Disney Sees Red Over Ruling on Download Codes

Ever since sales of DVDs and Blu-ray Discs began their long eclipse behind the rise of more convenient digital alternatives the Hollywood studios have sought ways to extend the life of the high-margin disc business by finding ways to integrate disc sales with the broader digital economy.

The most systematic effort was the UltraViolet initiative. By creating an UltraViolet account, consumers could register their purchase of a DVD or Blu-ray Disc and obtain access to a digital version of the same movie, which they could then stream to connected devices without a DVD or Blu-ray drive, via participating streaming services.

Disney, which never joined the UltraViolet consortium, had its own version it called Disney Movies Anywhere (now re-christened simply Movies Anywhere and incorporating most of the former UltraViolet studios). Disney packaged its discs with an insert containing a code, which, when entered by the consumer in her online Movies Anywhere account allowed her to stream the movie through participating online services, or to download the movie onto up to eight registered devices.

DVD rental kiosk operator Redbox has likewise struggled with consumers’ declining appetite for DVDs and Blu-rays. It’s main strategy has been to keep its rental prices extremely low, which has often put it at odds with the studios, who by and large would prefer to see the low-end rental market wither away. But Redbox, too, has sought ways to make itself digitally relevant.

It’s solution? Unbundle what Disney had bundled.

While some studios have made a reluctant peace with Redbox and sell discs directly to the kiosk operator Disney has not. To obtain Disney titles, Redbox has been forced to purchase inventory through other retail channels, often in the form of Disney Combo Packs, which include a DVD, a Blu-ray Disc, and an insert with the code for Disney Movies Anywhere.

As part of its digital relevance efforts, Redbox started breaking up the combo packs, repackaging the Movies Anywhere insert in its own packaging, and offering the download codes for sale through its kiosks, at a discount to the price of the disc. Disney objected, but lacking any contractual vendor relationship with Redbox it had no leverage to stop it. So the studio sued the kiosk operator for copyright infringement.

“When Redbox’s customers download Copyrighted Works using a Code purchased from Redbox, they do so without authorization and in violation of Plaintiffs’ exclusive rights under copyright, including the right of reproduction,” Disney claimed in its complaint. “Redbox is contributorily liable for copyright infringement because it (a) has knowledge that its customers will be reproducing the Copyrighted Works without authorization when they use the Codes to download copies of those works, and (b) induces, encourages, or materially contributes to the violation of Plaintiffs’ rights through its unlawful resale of the Codes.”

The suit also charged Redbox with breach of contract for violating the “terms and conditions” it claims govern the purchase of the Combo Packs, which purport to prohibit transfer of the codes.

This week, a federal district judge in California dealt the studio a serious setback in the case by declining to issue an temporary injunction to stop Redbox from selling the codes.

Worse for Disney, the judge concluded that the studio had engaged in copyright misuse, subjecting it to at least the remote danger of losing the right to enforce its copyrights on its movies, as Redbox is now demanding.

According to Disney, the codes represent a limited license to distribute the movie, not the sale of another copy, governed by the terms and conditions of the Movies Anywhere service (along with those of the related service RedeemDigitalMovies.com). Those terms state that consumers are only authorized to use the codes if they are currently the owners and in possession of the physical discs the codes were packaged with. Anyone who obtained and used the codes separately, therefore, is violating the terms of the license and thereby infringing Disney’s copyright.

According to the court, however, “There can be no dispute [per the first sale doctrine] that Disney’s copyrights do not give it the power to prevent consumers from selling or otherwise transferring the Blu-ray discs and DVDs contained within Combo Packs. Disney does not contend otherwise. Nevertheless, the terms of both digital download services’ license agreements purport to give Disney a power specifically denied to copyright holders by § 109(a)…This improper leveraging of Disney’s copyright in the digital content to restrict secondary transfers of physical copies directly implicates and conflicts with public policy enshrined in the Copyright Act, and constitutes copyright misuse.” (Emphasis added.)

As to Disney’s claim that transfer of the codes violates the shrink-wrap license governing the Combo Packs, the court dismisses the language on the outside of the packaging as insufficient to establish an enforceable contract.

While the facts of the case are new, the situation is not. Disney’s real concern here is not copyright infringement as such, it’s the business model implications of severing the download codes from the physical discs.

The codes are a one-time pad. They can’t be re-used once they’ve been entered the first time, so transfer of a code does not result in any more copies than Disney itself has authorized. They can’t be used to circumvent technical protection measures on other copies. They’re simply a product key.

The problem for Disney is that bundling of the codes with the discs is intended to enhance the value of the discs as an incentive to purchase. If the codes can be obtained and used without having to purchase the discs, that incentive is undermined. Why buy the cow when you can get the milk without it?

Selling the codes at a discount could also undermine the market for streams and downloads in downstream windows.

But a copyright is not a guarantor of the copyright owner’s preferred business model. It’s a limited grant of specifically enumerated exclusive rights.

What Disney is trying to do in this case is to use copyright law to try to prevent outcomes adverse to its preferred business model. But its preferences are not among those exclusive rights.

We’ve seen this movie before. As far back as 2002, a group of studios sued SonicBlue over its Replay TV DVR, arguing that by automating consumers’ own ad-avoidance behavior somehow amounted to copyright infringement, an argument Fox revived more than a decade later in its unsuccessful lawsuit against Dish Network.

It’s a bad habit that invites skepticism of legitimate copyright claims. Copyright owners do themselves no favors by falling back on it.

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. Read More »

Seeing Red over copyright

Having failed to put forth a competitive consumer proposition to counter Redbox’s dollar-a-night DVD rentals, the studios are on the verge of accomplishing what, from the point of view of their own economic interests, is the next best thing: they have brought the rental kiosk operator to heel and effectively forced it to accept a 28-day window after street date before it begins loading their DVD releases into its ever-expanding red maw.

On Tuesday, Redbox and Warner Bros. announced an agreement to settle the litigation the kiosk company had brought against the studio last year. As part of the deal, Redbox agreed to a 28-day “vending” window and to limit sales of used Warner discs. In return, Warner will allow Redbox to acquire its releases at a lower cost and promised to “cooperate” with Redbox on possible future digital delivery ventures.

While Tuesday’s settlement applies only to Warner, it’s widely expected that similar deals are in the works with Twentieth Century-Fox and NBC Universal, which are involved in similar litigation with the Redbox. Assuming that happens, new releases will essentially disappear from Redbox kiosks.

Make no mistake. Redbox rentals were hurting DVD sales and undercutting the studios’ other revenue streams. Its dollar-a-night rentals accounted for roughly one of every five dollars consumers spent on DVDs last year, and it returned a far smaller share of that dollar to the studios than Wal-Mart sends them when it sells a DVD. And from the studios’ perspective, the trend lines were getting worse. Something had to be done. Read More »

Miscalculating movie release windows

Speaking of windows, Disney has touched off quite the firestorm in Europe over its plan to release “Alice in Wonderland” on Blu-ray and DVD just 12 weeks after its March 5 worldwide theatrical debut instead of the usual 16 to17 weeks. Holland’s National Board of Cinema Owners is up in arms, and has organized a boycott among that country’s four largest theater chains, representing some 80-85% of screens. Three top chains in the U.K. are threatening to follow suit, vowing to keep Tim Burton’s 3D extravaganza off 95% of the 3D screens in the realm unless Disney backs down.

Good luck with that. I don’t see Disney backing down on this one. It obviously picked this fight with theater owners now because it knows it has the leverage to win. “Alice in Wonderland” will be one of the biggest-grossing theatrical releases of the year, with or without wide distribution in The Netherlands, and it has “Toy Story 3” in the wings, which will be even bigger. In crude terms, the theaters currently threatening boycotts need Disney’s movies more than Disney needs their screens, and both sides know it (U.S. theater operators have more leverage, of course, which is why Disney apparently has cut some sort of deal with NATO that would let it “experiment” with windows on one or two movies a year so long as it doesn’t make a habit of it).

The real question is: why is Disney so intent on getting “Alice in Wonderland” out on DVD and Blu-ray so soon.

In an interview with CNBC last week, Disney CEO Bob Iger said the early “Alice” release would allow the studio to “put the video out before the doldrums of the summer and to put it out when the movie is very fresh in consumers’ minds.” Read More »

Publishers throw the e-book business out the window

Book publishers have been crowing this week over having wrested control over e-book prices from Amazon. After a brief showdown with Macmillan Publishing, in which Amazon pulled all Macmillan hardcover and paperback titles from its physical-book store, the Kindle maker blinked and agreed to the publisher’s demand to raise the price of its e-books in the Kindle store from $9.99 each to $12.99-$14.99. Other leading publishers, led by Hachette Book Group and News Corp.’s HarperCollins unit, quickly said they would demand the same deal.

The publishers, of course, have long been concerned over Amazon’s strategy of pricing most new release e-books at $9.99 to spur sales of Kindle devices. Though publishers earn the same $12-$14 wholesale price from Kindle editions as they earn from hardcovers, they fretted that low prices on e-books would undercut sales of hardcovers, which typically sell for $20-$25 at retail. Eventually, they feared, the reduction in retail revenue would result in lower wholesale revenue as well. So long as Kindle owners made up the largest slice of the e-book market, however, the publishers had little choice but to go along. Read More »

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. Read More »

Coming full circle on video rentals

I have covered the home video industry for as long as it’s been an industry. And it never ceases to amaze me the lengths to which the Hollywood studios will go to try to deny the reality of consumer demand. The latest case in point: their scheme to stop the shift in consumer spending from DVD purchases to DVD rentals by carving out a sales-only window before movies would be widely available for rental.

Since the studios can’t legally bar retailers from renting the “sales-only” copies (the First Sale Doctrine, and all that) they would have buy the rental outfits off, presumably by offering them a lower wholesale price for DVDs if the retailers agree to delay the rental window. In his third-quarter earnings call last week, Netflix CEO Reed Hastings suggested the DVD-by-mail service might agree to go along.

“If we can agree on low-enough pricing, delayed rental could potentially increase profits for everyone,” Hastings said.

If Netflix were to go along, it wouldn’t be hard to imagine Blockbuster getting on board as well; it could use the earnings boost even more than Netflix could.  The trickiest case would be kiosk operator Redbox, which has been growing rapidly on the strength of dollar-a-night rentals, much to the chagrin of the studios. Relations are tense between Redbox and Hollywood, so a deal might be tough to negotiate. But it might be a way to resolved the litigation between the kiosk company and the studios.

Independent retailers would probably balk at the deal, seeing instead an opportunity to grab some market share back from the big boys by offering earlier rentals. But Netflix, Blockbuster and Redbox, along with perhaps a few other large chains (Movie Gallery/Hollywood) have enough market share among them at this point that the system might basically work.

Ironically, creating a protected sales window would completely invert standard industry practice back in the VHS days, when the studios maintained a protected rental window by pricing videocassettes at an un-sellable $99, before knocking the price down to twenty bucks or so three to six months later. But it would be no more consumer-friendly.

How about this, studios: Price all DVDs at $10, out of the gate, and make them available in 70,000 supermarket outlets nationwide. If consumers still wanted to rent, they could rent. But how many of those supermarkets would be putting in Redbox kiosks if they were simultaneously selling cassettes for $8.99, on sale? I’d guess about none.

You want to sell a gussied-up version with a bunch of extras and try to get $15 for it as a second SKU, go ahead. Knock yourselves out. Maybe you could get that for the Blu-ray, too. But a $10 base price would triple (or greater the size of the retail base for DVDs and make it easier for consumers to spend their money on packaged movies than on other entertainment options.

OMGZ! OUR MARGINS, I can hear the cries from Century City to Burbank. But what’s the point of protecting your margins if  you’re driving consumers out of the category? Why would you assume, at a time when aggregate consumer spending on DVDs is in free-fall, that you could convert any large number of Redbox renters into buyers at $15 – $25 a pop by actively frustrating their ability to rent?

The studios have been mis-pricing DVDs for a long time — from long before consumer spending started to decline — just as they’ve completely mismanaged the Blu-ray roll out (to say nothing of the high-def format battle that preceded it). They’re now paying the price for that mismanagement. Doubling-down on the same strategy isn’t going to fix the problem.

Blockbuster: Closed for renovation

It’s long been clear that there were too many video stores in America for anyone’s good. In the go-go years of the early 1990s, national chains like Blockbuster, Hollywood Video and Movie Gallery were adding stores at a clip of nearly one a day, each. Regional chains and independent operators expanded as well, until there were something like 10-15,000 video superstores in the country and probably twice that number of stores overall.

The numbers back then were compelling. Video stores were considered good tenants by strip-mall devlopers, stores ramped up quickly and threw off enough cash that much of the expansion could be financed internally. In addition to absolute growth in the market, the national chains could easily take share from incumbents when they entered a market, by virtue of their broader and deeper selection of titles, preferable locations and greater marketing clout. Read More »

Scared hens in the Fox house

Somewhere, Tom Freston is laughing.

murdochRemember when News Corp. was supposed to have figured out this New Media thing way better than the other media empires, and Sumner Redstone was firing Freston for letting Rupert Murdoch snare MySpace? These days, not so much. New Corp., in fact, appears to be getting a bit panicky over the whole New Media thing.

Yesterday, the company announced pretty ugly second-quarter earnings (fiscal Q4), low-lighted by a $403 million impairment charge against Fox Interactive Media, which consists primarily of MySpace, as well as a $228 million “restructuring” charge due mostly to layoffs as MySpace. That’s $631 million in charges for the same “prize” News Corp. snatched away from Viacom for $580 million in 2006.

In the earnings call, Murdoch declared that he intends to start charging people to read all News Corp. newspaper content online, from the Wall Street Journal  to the Page Three girls in the Sun, a sure sign that the company really doesn’t know what it’s doing online. Unless there’s some other strategy for leveraging the network economics of the Internet Murdoch hasn’t told us about yet, simply throwing up paywalls around everything isn’t a business plan. It’s taking your marbles and going home.page3girls

On the same call, newly appointed vice-chair and COO Chase Carey took a whack at Redbox, the $1 a night DVD rental kiosk outfit owned by Coinstar. “I think making our content available for $1 grossly undervalues it,” Carey said.

According to the Journal (sub. required, natch), Fox has told DVD wholesalers like Ingram Entertainment and VPD not to sell its movies to Redbox until 30 days after their initial release, the same anti-competitive-ish stunt Universal pulled earlier this year.

The fact that News Corp.’s No. 2 is spending his time worrying about dollar-a-night rentals tells you all you need to know about how far the studio is from figuring out to respond strategically to precipitously declining DVD sales.

If I were Carey (or Fox video head Mike Dunn) I’d be worrying about why Blu-ray, which Fox championed, hasn’t arrested the massive outflow of consumer dollars from the packaged media business. And I’d be focusing on how to structure my deal with Netflix before it finishes the job of remaking the online video-on-demand business into a non-transactional subscription business and Reed Hastings ends up with all the leverage, rather than risking litigation over my deal with Redbox. The DVD business is term-limited. Getting digital distribution right now will do a lot more for earnings in the long run than bashing a few kiosks to make yourself feel good.

Petulance is not a strategy.