Many people in the developed world have a DVD player. It’s not as big a market as cell phones, but it is a huge market. It’s historically been a pretty bad business, unless you’re the low cost manufacturer, because the format in which DVD discs are encoded is a standard that any manufacturer can create a device for.

Toshiba and Sony each saw a solution to the commoditization of DVD players: create and control a new standard for a new type of DVD disc that carries a lot more data, enough to carry movies in high definition. Toshiba, with its HD DVD standard, and Sony, with its Blueray standard, are fighting a pitched battle over who gets to control that high definition DVD disc future. A good amount of their fight has been over convincing the movie studios to back their respective standards. Yet the confusion over which type of player to buy has kept many people from buying either type of player. And when hackers cracked the digital rights protection on high definition DVDs, Fox stopped distributing high definition movie discs.

Meanwhile, Apple and startups like Vudu (see my prior post on Vudu) are seeking to use Internet connected boxes that would replace the DVD player entirely. Is an Internet connected box a better approach than a high definition DVD player? For any type of content, to me it seems the Internet is a better medium than a physical disc in 4 ways and a worse environment in 3 ways.

The ways the Internet is superior are:

1. Marketing. It’s cheaper to do marketing. You can tease people with parts of content and it’s easier for people to share what they like. With community features like YouTube ratings and the Facebook social graph, you can let people know what content their communities prefer.
2. Upload, storage, distribution. It’s easier to allow people to upload. In the physical world, only a select few get DVDs made. In the Internet world, anyone can share their video. The technological costs of storing and distributing that video are rapidly decreasing as the Internet evolves.
3. Encryption. It’s technologically easier to create an encrypted environment on the Internet because you control the software on both the server, client, and data packet sides. In the physical world it’s harder to update broken encryption systems once part of the encryption scheme has been shattered.
4. Update the interface. The interface for Internet based solutions can be revised and updated, as we see in the rapid changes happening to websites. This advantage of the Internet will spread to Internet connected consumer devices.

The ways the Internet is inferior are:

1. Technologically it’s cheaper to move large amount of data by moving discs than by copying bits. High definition video takes up a lot of data space. For a long time it has been cheaper to move that data around by truck than by a network because each physical disc can store tremendous amounts of data. The advantage trucks enjoy is diminishing, however, because the Internet is evolving swiftly and peer to peer file sharing systems dramatically lower the technological costs of distribution.
2. Legally it’s cheaper to move discs then to copy bits. For professionally produced content it’s a bit more expensive to buy or rent movies than it is to share physical discs (thus the current disc through the mail business models of Netflix, Blockbuster, Gamestop, LaLa). This is because although technology makes it cheaper to copy bits electronically then to move them physically, the law of copyright requires you to obtain rights to copy bits electronically but often lets you move them around physically without seeking permission. Therefore, despite the greater technological costs of moving discs, they have less legal costs, and therefore potentially less total cost.
3. Painful to hook up. It’s a bit difficult to connect the Internet to your high definition television type displays. The interfaces on the devices currently used to make this hookup are generally pretty poor and keeping the Internet connection live adds a potential point of failure.

Yet that’s just where things are currently. In the spirit of Wayne Gretzky, let’s ask where the puck is going.

Are physical discs going to become better at marketing, upload (openness), storage, encryption, or changing their interface, than the Internet? It seems to me self evident that the answer is a resounding no.

Is it going to get technologically and legally cheaper to move discs onto the Internet relative to the legal cost of moving physical discs? The discrepancy in technological and legal cost will likely diminish, but it’s unlikely for the legal cost advantage of physical distribution to disappear unless more and more content is unencrypted.

There are multiple approaches to dealing with the legal cost of moving content around. Apple is trying its best to get around this disadvantage by creating one environment (iTunes) to serve content (music, video, games, software) to a multitude of devices (the desktop, laptop, ipod, iphone, Apple TV). Internet stores selling professional content in a digital form may be able to leverage their growing market share (see story) to diminish their legal cost disadvantage. Like Apple, Joost has created an encrypted hard to upload environment, but there are also unencrypted easy to upload environment (think YouTube), or encrypted easy to upload environments (think Brightcove), which all circumvent some of the legal cost disadvantages that the Internet has over physical distribution. The growing size of the Internet advertising market also potentially will draw more professional content onto Internet based distribution systems.

Is it going to get less painful to hookup the Internet to your high definition television type display? Undoubtedly. User interface design in consumer devices is something that Apple is very good at, but it’s not beyond the capabilities of a TiVo, Microsoft, Google, or other party to innovate in such a space. And one significant advantage of building consumer electronics devices with a built in Internet service to distribute media is that you can continuously upgrade the interface of that device. We’ve seen this in the desktop, the laptop, and hints of this with Apple TV and the iPhone. Device development goes from a relatively slow iteration hardware model to a super fast iteration web site like model.

Although leadership in the Internet age can change rapidly (see my post on Murdoch’s statement “They’re all moving to Facebook now”), it is possible to create competitive advantage in the Internet. Apple has shown they can do it by coupling beautiful hardware, elegant software interfaces, a minimalist aesthetic approach to what a customer actually finds most useful, and a growing library of professional content that it has the rights to distribute (iTunes) and amateur content (YouTube through Apple).  Internet connected consumer electronics devices is certainly a better business than being a commodity DVD player manufacturer, if you can get traction with the consumer, and can maintain a proper pace of innovation. This is a point that Toshiba and Sony, with their massive initiatives on a waning medium, would do well to heed.

Update, 1-9-08: An alternative to Apple TV or the various Windows extender devices is to attach a full computer to the television.  See http://scobleizer.com/2007/12/27/the-macmini-hdtv-revolution/

Update, 3-14-08: An even better alternative may be to get Netflix’s streaming movie service ($13.99 a month for 2 DVDs in the mail AND unlimited streaming of about a third of Netflix’s movies) onto your television. Currently this requires a Windows PC (thanks to Apple’s refusal to license digital rights management to Netflix), but in the near future this Netflix service is expected to appear on other consumer products devices.

Rupert Murdoch is a very savvy businessman, and he’s often credited for moving fast to snap up MySpace at what seemed like a foolhardy price, until it wasn’t. However, one reason he is a good businessman is because he doesn’t fool himself when it comes to business matters.

In an interview with the Wall Street Journal (a company he’s trying to buy) (http://online.wsj.com/public/article/SB118115049815626635.html), here’s what he said about Facebook:

WSJ: The Tribune company was shopped around for quite a while.

Mr. Murdoch: Yeah, but there weren’t any buyers.

WSJ: There was one in the end.

Mr. Murdoch: For $90 million. Risk. That’s in the figures …

WSJ: Why didn’t you do it?

Mr. Murdoch: Don’t want to spend the rest of my life going through that, getting rid of people, ugly. I think they’re in decline, they can fire a few hundred people everywhere, save a couple of hundred million dollars … I guess they will have a billion a year to pay down the debt, that’s what it sounds like. No, a bit less. I would have thought that, although the decline in readership will probably go on.

WSJ: They’re all going to MySpace.

Mr. Murdoch: I wish they were. They’re all going to Facebook at the moment.

And here’s what he said about Google and Microsoft:

WSJ: Then what’s the opportunity for you? Digital?

Mr. Murdoch: I think it’s in the digital area, digital and TV. And I think we’ve got to pour some money into digital. We’ve got to do a lot of things there… There’s so much going on on the Internet. We’ve got to find new ways and new business models to get revenues. Or else the world is going to be owned by Google. I was asked at this investment thing I had to go to, what competitors I see I would have in five years time. Globally. I said I’m sure they’ll be a lot of them. I know one is Google. It’s just getting so strong, so powerful. And I know the guys, and like them. They’re friends of mine. But it is a big fact of life. They sort of just hit the mother lode of search advertising and they’re just destroying Microsoft search, hurting Yahoo‘s and making others irrelevant. I don’t understand the technologies but whatever their technology is, it seems to be producing a much higher margin of profit. What are they going to do next? I saw in the New York Times today they’re devising certain, a lot of computer applications which would directly challenge Microsoft, which they’ll give away. So it’s going to be very interesting. Four or five years ago we were all convinced Microsoft was going to take over the world. Now we’re all convinced it’s Google. But that’s another subject.

We live in interesting times, where mega-billion dollar market cap companies arise in very short time frames and fall from relevance even before their cash flow drops. I wonder how long it will take people to catch on to how fleeting competitive advantage can be on the Internet, even for what seem today to be the titans. It’s something to think about the next time someone bemoans corporate power or monopoly status of a company in the software industry.

Update, June 25, 2007: My friend Danah (danah.org) points out that MySpace and Facebook have different levels of popularity in different social classes: http://www.danah.org/papers/essays/ClassDivisions.html

The Bush Administration is proposing the Intellectual Property Protection Act of 2007.  Among other things, this law could make it a crime with a punishment of LIFE IMPRISONMENT if you use pirated software to provide a health care service.

The justification for such a punishment is that pirated software isn’t safe.  The truth is that pirated software is usually just as safe as the non-pirated version that was copied.  If there’s a bug in Windows: no worries. But if there’s a bug in someone’s stolen copy of Windows used by a hospital: life in jail.

For more: http://news.com.com/8301-10784_3-9719339-7.html

I agree that distributing boxes as a business is tough. Vudu has to convince people to shell out $300 when it initially starts selling boxes. Historically the cable companies and satellite companies (and now the telecom titans) have been able to eventually/slowly copy the features and are in a better position to promote it to their customers before the mass market really catches on. That’s what happened to Replay & Tivo. The only area in which being a box provider has been a huge
success is (a) with the Slingbox where you just pay for a box that lets you stream your TV content to your PC, not the service, and (b) the major videogame console manufacturers, where the box is subsidized by the closed environment for game software sales.

However, while box distribution is a challenge, I think Vudu has a shot, particularly if their patents on this type of instantaneous p2p caching holds up to scrutiny. The growth of video of all kinds on the PC through systems like youtube.com, iTunes, and Joost is an important story, but the mass market has avoided tying their PC to their large
screen televisions, and the mass market isn’t particularly happy with having to wait for a movie to download. While it’s great having all kinds of video on a PC, and movies are okay to watch on a PC (yay for Netflix), movies definitely also should be on the large screen, and they should be available instantly.

The customer ease of use (not having to configure with their wireless network and iTunes account, ala Apple TV or deal with the terrible menu systems to watch the movie they want as is the case with cable co and satellite channel lineup menus), the secure environment for copyright holders (with a Vudu box being an even more closed system for copyright than Joost or iTunes, as you can see from all the major studios and even alot of the minor ones signing up with them, the
holders of the highest popularity content agree: according to NY Times article, Vudu has 5,000 titles licensed, 10 times more than the 500 films Apple offers), and the instant start for a movie download, are all advantages that I think counterweigh the cost of box distribution.

However, even if Vudu itself fails, the basic idea of having a dedicated hard drive hooked directly to your TV and broadband which can instantly serve you movies due to clever p2p caching is an important idea, particularly if coupled with a closed environment in which the content holders feel secure.

One interesting point is that historically the cable cos have held tight control of their infrastructure. however, if you look closely at what they’re doing now, they and the telecom titans are trying to create more open APIs so that startups can come to them with ideas for which they can get more revenue. So maybe, as the NY Times profile of Vudu mentions, Vudu chips would be added to existing HD digital vide recorders by the cable and telecom titan companies.

Of course alot depends on (a) how Vudu’s patents on their p2p caching technology holds up to scrutiny, and (b) how much the mass market becomes comfortable with attaching their PCs to their TVs directly. Eventually I presume the community feel of youtube and Joost will come to the living room TV, and that may require a full PC hookup.

The startup that will bring this to you is called Vudu (vuduinc.com). It has built a $300 box (the price should drop rapidly) that hooks directly to your TV and to your broadband connection. Through some technological magic, as soon as you click on a movie it starts playing the movie, rather than making you wait for a download. Vudu has already signed deals with all the major studios except Sony for movie content. Unlike the Apple TV, this box doesn’t require you to have a personal computer, a wireless network, or be on iTunes.

Here’s a NY Times profile: http://www.nytimes.com/2007/04/29/business/yourmoney/29vudu.html?pagewanted=1&ei=5088&en=1605d6e7e6acc068&ex=1335499200&partner=rssnyt&emc=rss

The type of service Vudu Inc. provides is to my mind the next evolution of the entertainment industry. Does it challenge Netflix and Joost? Let’s compare:

Netflix is distribution of DVDs in the mail, where you are sharing them with other customers. With Netflix, the content creator gets paid for the DVD. Movie studios are happy to provide their content on DVD, because DVDs are an encrypted, closed system (there is software to easily hack DVD encryption but it’s too much bother for many people to use). Netflix cleverly shares the same DVD with multiple customers. It has relatively low content costs (the studios can’t jack up the price of DVDs easily), medium content and service distribution costs (better than a video store but requires a warehouse and mailing costs), but one big disadvantage: it takes time for the movie to get to you.

Joost is streaming video, using freely downloaded software on personal computers to display and store the content. Each Joost user’s personal computer stores some of the content other people will watch (a peer to peer system). With Joost, the content creator gets paid for their content, through a share of advertising. Studios are happy to provide their content on Joost, because the Joost player is an encrypted, mostly closed system (it’s possible to copy the video feed, but it’s too much bother for most people to try). Joost has relatively low content costs (the studios could jack up the price of their content but they are competing with each other on the Joost system and are getting a share of advertising), very low content distribution costs (download the Joost software, use their customer’s PCs to store much of the content, and free ride their customer’s broadband), low service distribution costs (viral growth of the Joost download by word of mouth), and instantaneous gratification with a video stream, but it usually isn’t connected to your TV.

Vudu is downloadable video, using a Vudu device you buy that’s hooked up to your tv. Each Vudu user’s Vudu box stores some of the content other people will watch (a peer to peer system). With Vudu, the content creator gets paid because Vudu can bill customers of their system or potentially sell advertising. The content is encrypted, on a closed, very secure system. Its content costs depend entirely on what the studios want to charge, low content distribution costs (buy the box, use their customer’s Vudu boxes to store much of the content, and free ride their customer’s broadband), moderate service distribution costs (get people to buy a $300 box), and give you instantaneous gratification.

I think Vudu will do well. It’s a new approach to creating distribution for people who want to be paid for their content, but it also is easy for the ordinary customer to use. It may be a threat to Netflix’s business model or its growth rate, although how it all shakes out will depend partly on how much customers want instant gratification and how much the studios require Vudu to charge for it.

Apparently a lot of people feel similarly.  For all the millions of multiple gigabyte iPods sold, Apple has only managed to sell about 20 songs per iPod through its iTunes service.

While I admire many things about the iPod, I won’t buy even one copy protected song on Apple’s iTunes.  Copy protection systems make using devices more complex, and they create a lock-in on the device.  Customers who buy copy protected songs must continue to use the devices supported by the manufacturer of the copy protection system, no matter what other competitive devices may later arise, or lose the value of their investment in the copy protected music.

Some people argue that Apple will always have the best devices being offered, so this isn’t a problem, but I think that’s very shortsighted.  The world is a big place with lots of innovation happening, the music playing device of 2015 will likely be rather different from that of today, and changes undreamt of can happen in shockingly little time.

What I would like to buy is music in an unprotected digital format, such as mp3.  Unprotected music can be easily moved from one type of device to another, from my home PC to my DVR to my portable audio player.

For a long time you could only buy mp3 music from a Russian outfit (www.allofmp3.com) which seems to me to be illegal, or from independent music labels, but now things are finally changing. The major studios are starting to experiment with selling mp3s (http://biz.yahoo.com/ap/061207/mp3_music.html?.v=2), a development that is long overdue. It’s rather shocking it’s taken them this long, since if you think about it every CD they sell is sold with unprotected music on it.

As electronic networks have gotten better, the amount of information shared electronically has become vast. Yet for the most pricey content, the advantage of the truck is that the legal issues that often curtail sharing electronically have not applied. That’s because copyright law hates copying, and while electronic transmissions have been interpreted to by their nature copy, atom transmissions have been interpreted as moving, not copying.

The electronic version of sharing started with local area networks, progressed to bulletin board systems, had a few intermediate stages, but didn’t really take off until Napster. If you wanted a music file, just start up Napster, search for the name, and download. It got shut down by the courts, because it had the ability to control the copyright infringment occurring on its system and didn’t prevent it. BitTorrent based networks, Grokster, eDonkey, Morpheus, and countless other software programs, which unlike Napster didn’t store information on what files were being traded centrally, took over where Napster let off.

The commercial companies involved in such software often got shut down by the courts, for copyright infringement, although the networks themselves often live on. New forms of file sharing, like AllPeers, and FolderShare, are just now starting to obtain traction, and are more focused on enabling sharing between people who know each other.

Sharing between people who don’t know each other still exists, but rather than rely on the wire, to find shelter from the outcries of the copyright owners it relies on the truck. The most significant example is Netflix, which allows multiple users to share a DVD. For music, the latest innovation is LaLa.com, which allows people to look up who has the physical CD they want, and then trade CDs for about $1.

Some people seem to think it’s just a matter of time before copyright law catches up to this divergence, and electronic sharing becomes the norm. Particularly promising is the funding of such content via advertising.

If sharing by electron does become lucrative due to advertising, given the economic stakes involved, will the purveyors of atom sharing be allowed to continue? Or will their source of content run dry…