Blu-Ray vs. HD-DVD Format War

Here’s a radical idea. The Blu-Ray vs. HD-DVD fight may never yield a clear winner as a two-tiered market for both technologies may emerge. The history that is repeating itself is not Betamax vs. VHS, but DVD vs. Video CD.

Everyone loves to cite VHS vs. Betamax and the battle fought by Sony and others as a case study of market share and marketing over technical superiority. Every MBA school from Harvard to University of Phoenix talks about it as a case study to apply forward. However, I think the press and industry participants are trying too hard to take the current DVD format wars and plug them into the template created by the history of Betamax and VHS.

While leaving CES I sat next to someone from an unnamed consulting group who was charged with helping architect the marketing case for one of the above formats (Names here are always changed to protect the innocent). I heard a good 15 minute tutorial about the technical and market benefits of both formats. Here’s a snapshot of what I think is important.

• Both formats are backward compatible with DVD.
• Both formats use the same laser wavelength, but use incompatible optical detectors. Dual format players would need parallel detector hardware to read the discs.
• Data is stored on optical discs in a long spiral, much like it was stored on analog LP’s. The tighter you place the track on the spiral, and the narrower the track itself, the more data you can fit. Blu-ray uses a tighter track format than HD-DVD and stores more data, and as a result has much tighter disc manufacturing tolerances.
• HD-DVD can use the same disc manufacturing infrastructure used for DVD’s. This means the existing, fully depreciated disc production infrastructure can be used to make HD-DVD discs. Blu-Ray requires these disc factories pay for a full equipment upgrade.

In short, the issue is about capital costs. Can the additional capital costs of a Blu-Ray upgrade be recovered? Absolutely. Why? The existing DVD equipment infrastructure isn’t going to be thrown away, just re-used to service a lower margin business model.

Video CD is the historical point everyone appears to miss. Video CD used the same format as the Audio CD’s you know so well from the 90’s except the data they contained was video, not just audio. Movies in the 4.7GB DVD format were shoehorned into the 650MB capacity of the CD by grossly sacrificing quality and sometimes requiring multiple discs.

While everyone in the US got on the DVD bandwagon, Video CD’s were a rip-roaring hit in Asia, particularly China. Even today, walking Temple Street in Kowloon you’ll see Video CD vendors by the hundreds, most hawking perfectly legitimate product (The DVD’s they sell, well that’s a different story).

Why did consumers choose a radically inferior format? Video CDs used the existing infrastructure and supply chain already in place to make dirt-cheap products. The magnitude of marginal costs for DVD hardware and media for Western consumers were minor when compared with Video CD, but for the emerging middle class of Asia it was a substantial cost difference. Five dollars more for a western consumer is not the same as five dollars more (or 40 Yuan) to a Chinese consumer.

Even better, content owners could tariff less for media in Video CD format because the quality sucked. The marginal costs of selling another copy of “Terminator” are virtually zero to a Hollywood studio. Video CD’s allowed them to create a lower pricing tier and extract more marginal dollars than they could by selling the more expensive DVD format.

Once the fixed costs for the Blu-Ray upgrade are absorbed, the marginal costs for HD-DVD and Blu-Ray media probably won’t be that different, and the costs for the players will be nearly identical from a Western consumer perspective. That means Western consumers won’t be biased on price in the long run, and may be slightly more biased to Blu-Ray for technical reasons.

Content owners really don’t care so long as the new copy protection gets implemented – they want to kill off the DVD and close the copy protection hole pronto, particularly in Asia. The opportunity to migrate to a new format gives them the perfect chance. Why not re-use the existing DVD media production infrastructure and sell the lower cost HD-DVD format in emerging markets?

The result? Both formats win.

• The existing DVD production infrastructure is used to make HD-DVD for the lower end market, perhaps with a compression quality that is intentionally inferior to Blu-Ray (existing DVD quality maybe?) and DRM that is much superior to DVD.
• These discs are sold to consumers in emerging markets that consider the marginal costs of Blu-Ray to be substantial. Content owners get to swap in stronger DRM and plug the hole that the DVD created and extract more marginal income from 2nd tier consumers. It becomes the new Video CD.
• Blu-Ray production infrastructure upgrades get financed by Sony, Panasonic, Hollywood, etc. They will make a large return on that investment just from Western consumers re-purchasing media in the new format.
• The only real barrier to Blu-Ray, capital costs, evaporates.

The fact is that even if this is a format war, it’s probably the last format war we’ll see until some new mega-bandwidth hog media format comes about that requires holographic storage. 35mm film, audio CD’s, CD-ROMs are all transported digitally now, with 100Mbs connections to the home it won’t be long before video is distributed exclusively electronically.

Finally, I can say that regardless of what physical format is used, High Definition media absolutely blows DVD quality out of the water. Stop building your DVD collection today, you’ll wish you had the new format. And if you’re reading this blog, it’s likely you’ll be running Blu-Ray.
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(Header image from Engadget.com, ‘Strive’ image from Flickr user rollerboogie)