Alarm bells come too late for Sony Pictures

The memo Sony Pictures co-chiefs Michael Lynton and Amy Pascal sent to employees Monday announcing massive layoffs, most of which will fall in the home entertainment and IT divisions, obviously wasn’t meant to be made public. But it’s fitting that it was leaked when it was, the same day that Bernstein Research analysts Michael Nathanson and Peter Choi published what amounted to an obituary for packaged media as a profit driver for Hollywood.

According to Bernstein:

  • For 2009-2012, we [previously] forecast overall U.S. home entertainment industry revenues to decline at a -2.1% CAGR. This underscores the mature nature of the industry, plus the importance of share gains for individual players. Over this time frame, aggregate operating profit declines of low single digits are also expected.
  • Now one year later, looking at the cold hard facts of 2009, retail spending on sell-through DVDs and Blu-Ray discs dropped by -18% while rental of these products actually increased by 4%. As a result, the sell-through of physical discs declined from 63% of the market to 57%.
  • This massive change in behavior continues to have negative implications for studio profitability as every home video executive would rather book the $16 of profit contribution per transaction from selling a disc vs. the $3.50 to $1.40 per disc profit contribution from rental.
  • [snip]
  • Our analysis also shows that the Blu-Ray format is having a more modest acceptance rate that traditional DVD. In 2009, three years after its introduction, Blu-Ray’s penetration of TV households stood at 4.4%, compared to 13.0% for DVDs in 2000. We also find that Blu-Ray [sic] has seen lower numbers of titles shipped per converted household relative to DVD. We don’t see Blu-Ray stemming the decline of physical sales.

It’s that “massive change in consumer behavior,” according to Lynton and Pascal, that now forces Sony into “hard” decisions and “difficult” steps:

In our article in The SPE Reel in December, we spoke about the shifting landscape of entertainment and its impact on the economic model at the heart of this industry.  Despite the records our studio set at the box office, we’re not immune from these forces, and we said then that costs needed to be controlled as part of a sustained and strategic effort to remake Sony Pictures for the future.

[snip]

Today, we want to let you know, in a timely manner, what will be involved in the crucial – and difficult — next phase of this process.

In several stages, we will have a workforce reduction, with most of the notifications taking place by the first week in March.  It will affect each of the studio’s divisions, with the majority occurring in home entertainment and IT, and in the United States.

[snip]

The decision to take this step was difficult.  But it’s being done in the context of a strategy designed to help us safeguard our competitiveness and chart our own course through these troubled waters.

The need is clear:  from the growth of online piracy, to the social media effect on the performance of films, to the way people have changed how they watch television and acquire DVDs.  The business is going through a rough period of trial and transition, and we have an obligation to take the steps necessary to get through it.

According to Sony Pictures Home Entertainment president David Bishop, the studio is at risk of falling victim to forces “outside of [its] control” if it doesn’t act now, as he said to employees last week in his own memo:

Our choice is simple – we can make strategic choices today to direct the evolution of our business, or be overwhelmed by changes that are imposed on us by forces outside of our control.

We’ve chosen to act now to meet the shifting demands of a fast-changing marketplace. We’re building a new operating model that will streamline decision-making, increase accountability and innovation, and focus on strategic and analytic thinking.

[snip]

Emphasizing our new business model’s focus on innovation, John Calkins will transition from his current role in SPE Corporate Development to a newly-created position within SPHE as Executive Vice President of Global Digital and Commercial Innovation. This new team will focus on developing and implementing strategies to maximize new technologies.

Better late than never, I suppose, but “forces outside of our control”? Like what? Piracy? Some,certainly, but how much “piracy” has resulted from the studios’ failure to respond effectively to reasonable consumer demand for content portability and format transparency? How much time have they wasted suing Kaleidescape instead of figuring out how to take its secure personal copying system industrywide? Yes, I know the case was about the CSS license, blah, blah, blah. But that was never more than an attempt to evade the real issue: personal use copying.

The shift in consumer behavior toward rental? That was a function of wholesale pricing and the consumers’ perception of value, which are entirely under the studios’ control. If 40,000 supermarkets in America were selling new release DVDs for $8.99 by the checkout counter, how many consumers do you think would be lining up at the Redbox kiosk in the parking lot? How many supermarkets do you think would let Redbox on the premises?

Don’t believe me? Then how is it the studios were previously able to alter consumer behavior from rental to purchase when they introduced the (comparatively) low-priced DVD to replace the high-priced VHS cassette?

Digital? The need for a viable post-DVD digital strategy has been blindingly obvious for most of the past decade. But instead of focusing on that existential challenge, the industry wasted four years on Blu-ray, an absurd format that addressed no identifiable consumer demand that could not have been met years earlier, more cheaply and with less consumer confusion with readily available alternatives, like HD DVD or even red-laser DVDs.

The industry is still wasting time and resources trying to invent uses for Blu-ray to justify the time and cost sunk into it.

Hitting the snooze button when the alarm goes off doesn’t mean that what happens in the meantime is beyond your control. It means you’re asleep.