Movie studios fear the sequel to iPod

They see risk that new Apple TV signals effort to control distribution.

By Dawn C. Chmielewski and Michelle Quinn
Times Staff Writers

June 11, 2007

Some movie fans hope Apple TV will do for Internet video what the iPod did for digital music.

That's precisely what some Hollywood executives are afraid of.

The device from Apple Inc., which debuted this spring, aspires to bring movie downloads from the geeky fringe to the living room. Touted as elegant and easy to use, Apple TV lets movies and TV shows bought through Apple's iTunes online service — plus, later this month, videos from YouTube — pass from computers to television sets. It also lets users watch their digital photos and home videos on their TVs.

But despite Apple TV's promise, some of the biggest movie studios won't sell their films through Apple's iTunes store. They fear that the Cupertino, Calif., company will come to dominate online distribution of movies as it now controls more than 70% of the digital-music market in the United States.

If it does, that could drive down the prices of newly released DVDs, which is great for consumers but bad business for the movie studios. Even more threatening to the studios is the possibility that iTunes could kill the premium they hope to collect for the new generation of high-definition movie discs.

These concerns about Apple TV have kept most of the major movie studios from signing deals to sell films through the companion download service, iTunes. Missing are movies from Sony Pictures, 20th Century Fox, Universal Studios and Warner Bros.

So far, only Walt Disney Co. has ponied up new releases while Paramount Pictures Corp. and a few smaller studios have made their older catalogs available to Apple.

"As a long-term business matter, Apple has to get all the studios feeling good about the product and what they're doing with iTunes," Gartner Inc. analyst Mike McGuire said.

Movie executives, though, are worried about the here and now — and how offering inexpensive movie downloads through Apple could hurt their sizable DVD businesses.

Apple already changed the way the music industry does business. For years, record labels were able to keep prices for albums on CDs at around $13 — that is, until Apple persuaded label executives to let shoppers buy individual songs online for 99 cents as an alternative to downloading free, pirated tracks on file-sharing networks. Apple doesn't need to make much money selling music because it sells so many high-margin iPods — more than 100 million to date.

The studios fear Apple is using a similar strategy with movies: Sell them for cut-rate prices so people buy more hardware. Senior studio executives say Apple could turn movies into a commodity.

That would turn the home-video business on its head. The studios have managed to keep the price of a DVD pretty constant in the decade since the DVD player was introduced. In 1997, consumers paid about $19 on average for a major film released on DVD, compared with about $22 today, according to the DVD Release Report, an industry trade publication based in Escondido, Calif.

With DVD sales growth slowing, Hollywood is now pushing high-definition Blu-ray and HD-DVD movie discs that cost an average of $22 to $23. That makes studio executives less than enthusiastic about embracing new, inexpensive digital distribution that would depress the price of new releases.

Home video purchases and rentals brought in $24.9 billion last year, according to Adams Media Research. In comparison, the firm said people spent $29 million for downloaded movies and $83 million for TV shows last year. Price isn't the only concern. Studio executives are using Apple's desire to offer more film downloads as an opportunity to press broader concerns about digital piracy.

Their major gripe is with the iPod, which plays pirated versions of movies and television shows that can be obtained at illicit file-trading sites or transferred to computers using software that pries the content off DVDs. Piracy experts say Apple TV could work the same way to transfer bootlegged movies and shows from the computer to the TV.

Apple says it trusts its customers to do the right thing, but movie studios don't think that's enough. So some are holding up licensing deals, trying to pressure Apple to take more aggressive steps to combat piracy. For example, they want Apple's devices to look for a unique identifying code, known as a watermark, on digital video to certify that it is a legitimate copy — and to refuse to play the film when that watermark is absent.

"Our position is, if you want our content, you have to protect our business," said a movie-studio executive, who, like every other entertainment executive interviewed for this article, requested anonymity because he is involved in negotiations with Apple.

Apple executives declined to comment for this story because of the continuing talks. Speaking at the D: All Things Digital conference last month, Chief Executive Steve Jobs jokingly referred to Apple TV as the company's "hobby."

"The reason I call it a hobby is a lot of people have tried and failed to make that a business," he said.

Anxiety about doing business with Apple is nothing new. The music labels and television networks also worried that digital distribution of songs or TV shows through Apple would cannibalize their existing businesses. But ultimately, they took the plunge.

The label executives did so mostly out of desperation. Piracy was savaging their business, and Jobs looked like a savior. TV executives are looking for new distribution methods because they feel threatened by commercial-skipping technologies such as digital video recorders. But the motion picture industry doesn't have to grapple with the same level of threats.

Apple has won a few distribution deals with movie studios. Disney became its first partner in September, when CEO Robert Iger joined Jobs in unveiling the iTunes movie store in San Francisco. Jobs is Disney's largest shareholder, thanks to its acquisition of another company he ran, Pixar Animation Studios.

Paramount Pictures, Lions Gate and Metro-Goldwyn-Mayer Studios Inc. have since agreed to sell their older movies — but not new releases — through iTunes. The store offers more than 500 movies and has sold more than 2 million downloads.

"They're the most popular, successful platform in this space, so why wouldn't we want to enjoy part of their elegant, successful ecosystem?" said Douglas A. Lee, MGM's executive vice president of worldwide digital media.

One reason other studios have yet to sign on: Apple offers less for newly released films than rivals such as Wal-Mart Stores Inc. Apple buys new movie downloads for $14 to $14.50, then sells them for $14.99. In contrast, Wal-Mart pays the studio $15 to $18 for DVDs, which it sells in the stores for slightly more.

The studios fear that offering new releases through iTunes will cause Wal-Mart to retaliate by slashing DVD prices.

"Until they show success, there's no hurry for other studios to jump aboard," said Tom Adams, president of Adams Media Research. He believes the studios will ultimately overcome their qualms and do deals with Apple. But they're "nervous about the actual price."

That's why the studios are moving cautiously when it comes to Apple.

"You have to be careful about any one person taking the marketplace," said Amy Jo Smith, executive director of DEG: the Digital Entertainment Group, a consortium of consumer electronics companies, studios and music labels.

Still, there's little guarantee that Apple TV will succeed. The company won't say how many units it has sold, only that the number is in the hundreds of thousands.

Apple TV is what McGuire refers to as an electronic "beachhead," a first-generation product that accomplishes basic goals. As did the iPod, it will evolve as Apple learns what digital consumers want. Just last week, Jobs announced that Apple TV soon would play YouTube videos.

Indeed, Apple has sacrificed margins on Apple TV to gain market share, according to researcher ISuppli Corp. of El Segundo, which estimates hardware costs based on the price of components. The firm calculates that Apple collects a 20.7% profit margin on the $299 Apple TV, meager compared to the 40% to 50% margins on iPods. As movie downloads accelerate and prices drop, ISuppli predicts, Apple could succeed where others failed and sell 1 million Apple TVs by the end of the year, then 1.4 million in 2008.

Other industry analysts suspect Apple TV will follow the path of TiVo Inc., which pioneered the digital video recorder but has struggled to compete with generic versions from cable and satellite TV providers.

"Apple TV is not a mass-market pleaser — it's a 1-million-person pleaser," said Forrester Research analyst James McQuivey. "Beyond that 1 million, where do you go from there?"