CinemaNow's Internet Cliff-Hanger

The online movie business hopes downloadable DVD services will start an industry-wide trend. But studios want to see strong sales first

The movie download business just got more fast and furious. On Sept. 26, online movie distributor CinemaNow announced it will sell a $9.99 downloadable version of Universal Pictures' new home video release "The Fast and the Furious: Tokyo Drift" that can be burned to a digital video disc and run on standard DVD players.

The deal marks the first time a major studio is releasing a DVD in retail stores and on a download site at the same time. Studios typically release their movies as DVDs in retail stores first, then hold off six weeks or more before making them available for download.


  CinemaNow CEO Curt Marvis sees the offering as a catalyst that could push the download business to finally take off. The California-based company is in discussions with other Hollywood studios to distribute first-run DVDs in download-to-burn format.

Significant online demand for the car-racing flick could entice more studios to get behind the wheel, says Marvis. "For us, it has always been a situation where you have to get someone to say yes before you can kind of get things moving forward," he says. "We think this will open up the door…we are very encouraged that more studios will join us for day and date [new release] titles to burn."

Studio executives say they are watching the experiment closely. "The test is, are consumers going to find this an interesting thing," says Thomas Lesinski, Paramount Pictures' president of digital rights. "I think burning will get a lot of focus early next year."

To date, Hollywood has been slow to embrace download services. Though major studios have provided many older, "back catalog" movies to download sites, they have typically reserved new releases for brick and mortar stores such as Wal-Mart (WMT), rental giant Blockbuster (BBI), and online mail delivery services such as Netflix (NFLX) and Amazon (AMZN). Concerns that downloading could pave the way for mass piracy coupled with fears that downloads will erode the lucrative DVD market have fueled the studios' reluctance to offer new releases (see, 9/12/06, "Don't Nix Netflix Just Yet").

The studios' caution makes sense considering the amount of money DVDs generate for them. PricewaterhouseCoopers estimated that retailers sold $18 billion worth of DVDs in 2005, compared with about $10 billion in box office revenues. (see, 7/11/05, "What's Driving the Box Office Batty"). "If you are a movie studio, and you are generating more than 50% of your revenues from plastic distribution, it is quite a gamble to bet on digital download," says Jefferies & Co. analyst Youssef Squali.


  Copyright technology has also stalled the business. Until July 19, when CinemaNow released a beta version of its download-to-burn service, downloaded movies couldn't be watched on most DVD players. The reason? DVD players did not support the version of Microsoft's (MSFT) Digital Rights Management software that most download services used to keep movies from being unlawfully copied. CinemaNow got around this problem by buying technology for their download-to-burn service from a German company that had created a DVD player-compatible code, to prevent burned movies from being copied.

The copyright compatibility issues meant that those few brave souls willing to download movies from the Net found them confined, by and large, to the computer. Movie fans had to watch flicks on their computer screens, unless they hooked their computers up to their televisions through a special cable—a kludgy process that could sometimes compromise picture quality. Several companies are working on solutions to this problem.

Apple (AAPL), for example, unveiled a new product Sept. 12 intended to wirelessly beam computer content to the television. The device, called the iTV, is a companion to its newly launched iPod movie download service and will be released in 2007 (see, 9/13/06, "Apple's Latest Fruits").


  With that major obstacle soon to be out of the way, CinemaNow thinks consumers will flock to a download-to-burn service. Already, the roughly 100 download-to-burn titles CinemaNow offers are downloaded about five times as much as download-to-rent and download-to-computer films. And where the consumers go, the studios will have to follow, reasons Marvis.

"I would say the studios are cautious but very aware that digital distribution is an enormous marketplace that sits in front of them," he says. "Studios are always looking for new marketplaces that can have a lot of growth associated with them. And I think they all recognize that the same pattern that occurred in the music industry will hold true for video content." Marvis is so confident that he believes CinemaNow will have between 500 and 1,000 download-to-burn titles by the end of the year.

Analysts, however, are not as certain that movie studios will race to release their content online. Charles Wolf, an analyst at Needham & Co., says that broadband connections are still not fast enough and demand is not large enough to get studios to abandon DVD retailers and mail delivery sites for downloads. "This is an emerging technology that probably will not become material for several years," says Wolf. The analyst argues that, instead, the Netflix model, in which people pick out movies online and then get them by mail, will continue to gain market share and present the most potent challenge to retailers like Blockbuster.


  Wolf believes that downloading technology will eventually gain market share and co-exist with services like Netflix'. In the near term, he believes movie studios are still focused on traditional DVD sales and new DVD technology such as high-definition DVDs and Blu-ray technology (see, 10/05/05, "A Warner Bros. Green Light for Blu-ray?").

Still, DVD sales in retail stores have slipped in recent months. If the weakness continues, Hollywood will have more reason to look for alternative sources of revenue. Wal-Mart, which accounts for 40% of the DVD market, is feeling pricing pressure from new services by Apple and others (see, 8/31/06, "Wal-Mart and Apple Battle for Turf").

Marvis, for one, is hopeful. "By the end of this decade, we will see a shift in the video business," he says. "Downloading video will be common."

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