Survival of the Fittest

Forget Tiger Woods' nuptials. When it comes to hot marriages, the "joint entertainment offering" of Netflix and TiVo has couch potatoes salivating. Shernaz Daver, a Netflix rep, describes the service as an expansion of Netflix's current DVD service, which should launch by the end of 2005. "We've always talked about digital distribution of our assets," she says, "and we see TiVo as one step in that direction."

But what that step will be is anyone's guess. The early buzz is that Netflix will deliver movies straight to TiVo, eliminating the need to mail DVDs—in short, answering consumer need.

Consumers want to be able to surf the Net, order a movie, have it delivered via broadband to the digital video recorder (DVR), then watch it on TV. But the two companies are running into a snag: the quagmire of movie-distribution timelines and release windows for home video, video-on-demand (VOD) and subscription TV.

"Hollywood windowing is a black science that most people don't know exists," says Bob Greene, senior vice president, advanced services, Starz. "A lot of these hypothetical offerings are interesting, but you have to get down to actual implementation."

Industry opinion is that the Netflix-TiVo partnership can exist only within the VOD window, which follows the home-video window. During this period, which typically lasts five months, Netflix/TiVo will offer content alongside other VOD providers. The movie studios make too much money from home-video sales to shrink that window. Given the popularity of hit movies, subscription channels, like HBO and Starz, pay millions to entice customers.

"We know we've secured exclusive rights to our movies, and that includes rights for Internet distribution," says Greene. Subscription-based cable networks hold onto subscription rights with an iron grip: "We don't see the ability for anyone else to come into this space." (Moreover, the control that Starz, HBO and others exert over cable and broadcast windows lasts seven or eight years. Unless those windows change, look for a subscription Netflix/TiVo service to be a non-starter. But if they do, everyone will be affected, including competitors MovieLink and CinemaNow, two Internet services.)

Because the theatrical-movie distribution timeline requires 45 days of home-video exclusivity to generate greater DVD sales, this first window could pose the biggest challenge to the successful launch of a Netflix-branded service. At present, Netflix subscribers pay $23 a month to rent three DVDs at a time, which are mailed to their homes. This business model is economically attractive to the movie studios. They make $10-$12 from each DVD sale, compared with only $2 per VOD sale.

"The studios aren't against new services," says Ken Jacobus, manager of business development for copy-protection company Macrovision, "but their hands are tied long-term."

Where does that leave the Netflix/TiVo partnership? Facing a VOD window. Movielink and CinemaNow already allow users to visit their sites and download movies during that window.

According to Movielink CEO Jim Ramo, about 15% of Movielink users store movies on the PC, then connect the PC to the TV—an example of the convergence that was a big deal in 1998 but has since become an everyday reality. "As homes move to digital technology, they can handle either a digital cable or a digital broadband signal," he says. Add home-networking technology, and content can be moved from the PC to the TV.

"We're very interested [in getting on TV]," says Ramo, "and we continue to solidify deals and develop things with companies whose main job is to connect the Internet to the TV." Movielink has signed deals with cable operators such as Time Warner and Charter to have a presence on broadband homepages in return for affiliate fees and promotions.

Beyond the deals and the competition, there is the technical issue of making a Netflix/TiVo service work.

Tony Wasilewski, chief scientist for Scientific-Atlanta, a manufacturer of DVR set-top boxes akin to the TiVo boxes, says that effort is going well. Boxes with dual tuners can use one of them to download content from the cable headend. A Scientific-Atlanta technology called Broadcast File System (BFS) enables a carousel of content to be played out to the set-top box.

A download service would have some lag time," says Wasilewski, "but it's definitely less than U.S. mail, which Netflix currently uses."

He does see some potential in a download-based service, especially if it's coupled to a new DVR set-top box that Scientific-Atlanta will roll out in the second half of next year. It has a recordable DVD drive, which means content can be bought as opposed to rented. He says that, while content owners don't want cable subscribers to have a "DVD printing press," with the proper digital-rights management (DRM) system, the new DVR set-top box could be a big hit.

The DRM issue does loom as a trouble spot: Digital-rights management on DVRs and other devices is a vexing problem for Hollywood. But Jacobus says Macrovision's latest technology is ready for TiVo and other DVR devices.

DRM is also expected to be used in the new Netflix/TiVo service. "The rights owners will insist on protecting the content for distribution over analog outputs," says Jacobus. That's because, when a signal is converted to analog, it's much more susceptible to being copied and distributed illegally.

One of the more interesting aspects of Macrovision's latest technology is that it allows content to be stored on a DVR for a period of time (say, 30 days) before it is automatically deleted.

"It's more of a content-management system," Jacobus says. "It also allows content to be moved around the home and viewed on different devices and hard drives." It even permits transfer to portable video players.

That may explain the TiVo-Netflix nexus. "Both parties are hoping to differentiate their movie services by adding the other," says Adi Kishore, media and entertainment analyst with The Yankee Group. "They each have fantastic ideas, but they need to stay a step ahead as their initial concepts become commoditized by bigger players."

The more pressing problem facing the service is the future of TiVo itself. There are 2 million TiVo subscribers in the U.S., with 1.2 million getting the service through DirecTV. If DirecTV doesn't allow the Netflix service to be delivered to its set-top boxes, that leaves the potential audience at 800,000. And future TiVo growth could be curtailed by cable DVR boxes and the entry of NDS technology as a DirecTV DVR option.

In the end, the Netflix/TiVo union may echo the dotcom boom. Video and audio content companies flooded the Internet, promising to compete with the traditional TV and cable networks. They quickly found a paucity of compelling content, and boom turned to bust.

The trick for Netflix/TiVo will be to create a unique service that carries content available elsewhere.