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Studios holding out for bigger piece of pie

Cable operators should not hold their breath for a video-on-demand windfall anytime soon — at least not unless they’re prepared to give Hollywood studios a bigger share of the splits and pay them minimum guarantees.

That’s the conclusion based on new research from the investment research wonks at Sanford Bernstein, who believe VOD-hungry cable operators will be lucky to poach even 25% of today’s $10 billion homevideo rental market by 2008. While that $2.5 billion in incremental revenue isn’t exactly peanuts alongside the $35 billion U.S. cable ops already generate from video services, it’s still only marginally higher than today’s estimated $1.5 billion generated by pay-per-view.

The problem is that while pushing VOD is a clear win for cable operators, who can use the service to woo new subs and cut churn with only minimal capital investment, studios risk cannibalizing their precious DVD sell-through market.

Based on Bernstein’s preliminary math, that fear may be more real than imagined.

Studios typically earn $12 for every DVD movie they sell and $1.50 for every movie rented by retailers like Blockbuster. By contrast, a VOD movie, at today’s 60% splits, brings the content owner around $2.40 per buy. Assuming only a modest cannibalization rate, with 16% of DVD unit sales replaced with VOD buys, studios stand to see total revenues fall 4%, while cable operators gain 200% off their admittedly low base. Increase that cannibalization rate to 25% and a DVD-heavy studio like Disney stands to lose 12% of its home entertainment income, while overall industry revenue would contract by 4%.

That leaves cablers like Comcast, eager to spearhead the VOD revolution, in a bit of a jam. And unless cablers are prepared to offer splits in excess of 80% to the studio along with minimum guarantees to protect content owners’ risk, say some observers, the studios could circumvent them entirely by embracing the web as a distribution alternative.

So-called Internet Bypass, whereby studios could deliver encrypted content direct to consumers to be “rented” or even burned onto a DVD, could ultimately prove the most lucrative VOD model for rights holders, though it risks souring relations with cable distribs and DVD retailers like Wal-Mart.

“If cable operators were willing to raise the splits, the business wouldn’t look nearly as ugly,” said Bernstein analyst Tom Wolzien.

One reason for Comcast’s bid for Disney is the potential to break the VOD deadlock by getting prime Mouse content onto Comcast’s digital pipes and helping to accelerate the studio release windows.

But Comcast may not need to buy Disney to benefit from VOD. “It’s certainly cheaper for Comcast to offer to pay the studios a VOD guarantee rather than going out and buying Disney,” said Wolzien.

Time Warner’s own Catch-22 between supporting Time Warner Cable’s VOD efforts with Warner product and the lucrative returns from DVD sell-through has led to a VOD stalemate.

Cablers like Comcast are understandably impatient about getting VOD rolling, for both defensive and offensive reasons. Not only does the technology represent a new revenue stream, but offering subscription VOD and TV on demand services for “free” as part of the digital package is considered a big lure for new subs and reduces churn. It’s also a service that rival satellite platforms cannot easily duplicate.

Comcast reports that 68% of its On Demand subs in Philadelphia reported using the service in the past 90 days. In January, company counted 7.9 million orders — more than 16 per sub per month, and representing a 21% increase over December.

VOD is available to 50% of Comcast customers. That’s expected to increase to over 80% of basic subscribers by the end of this year.

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