Why Hollywood Is Winning Its War

Consumer electronics is now split into several factions, leaving it less able to battle the entertainment industry's protection demands

In November, after a long, controversial battle, the Federal Communications Commission unveiled its proposal for the "broadcast flag," a technology that protects the high-resolution programs shown on digital TV from being shared on the Internet. The Motion Picture Association of America (MPAA) and big-name consumer-electronics outfits such as Sony (SNE ), Matsushita (MC ), Toshiba, and Hitachi hailed the FCC's move as a smart compromise between consumers' right to make copies of movies and TV programs for personal use and protecting content owners' intellectual property.

Not everyone is satisfied, however. Philips (PHG ) warns that the broadcast flag could render obsolete the 74 million DVD players now in U.S. homes when it's implemented in 2005.

Here's why: Say a few years from now you capture a TV program on your new DVD recorder -- the digital equivalent of today's VCR. The recorder, equipped with special software, will be able to read the flag's signals and save TV programs. But try putting that disk in the older DVD player in the bedroom, and it won't work because DVD players purchased before the advent of the flag won't be able to play the recorded copies. So unless you're content to only buy or rent DVDs, you'll eventually have to junk today's snazzy DVD player.


  That's bound to make a lot of consumers angry, a big no-no in the ultracompetitive consumer-electronics market. "We're concerned because as an electronics maker we have a pact with the consumer that says old stuff and new stuff will work together," says Michael Epstein, manager of technology and standards at Philips. "A Hollywood solution like the broadcast flag creates problems for consumers even when they aren't doing anything wrong. It's a side effect that stops them from doing something they legally should be able to do."

Worse, Epstein and others fear, such uneasy compromises could become increasingly common. The reason is that digital TVs, DVD recorders, and home-entertainment servers aren't simple playback devices but rather intelligent computers that can manipulate, store, and share digital bits. After watching the music industry's turmoil in the wake of Napster, Hollywood is taking no chances that it will star in Napster: The Sequel.

So it has set its sights squarely on the consumer-electronics industry. Alongside its multimillion dollar federal-lobbying campaign, the MPAA has launched a full-frontal assault on state legislators. To date, 15 states have introduced bills to restrict features in new digital devices or to mandate copyright protection. The governors of Arkansas, Florida, and Virginia already have signed such bills into law.


  The intensity of Hollywood's battle may be new, but the war isn't. Consumer-electronics makers have always had an uneasy relationship with Hollywood. In the 1920s, vaudeville players sued Marconi for inventing the radio, claiming it undermined their live-performance business. Until the '50s, movie studios shunned the broadcast networks, fearing that TV would undercut cinema ticket sales. In the 1980s, Hollywood sued to stop Sony and others from selling VCRs.

Through the years, consumer-electronics producers have fought -- and in most cases beat back -- the entertainment industry's instinct to block new technology. And no one has benefited more from the march of technology than Hollywood: VHS and DVD rentals now account for more than 40% of entertainment revenues.

Fending off Tinseltown's latest assault will be tough, though, not least because the consumer-electronics industry is divided. Major players in the business are part of larger conglomerates with varied agendas and revenue streams. Thomson (TMS ), for example, owns Technicolor, a disk-replication business, and has invested heavily in developing digital-rights-management (DRM) software. Sony, through its movie studio and music label, has transformed itself into a content giant. Philips, by contrast, remains a technology company and earns an increasing portion of its revenues from patents and royalties.


  That explains why electronics makers find it hard to present a united front. Meanwhile, Hewlett-Packard, (HPQ ), Dell (DELL ), and Gateway (GTW ), though they have different ideas about how to implement DRM, agree that they'll sell more PCs only if consumers have the freedom to manipulate audio and visual content.

Electronics makers also worry that a more united computer industry could elbow them out of new, profitable markets. That's what happened in the early 1990s with CD burners. When electronics outfits introduced the product, the Recording Industry Association of America demanded that if consumers were going to make copies of its CDs, artists should be compensated for lost revenue. The solution: A tax of 3% would be levied on the price of each blank disk. PC makers argued that their users shouldn't be subject to the tax since they were using CDs to back up digital data, and an exemption was carved out.

Then, in 1998, Napster emerged on the scene, and suddenly PC users were using blank disks to burn tens of thousands of stolen songs to CDs -- and using cheaper data disks to do so. In 1999, just 12.5% of consumer PCs and notebooks sold had a CD burner drive. In the first 10 months of 2003, 92.8% of PCs sold had CD burners, according to research firm NPD. Stand-alone CD burner sales have been "minuscule," says NPD analyst Stuart Baker.


  The same thing appears to be happening with DVD burners. In the first half of 2003, sales of laptops and PCs with built-in DVD recorders jumped 550%, from 32,297 to 209,959, according to NPD. Compare that to the sales of stand-alone DVD burners, which jumped 316% but reached only 58,000.

That could spell big trouble for electronics makers, who have managed to squeak out revenue growth only because of the remarkable success of DVD players, the fastest-growing consumer-electronic product ever. As this market matures, electronics makers will need to find a new hit.

A landmark agreement with the cable industry, announced in September, is expected to boost digital-TV sales because consumers will no longer have to purchase a special TV and a special digital-cable set-top box. Instead, it will work as simply as analog TVs -- plug the new digital set into the cable outlet, and you're off. In 2002, digital-TV sales totaled 2.1 million. In 2004, they're expected to reach 5.4 million.


  Will such successes be enough to compensate for the deleterious effects of copyright rules on electronics makers? Bob Perry, vice-president for marketing at Mitsubishi Electric, co-chairperson of the broadcast flag discussion group and a veteran negotiator, is optimistic that they will.

After the September cable deal, he says "consumer-electronics companies now have a very clear path for making a host of products -- cable-ready TVs, high-definition digital recorders, TiVO-type devices that can search and record favorite TV programs, and network devices that allow you to share content through the home -- available to consumers." It also sets them on a continued path of conflict with Hollywood in the digital-copyright wars.

By Jane Black in London

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