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Take the money and run

In August 2007, during the HD format wars between HD-DVD and Blu-ray format, Toshiba offered Paramount and Dreamworks $150 million to produce HD versions of their movies exclusively as HD-DVD.[1]

This type of deal is equivalent to an “advance” offered to a book author. The DVD manufacturer pays studios up-front cash for the right to make its DVDs. From an accounting point of view this is treated as an advance that the manufacturer recovers by selling the DVDs back to the studio’s video division in the same way a publisher earns back the advance it gives an author.

In this case, the payment was so large and the sales of HD-DVDs so small that Toshiba was unlikely to earn back the entire advance. The way the deal made any sense for Toshiba was that it was exclusive: the studios could not continue to release their movies in Blu-ray. The deal was done explicitly to hobble a competitor and create “critical mass” of content for its own format.

But then in March 2008, Toshiba threw in the towel and abandoned the HD-DVD format. The way the deal worked, the studios got to keep almost all of the $150 million. They then re-released all their movies in the Blu-ray format. The only “cost” to the $150 million windfall was that there was a nine month delay in the eventual release to Blu-ray–a small price to pay for an emergent format without a large install base.[2]

Platform owners go to great lengths to ensure “content” for their platform. They will, essentially, finance an ecosystem when there are barriers to entry or when competing ecosystems are far more lucrative.

This scenario for movies is being played again with Netflix, Hulu and other distributors who need to fill their pipelines. Netflix’s content acquisition costs are exploding and putting the whole company’s future in doubt.

But this scenario is also being played out with app developers. Most recently, news broke that developers are receiving payments from Microsoft for Windows Phone ports of popular apps. In mobile platforms, apps are the new content and developers are the new studios.  It’s also a practice that is not without precedent[3].

This is as it should be. The value of the platform lies mainly in what is built on top of it just like a foundation is not much use without a house on it. However, the practice of “priming the pump” with cash payments for porting is not ideal. Like spiffs, those who receive payments may become used to it and withhold development if there is no payment. Also, those who did not get payment offers may feel shunned and retaliate in kind. Those who receive payment may become cynical about it and may not put in the extra effort (or, more probably, outsource) to make the work spectacular.

Or, like Paramount, they may just take the money and run if/when the platform fails.

Notes:

  1. Source: The Hollywood Economist 2.0: The Hidden Financial Reality Behind the Movies by Edward Jay Epstein.
  2. Paramount made $250 million more from three “replication output” deals: $50 million from Toshiba for agreeing to release Titanic on DVD in time for Christmas sales, $150 million from Panasonic for agreeing to allow them to take over video replication from Thompson, and $50 million from the law firm Ziffrin, Brittenham and Circuit City stores for agreeing to support the DIVX format. Paramount got to keep the money even though DIVX never launched.
  3. Although it’s never been reported that Apple pays developers for building iOS apps, some developers do benefit from promotional placement and visibility during launch events and from early access to devices or SDKs under development.
  • James

    I think as a general rule of thumb, it’s not a good sign if you have to bribe developers to get them to develop for your platform. Consider the number of iPhone apps that were written *before* Apple even offered an SDK, and compare that to Microsoft trying to get popular apps ported to Windows Phone, for example.

    • Walt French

      Horace had a nice “it’s only business” tone to the article; where does the word “bribe” fit into it? Developers like to have fun and advance a platform they care about, but serious software is a serious, money-making business.

      Microsoft is in a situation where accelerating app development is very advantageous; I’d almost say necessary. While the payments might actually get some developers to commit who might not otherwise have, they *could* also serve to signal to other developers that Microsoft is serious about making the platform work — a signal that I don’t otherwise see.

      • http://twitter.com/grumpycola Eka

        Or they could view it as Microsoft’s desperate attempt to grab a portion of the market that has run away from them. 

        Porting apps to Windows is no easy matter.  It requires significant investment in its tools set and code rewrite. While the “investment” from Microsoft is nice, it may be too expensive for development studios to keep supporting it if the consumption for it barely register above 1% in most market. 
         

      • Walt French

        Well, yes. Still, I don’t think that Microsoft should be in “desperate” mode. I personally think they should be more aggressive than they have been, but they must have their reasons.

        The Lumina 900 is a ho-hum device, almost guaranteed not to get much interest and to further advance the perception that they’re rather out of it. Surely their product marketing types easily understand that. So the question is why Microsoft would be in the market with the purpose of failing, why they’re not desperate.

        Perhaps they are waiting for 8, perhaps they’re in total confusion. But desperate, no. My best guess is that the marketing types are assured by the tech types that 8 will be awesome, and integrated between the phone/tablet/laptop/desktop/servers, guaranteed to succeed. If *I* were in charge of marketing, I’d note that I’d been hearing the same song for years now, and try to make plans for how to promote a ho-hum capability. I think that’s what we’ve seen so far, and what we will see.

        Too bad for Ballmer’s career. The Lumina 900 is not his 3rd envelope; that will wait for the reception of Win8, maybe six months later.

      • addicted4444

        The major issue with giving developers money for porting their apps is that the developers don’t really care about the audience, because they aren’t making money off them, but rather, are getting paid upfront.

        So they have an incentive to take money from MSFT, but reinvest that money in improving their iOS/Android apps because there the improvement in the app will actually lead to an increase in sales, since there is a substantial customer base, rather than improving the WP7 app, where there isn’t much money to be made by impressing the users, since there aren’t that many users.

        Which leads to users comparing iOS with WP7 and coming to the conclusion that iOS apps are almost always better than WP7 ones, so maybe iOS is the better platform.

        Which brings us to the real difference between apps, and the other mentioned examples. Exclusivity. MSFT is not getting exclusivity for the apps, which means that they are making payments just to stay in the race, not to compete. This is unlike XBox/PS3 for example, where MS/Sony pay developers to release games exclusively, thereby adding tremendous value to their platforms.

    • Svdwal

      There is no bribe being paid, but a compensation for the opportunity costs a developer pays when he develops for a new platform. He could also develop for the platform where the money is being made NOW, instead of your new platform where money might be made in some unsecified future.

  • Mario

    Actually Apple is paying for people to create apps for their app store.
    They only were smart enough to outsource the management of that process to KPCB.
    See http://www.kpcb.com/initiatives/ifund and http://en.wikipedia.org/wiki/IFund

    How the money gets from A to B may be different but the result is the same. Companies get money pre-release to create an app. 

    • germanguy

      In your links there is no proof whatsoever that Apple pays developers. The fund blog only states “Apple provides market insight and support to KPCB and iFund companies developing on its iOS platform”. Do you have further proof? Because it seems that Apple’s ecosystem is so helathy right now that there is no need at all to “persuade” developers to write apps for iOS.

    • JohnDoey

      App Store gained a critical mass of apps and became a must-support platform for developers on the backs of the 6-8 million iPhone users when App Store launched, and on Apple’s technology leadership. In other words, business people came to App Store to sell to those users, and developers came because it is by far the most advanced mobile app development. This happened 4 years ago.

      No other phone has even outsold those 6-8 million users, since. Except for newer iPhones. There is no other user base like iPhone.

    • normm

      KPCB is a venture capital firm — they make money when the companies they fund become successful.  They aren’t “paying” anyone.  They’re investing and presumably making a ton of money, as iOS developers have earned over $4 billion dollars.

  • KirkBurgess

    Microsoft is used to this strategy, it has been using it for its Xbox division since it launched (paying for exclusives etc).

  • http://twitter.com/ToddbboT ToddbboT

    The disruption of the “software” business model is something I have been thinking about lately and I can’t recall it being addressed quantitatively here (please correct me if I’m wrong).  The undercutting of Microsoft’s Office business by the likes of Google Docs (free) and Apple’s iLife apps is clear.  The change to the entire software industry wrought by 99 cent apps on massive scale is a bit more subtle.  

    There are at least 4 different software/hardware business models competing head on in the market today with various success:

    1) Microsoft, high cost software, commoditize all the hardware and take most of the profit from the value chain (dominant 90s/ 00s model)

    2) Google, Free software, commodity hardware, sells your eyeballs to advertisers

    3)  Apple, Higher cost and quality hardware, cheap software

    4) OSS, Free to use software but doesn’t really compete well in non-geek market

    High cost software, cheap hardware was the dominant model for decades.  That seems to be breaking down rapidly as all the commodity hardware OEMs are failing and MS continues to suck the profit out and leave them to compete in a race to the bottom.  Apple and Google seem to be on the same side here in a challenge to this model by commoditizing software.  Apple’s OS upgrades and office/photo/video/phone/tablet software are high quality and low cost.  Google’s is mostly free if you are willing to sell them your privacy.  There is probably an interesting diagram to be made of this four-way showing who is trying to screw who’s margins.

    Any thoughts on how this software cost disruption will play out?  Is this really a serious challenge to MS’s cash cows?

    • Addicted4444

      Good post, but a couple of issues:
      1) Google Docs is not free for business. But your point still stands, in that it is substantially cheaper.
      2) The OSS model is very popular. The thing you have missed out that the OSS model is “Free” software, with money made off services and customization. Red Hat is a billion dollar (revenues) company based solely off that model.

      I think the MS model is dead. It will be a battle between the Google/Apple model, with the Apple model winning out. We are already seeing this in Android vs. iOS where all the money is being sucked by the hardware makers (Samsung/HTC), while Google is almost certainly losing money off Android (they are probably breaking even on an annual basis without considering opportunity costs, and are most likely not recouping any of their investments). Google also seems to recognize this, hence the Moto purchase.

      We live in interesting times.

    • http://www.asymco.com Horace Dediu

      I consider the app model to be more disruptive than the alternatives offered by Google, Apple or OSS. Apps are competing with software non-consumption.

      • http://twitter.com/ToddbboT ToddbboT

        So  the App Model is bringing in many of the previous non-consumers and training them to think of useful software as “worth” either nothing with ads or 99 cents to $4.99.  It’s interesting to see many expensive smart phone owners balk at paying even 99 cents for software.  Aside from some useful shareware titles, historically, productivity software and good games cost either $200+ or $50.   
        When I have a great $5 game on my iOS device that I can push over airplay to a large screen and that experience becomes “good enough”, will it disrupt the console market also?

        To Addicted4444 below, You make some good points.  I did give OSS short shrift in my post.  I was thinking more of home users than business customers.

      • http://www.asymco.com Horace Dediu

        It always happens this way. Prices come down but so do costs while consumption explodes. There are winners and there are losers. Plan accordingly.

      • http://twitter.com/ToddbboT ToddbboT

        It’s sort of sad that MS is being forced to pay developers to create inexpensive software for it’s mobile platform, helping to hasten the disruption of it’s high value software businesses.

  • gprovida

    When Microsoft entered the game station market with XBox, PS2 and Nintendo had huge backlog of content to push into PS3.  They bought game companies, think Halo, and encouraged, paid?, for more “exclusive” content.  It worked OK, although I am not sure the total investment in XBox over the last umpteen years has really paid off in spite of recent quarterly profits.  It looks like this will play out again with movies etc. over XBox.  Microsoft does have deep pockets, but loosing money upfront to gain market has not been a universal success formula, it demands a lot of commodity business savvy, e.g., Amazon, Walmart, Best Buy, and Target – not a hallmark of US tech companies.  Bing, Zune, Play4Sure, etc., have at various times tried these marketing tricks without a lot of success.  I see the MS Store and the current game on Nokia/MS marketing as doing the same kind of marketing – in this case spending funds to attract people and press buzz with celebrities, again a useful add [think of Jobs in his Apple Music events having guest performers, e.g., Norah Jones], but not the foundation to build success upon.

  • vincent_rice

    The defeat of HD-DVD was a blow for myself and other independent DVD producers. Sony essentially killed off any chance of small production facilities moving into short-run, B2B hi-def disc production. HD-DVD was a relatively simple extension to standard DVD authoring with a similar programming paradigm. Apple would have supported it in DVD Studio. BlueRay is a completely different kettle of fish that requires Java application programming plus complex legal licensing. 

    It was a calculated move that still annoys.

    • vincent_rice

      Sony sold it to the studios on the back of piracy paranoia. So that worked out then…

      • http://www.asymco.com Horace Dediu

        Machinations of this sort never create value.

      • http://twitter.com/handleym99 Maynard Handley

        Quick question:
        We know that HD-DVD lost money for its backers, but did BluRay make money? My gut suspicion is no. We have the cost of the initial development and tooling, not to mention all those subsidized PlayStations, and as far as I can tell the real world (as opposed to the world of a few obsessive geeks) has passed BluRay by, considering the quality of DVD to be adequate, and the future to lie with online models ala NetFlix, Amazon on Demand, or iTMS.

        The fact that Sony is still bleeding massively tends to confirm this view. 

        I suspect that, in ten years or even less, BluRay will look like a crazy decision, along the lines of Sony buying music and content industries.
        Sony thought it was smart by guaranteeing itself content, but what it actually guaranteed was that it would create hardware desirable to content providers, not hardware desirable to actual customers. 

        This goes to your point about eco-systems; and perhaps the answer is that the only really successful way to do this is to create a baseline eco-system that is so customer-desirable that content automatically follows. Attempts to do anything else, bribing or otherwise putting the wishes of the content providers first seem, ultimately, to lead you down the path of Sony (and MySpace, and AOL..) — a jolt of adrenaline for a few quarters, followed by death as everyone abandons your godawful eco-system for something that doesn’t completely suck.

      • http://www.asymco.com Horace Dediu

        Blu-ray is classic over-service. Removable storage was going to be disrupted and instead of investing in the disruption (software, cloud, devices) Sony and the other consumer electronics incumbents tried to make removable storage “better” (with the format wars a battle between incumbent rivals). The consequences for those incumbents are plain to see. http://www.bloomberg.com/news/2012-04-10/sony-widens-net-loss-estimate-to-520-billion-yen.html

    • Brand B

      While your issues with the format are understandable, from a purely consumer perspective,  blu-ray was always my preferred format for a couple of reasons.  The larger storage capacity and higher output bandwidth gave it better performance (would 3D HD-DVD even have been possible?), but most importantly to me anyway, the hard coat meant the discs were far more durable. 

      I have had to return many DVDs to Amazon that were off their hubs and loose during shipping, resulting in a scratched mess.  Of the probably 15 or so blu-rays I have received in a similar state, 2 from Amazon in the UK, not one was marred.  Not to mention the occasional dropped disc.

      Interestingly, sort of the opposite situation to normal software, where the producers would LOVE to abandon backwards compatibility and the consumers insist it be retained.

    • JohnDoey

      HD-DVD was never going anywhere. It was 100% mirage. There have benn successful content formats and unsuccessful, and HD-DVD had nothing in common with the successful ones and everything in common with the unsuccessful. It was basically a scam that we content producers had already seen before. The reason MPEG exists is to avoid that scam.

  • jamie_hardt

    Fun old story which I’m not sure is related:

    There was once a film lab in Hollywood called CFI, and it specialized in low-budget productions, often advancing producers the cost of developing their negative in exchange for their repeat business, packaging their processing with other services, etc.  They were one of the first labs to offer a one-stop-shop post production service: you give them camera negative and a list of movie theater addresses and they’d take care of everything from the neg cutting to the theater delivery to the print reclamation.  They didn’t actually sell the movies to the theaters and film exchanges, the producers still needed sales people, but they were still spared a ton of capital investment.

    Eventually in the early 30s, this became unsustainable, and CFI was essentially carrying Hollywood’s entire silent-era Poverty Row on its accounts receivable.  The owner of CFI at the time, Herb Yates, called up all the old-time B picture companies he was creditor of, and bought them out at fire sale prices in exchange for wiping out their debt to him.  Thus, Monogram, Mascot, Republic, Chesterfield, and a gob of other silent film companies that couldn’t afford the capital investment required to transition to talkies were consolidated under CFI’s “Republic” name and the lab itself became a huge producer/distributor of B-movies and serials.  It was also, coincidentally, one of the first companies to license its material to television.

    Not to suggest that Toshiba was trying to buy Paramount, but it can become deleterious when the pump-priming turns into business as usual, and they come to depend on the advance instead of using it as a windfall (i.e. “running”).

    (CFI existed until a couple years ago as an independent outfit, when it was finally bought by Technicolor, itself bought a few years ago by the big Thomson/Thales aerospace-military-electronics combine, which decided at the time to rename itself after it’s acquisition, thus now Thomson SA is “Technicolor”.  Once again, Hollywood brands demonstrate their appeal and staying power.)

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