came to market earlier than Blu-ray. HD-DVD did not win because it did not build enough early sales to slow its competitor’s later sales, which went well enough to nearly tip the market.
The HD-DVD coalition responded by offering subsidies for content providers, keeping the fight alive. Reportedly, buyers bought a million units of HD-DVD and a million of Blu-ray, with the latter being more recent. Retailers – especially Wal-Mart and Best Buy – have recently lost patience with splitting precious shelf space between formats, and have settled on Blu-ray, the format that sells more content.
In brief, neither side exits this war with profitability. HD-DVD will soon assume niche status, and the coalition will take a write-down. At best, Sony avoided disaster by not losing completely. Still, that avoidance happened only with a very high initial expense that Sony cannot possibly recover until Blu-ray sells many units for a long time. In brief, neither side has profited, or will do so for some time.
The lesson for an impatient buyer: a format war does not benefit every impatient buyer. An impatient buyer wants the latest functionality at almost any price and wants it soon. Those buyers exist in every market for consumer technology gadgets, benefiting from the usual free-for-all. Things will turn out well for one group of impatient buyers, those who bought Blu-ray, but not necessarily as well for the other group, or HD-DVD buyers. The latter own a system with a good chance of becoming orphaned by hardware vendors and movie title providers. There is no way to buy insurance against such a contingency, nor is there a large tax deduction for donating obsolete equipment to museums stocked with 78 RPM turntables, 8-track tape players, and laser discs.
The lesson for a patient buyer: patient buyers gain certainty by ceding control. Patient buyers usually do not itch to change their situation quickly, waiting for a new gadget to exhibit a clear and pragmatic value proposition. Vendors believe that there are many such buyers in this market, comprising the vast majority of VCR owners. Indeed, it looks as if patient buyers benefited from waiting out this format war, and will soon experience lower prices, larger libraries, more convenience, and reduced uncertainty. Yet, as in prior wars, waiting has its risk. Patient buyers ceded control over the format choice to impatient buyers and sellers. Did earlier market participants make a choice that serves the interests of later market participants? It is difficult to say at this point.
Pai-Ling Yin, assistant professor of strategy at M.I.T.’s Sloan School of Management:
Unfortunately for Sony and Toshiba, both Blu-ray and HD-DVD lost the battle long before Toshiba’s withdrawal. To see this, it helps to remember that this is indeed only one battle in a much longer and larger war.
First, the longer war: technology markets are characterized by waves of innovation, where the latest and greatest of last year is replaced by the latest and greatest of next year. Joseph Schumpeter described this pattern as “the perennial gale of creative destruction.” Blu-ray and HD-DVD are simply the next generation of discs, replacing the standard DVD of the last generation. Thus, there is but a limited amount of time (until the appearance of the next generation technology) for the firms and the technology of this generation to reap the rewards of being the shiny new item on the block.
In the presence of indirect network effects, that window of opportunity can be eaten away in a standards battle between two incompatible technologies. Movie studios and game developers want to produce DVDs compatible with the standard that the most consumers adopt, and consumers want to buy the DVD player for which there exists the largest selection of movies and games. Consumers, worried about buying the losing technology (think Betamax vs. VHS), may delay adoption of both technologies until the battle is resolved.
To avoid delayed consumer adoption, Sony and Toshiba tried to coordinate on one technology standard in 2005. Their failure to do so led to the protracted fight in the market for content and distribution allies that leads us almost 3 years later to ask, “Is the battle over now?” The reality is that relative to the sales that could have been garnered from faster and higher volumes of DVD players had Sony & Toshiba been able to come to some agreement, both firms have lost. (It is interesting to note that the straw breaking the camel’s back may have been Wal-Mart’s decision to stop carrying HD-DVD players, reinforcing the importance of distribution and access to new technologies in market-tipping episodes such as the browser wars between Netscape and Internet Explorer — see Bresnahan & Yin’s “Standard Setting in Markets: The Browser War” — and from floor-based to electronic exchanges — see Cantillon & Yin’s “Competition Between Exchanges: Lessons from the Battle of the Bund.”)
Even worse, the window of opportunity is closing. This battle will end with both HD-DVD and Blu-ray retreating in the face of a new challenger: digital downloading. Disney movies can already be downloaded via Apple iTunes, cable companies offer videos on demand, and consumers can record shows and movies in high definition on their HD-compatible digital video recorders. The ability of consumers to perceive this challenger just over the horizon further stalls DVD player adoption. Why bother investing in a player when it may soon be obsolete?
This question brings us to the larger war: the next-generation DVD player is only one battle in the larger war over the living room. Who will control the home entertainment center? As digital technologies converge, firms like Sony, Microsoft, Apple, and TiVo continue to add more and more features to their respective products, allowing consumers to use a single device to manage pictures, music, video, games, etc. Blu-ray or HD-DVD is one feature. Another feature is network capability. Even when Blu-ray becomes obsolete, Sony hopes the device upon which it entered a household will maintain its prime real-estate position in the living room, and download a Sony Pictures movie via its Internet connection, as well as manage all other digital media in the home. As a result of Sony’s ownership of content, Sony may have a stronger interest than Toshiba in holding out in this losing battle, if only to get a foot in the door of as many homes as possible.
Andrei Hagiu, assistant professor of business administration at Harvard Business School:
Even after Time Warner’s announcement last month that it was dropping support for HD-DVD and becoming Blu-ray exclusive, and after Best Buy, Netflix, and Wal-Mart all announced earlier this month that they would give more prominence to Blu-ray and gradually but surely retire HD-DVD hardware and DVDs from their offerings, there were still some people who thought that HD-DVD had a small chance. Not any longer, after Toshiba officially conceded defeat recently: the HD-DVD format has lost — that much is certain.
The more interesting question is, “Has Blu-ray has really won?” This epic standards duel has lasted about two years and, as a result, both camps have sunk hundreds of millions of dollars into trying to gain the upper hand — not necessarily by improving their respective standards technologically, but, say, by paying bribes to large content providers in order to win their support.
For example, as a result of such tactics, Paramount and Dreamworks signed 18-month exclusive deals with HD-DVD last summer. (They were reportedly paid $150 million by Toshiba and its allies.) Given the outcome this winter, that looks pretty wasteful. Sony and the Blu-ray camp have also had to throw out a lot of money to sway movie studios, as well as to convince retailers and consumers that Blu-ray is the wave of the future rather than HD-DVD. It is not clear that the current size of the “pie,” which is now available for sharing between Sony and its allies, is big enough to offset these losses. In fact, the greatest irony of all is that Toshiba’s price went up 5 percent after the announcement last week. That’s not so surprising, in light of the above: investors must be relieved that Toshiba will finally stop throwing money away in order to get people on its standard.
Most importantly, what if this heavily publicized standards battle ends up being just a footnote in history, an irrelevant battle for an obscure technology, once the spotlight has shifted to other technologies (e.g., video on demand, IPTV and Internet download service) that might completely leapfrog DVD standards? And Sony, for all its might in consumer electronics, has generally looked awkward, slow, and uninspired when it came to designing content portals. (Think Sony Connect in digital music — about 3 years late on Apple’s iTunes; or its silly approach to content for its eBook — why would anyone pay for electronic books that you have to read within 3 months before they disappear?) Today, the company is nowhere to be seen in digital video services. Yes, the Blu-ray victory must feel especially sweet after the Betamax debacle 20-odd years ago, and given the reinforcing effects with PlayStation 3. But the company would be well advised to start looking into services such as Apple’s iTunes, Amazon’s Unbox, and many other advances that are threatening to make physical digital formats irrelevant.
So did we learn any new lessons about how to win a standards war? I’m not sure: it’s still all about doing whatever it takes to secure favorable expectations (from consumers and content providers) and getting exclusive deals for content or distribution (in the end, that’s what carried the day for Blu-ray, despite more expensive hardware). And oftentimes, these actions are not related to making better products.
Perhaps one lesson that this particular war drives home particularly well is this: not fighting in the first place might be a very good strategy to win, if only the contestants could be smart enough at the beginning. Mounting investments in standard wars is akin to a bidding war for a $20 bill: once you’ve decided to participate, you are sucked into a wasteful battle, in which people bid higher than $20. The worst consequence of fighting between incompatible standards is that consumers will simply not buy either until one has clearly won; why would anyone pay $400 plus for a 50 percent chance of getting stuck with a losing technology (a new Betamax if you will)? And then, when one technology has won, consumers might not rush to the winner if substitute technologies have appeared.
Bystander players in standards wars (in this case, content providers such as Hollywood studios) also have a lesson to learn: indecisiveness can be very wasteful for them, too. Sitting on the fence for too long rather than taking a stance and trying to make the market tip to one standard (which they have the power to do!) makes the pie shrink for everyone, including themselves. For example, why did Time Warner have to wait so long before committing?
For a long time, this war was a relative standoff, with HD-DVD selling more players and Blu-ray more titles, with an almost 2-1 margin in the first three quarters of 2007. Then the hammer fell, just before the Consumer Electronics Show in early January, when Warner Bros. announced that it would support Blu-ray exclusively.
This move left only Paramount and Universal as the major studios supporting HD-DVD, and gave Blu-ray a huge advantage in what counts the most in the war: content, with 70 percent of titles released only in Blu-ray. After all, what good is a player with nothing to play?
In the past few weeks, it’s been like a snowball rolling downhill, gathering speed. Netflix announced it was dropping HD-DVD, then Best Buy promoted Blu-ray over HD-DVD. And finally, Toshiba is throwing in the towel. And perhaps the biggest blow: on Friday, Feb. 15th, Wal-Mart announced that it would drop HD-DVD. When the world’s largest retailer drops you, you are toast.
Yes, the war is truly over. The lesson learned is an expensive one, for the companies involved as well as for consumers. For the former, the lack of a unified standard will end up costing the “losers” millions. You would have thought this lesson would have been learned after Betamax, but apparently it was not.
For consumers, the lesson is: don’t rush in immediately when something new comes out. Even without competitive standards, the number of problems in the early players, particularly Blu-ray, screamed, “wait.” Consumers should at least give new technology time to shake out the bugs, and, with competition such as this, let the dust settle. With this war over, though, there may be a new war beginning that the consumer can win: Blu-ray player price wars.
But does Blu-ray still have its work cut out for it? I believe this is the case, though its fate will take some time to play out. One need only look at recent announcements from HBO and Netflix to see the writing on the wall. Streaming video is the future, and will probably dethrone optical discs in the end – though probably not so fast that the Blu-ray Disc Association won’t have time to gloat.