Walmart Does That VOD Vudu

Let’s stipulate that the $100 million price tag being bandied about for Walmart’s acquisition of Vudu is exaggerated, or includes various earn-out targets that likely will never be met, making the ultimate price something less than nine figures. Walmart hinted at as much in its press release, indicating the acquisition would “not be material” to its first fiscal quarter despite being scheduled to close within that period, suggesting there are triggers and contingencies in the deal that will play out over time, if at all.

Yet the fact that we’re even talking about a price that could reach into the $100 million ballpark suggests there’s something more going on here than meets the eye.

Or maybe not. Perhaps, as has been suggested, Vudu,  somehow, simply blew smoke up Walmart’s ass and convinced it to overpay for a marginal VOD provider. Or perhaps, as Streaming Media’s Dan Rayburn argues, Walmart simply doesn’t know what it’s doing in digital delivery and is setting itself up for another massive VOD fail.

But I think that’s too narrow a view of what Walmart is up to.

From Walmart’s perspective, Vudu has a number of valuable assets that make it more than simply a VOD provider with some nice content licensing deals. One of those is the HDX encoding format, which Vudu introduced back in 2008. With HDX, Vudu claims, it can deliver genuine 1080p video over the Internet in 4.5 Mbs of bandwidth. The format is optimized for LCD and plasma screens over 40-inches in size and incorporates a process Vudu calls TruFilm, which simulates the cinematic experience in a home theater by preserving film grain and other textural qualities of film.

That gives Vudu a distinct quality advantage over other would-be over-the-top video distributors, including Netflix, iTunes, Amazon and Xbox Live. Even the “high-def” content those services deliver is encoded in 720p at best, and at lower bit rates than Vudu uses. It also looks worse as screen sizes increase.

At some point, as consumers come to expect to watch Internet-delivered video on their TVs, they will begin to realize how crummy most IP video looks on their 50-inch LCD display, even compared to noisy, over-compressed cable HD.

That day is coming faster than you might think, too. According to a survey conducted by iSupply, 25% of all TV sets sold in America in January were connected to the Internet by the middle of February, either directly or through a game console, Blu-ray player or other set-top box.

More significant for Walmart, though, is that HDX and TruFilm are proprietary. Vudu does not–or at least need not–interoperate with other streaming or download services built to support other encoding formats, or with content encoded in those other formats. It’s a closed channel, like iTunes, only with a decent-looking picture.

That’s where Vudu’s other asset to Walmart comes in: It has deals in place to embed its streaming platform in HDTV sets and Blu-ray players with seven of the nine largest TV makers by market share.

Now imagine you’re one of those TV manufacturers. Walmart sells about 15% of the HDTV sets nationally, but for some manufacturers, like Vizio, it’s market share is far higher. Not only do you have a powerful incentive to embed the Vudu platform in devices you hope to sell through Walmart, you have an incentive to not embed anyone else’s, for fear your products would be marginalized on the Walmart sales floor, assuming they even got that far.

If your not one of those manufacturers licensed by Vudu you have a strong incentive to become one if you have any expectation of selling your products in Walmart.

Over time, then, if all goes well, Walmart will accrue a very large installed base of connected TV sets and set-tops with its proprietary streaming platform baked in–much larger than anyone else’s installed base.

Other retailers will be significantly disadvantaged, forced to choose between selling devices with Walmart’s software embedded, or selling brands that cannot access content from the most popular service. Other service provides could also find life far more difficult as well.

Now imagine you’re a movie studio or other content owner. The DVD business is collapsing around your ears. What’s left of it is going to subscriptions and dollar-a-night rentals, leaving you sucking hind tit, margin-wise. Blu-ray will keep the packaged media sell-through business alive for a while, thanks to retailers like Walmart and a few others, but that’s not exactly a growth strategy.

Eventually, if not already, you will need a transactional, on-demand rental (and perhaps sell-through) channel that delivers real HD video to the living room. And you have to develop that business without disrupting the Blu-ray business before it’s time.

Now think about how much you could end up needing Walmart: It’s the largest buyer of Blu-ray discs in the world, keeping your packaged media business alive, and it could soon have the largest, proprietary channel into the living room for IP-delivered video.

That’s going to leave a mark.

The strategy isn’t perfect, of course. Consumers are yet to warm to VOD, despite a decade of effort by the cable industry and later by the likes of CinemaNow, Movielink, iTunes and others. It also doesn’t solve the problem of content portability between devices. But imagine (it’s not much of a stretch) that Walmart were able to use its leverage with the studios to carve out for itself an exclusive, high-def VOD window via Vudu immediately after a movie’s theatrical run and ahead of its release on Blu-ray. What might that do for consumer adoption of VOD?

Vudu’s business right now is VOD. But that doesn’t make its acquisition a VOD deal from Walmart’s perspective. While it’s not a sure thing, the Vudu acquisition gives Walmart tools it can use to try to establish and control the de facto industry technical standard and the dominant distribution platform for delivering high-def video to the living room via the Internet. If successful, it would be in a position to extract rents (in one form or another) both from content owners and device makers for use of the standard and platform while leaving other retailers and service providers at a distinct disadvantage.

That might well be worth $100 million some day.

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