Why film studios are betting on Web again

Hollywood could have snubbed Netflix, ditched Hulu and stuck with traditional distribution. Instead, they're licensing content for Web TV and taking on former partners, including theaters owners.

Screen shot of Disney's new digital movie store, which according to the Los Angeles Times, was quietly rolled out recently. Screen shot by Greg Sandoval/CNET

As Netflix revenues soar and as Hulu ponders a $300 million public offering, a group of people who played an enormous part in the brightening prospects of Web TV is very much overlooked.

Managers at the major Hollywood studios: Disney, Warner Bros., 20th Century Fox, Paramount, NBC Universal, and Sony Pictures are pretty much despised in tech land allegedly for their anti-innovation and protectionist ways, but the record shows that, over the past year, they have helped build the foundation for Netflix's success and are embracing digital distribution like never before.

"We did a couple of high-profile deals that were symbolic of how the Internet could be a profitable channel"
-- Ted Sarandos, Netflix's chief content officer

Last summer, the studios signed unprecedented licensing deals for Netflix's streaming service. This week, Disney quietly launched Disney Movies Online, which enables fans to rent or buy Disney and Pixar films over the Web. Perhaps most telling is the studios willingness to throw rocks at some of their most precious windows.

A window is a term used in the film business to describe the period of time when a specific distribution mode, such as cable or broadcast TV, has access to a film. The most important window of all is theatrical, when a film first makes the all-important public debut in a movie house. The studios are doing what once was considered unthinkable. They are to beginning to ask whether theaters should have exclusive rights to new releases.

Eric Garland, CEO and co-founder of Big Champagne, a company that tracks the consumption of digital film and music downloads, said he's privy to the digital plans of several a number of major studios and some bigger independent film companies and that the public will see "some shocking risk taking over the next few months." What this means is that the studios are playing an important role in providing consumers with alternatives to theaters, DVDs, cable, and traditional broadcast. But Garland warns their commitment to digital is fragile. He said a few bad quarters could still spook them away from the Web and back into the arms of their traditional distribution partners.

As for now, Garland gives the studios credit for adapting faster to the Web than other media industries. He notes that if the studios followed the same path as their counterparts in music or newspapers, they would be trying to kill off Web TV right about now. He acknowledged, however, that a year ago, the studios appeared ready to do just that.

"There was this flurry of news and gossip about how the studios were questioning the value of these things," Garland said. "I think it happened first with Hulu, when Fox got really unhappy and pulled [three seasons worth of episodes of the FX show 'It's Always Sunny in Philadelphia'] out of the Hulu pool. But thankfully for the industry, something else has won out in terms of the strategic thinking...the greater fear won out: 'If we don't start to change the way we distribute our content and if we don't start to meet the consumers' needs, it doesn't mean that distribution doesn't change or that consumers needs aren't meant. It means that someone else will drive that revolution.'"

Good partner
The roots of the strategy can be traced to consumers. Too many were choosing to download films illegally. Younger people who didn't go the file-sharing route ignored Blockbuster and cable and gravitated to the Internet's top video-rental store, Netflix. There were other legal services of course. Apple's iTunes offers movies for download and rent and Hulu, the ad-supported video portal that provides TV shows and a smattering of films, were generating mediocre revenues, multiple studio sources told CNET. It was at this point the studios began to lose faith in the Internet as a means of distribution, according to the sources.

Then, Netflix CEO Reed Hastings showed up and, unlike some tech companies Hollywood has worked with, Netflix never regarded the film guys with a "you-just-don't-get-it" attitude, said film industry insiders. Netflix impressed studio suits by its willingness to take heat from customers and pundits for delaying nearly a month the rentals of newly released DVDs so studios might boost disc sales.

Click on photo to read more about how Hollywood nearly lost faith In Web TV. Screen shot by Greg Sandoval/CNET

Hastings also compensated the studios unlike other Web service ever had . In July, Netflix struck an agreement with Relative Media that enabled the video service to stream that company's films a few months after their DVD release. The next month, Netflix announced a similar deal with pay-TV service Epix . The Los Angeles Times wrote that the deal was worth close to $1 billion over five years. "We did a couple of high-profile deals that were symbolic of how the Internet could be a profitable channel," Ted Sarandos, Netflix's chief content officer, said Friday. "Up to then...things [for the Internet services] weren't looking very promising."

Hollywood still isn't ready to share content with everybody yet. Last week, Fox joined the other major TV broadcasters to block Google TV, which enables people to watch Web content on their TV sets, from accessing the shows it posts to the Web.

Retrench
Not even Netflix may be safe if the studios reverse course on digital, according to Garland. It all comes down to how much pain filmmakers are willing to accept in building their digital businesses. Garland points out that for digital to succeed, the studios must make moves that will likely choke off revenue from DVD sales, cable broadcasts, and even ticket sales.

"Your controlling mandate is to build the thing that replaces the business that you now have to acknowledge is in full-blown decline," Garland said, referring to DVDs. "That's a very difficult mandate, right? You have to be the instrument of your own demise...That's tough, but [the film industry execs] are doing pretty well with that at this moment. But if they get stung or if they feel that they experimented and lost the concern is that they retrench."

It will be easy to determine whether Hollywood pulls the plug on digital distribution: content will dry up at Web TV services. Another sign will be whether the studios continue to challenge traditional distribution partners.

In May, The Wall Street Journal reported that the studios were in talks with a major cable company to offer films 30 days after they hit theaters. This is not insignificant. The average length for theatrical exclusivity is four months. Two weeks ago, Time Warner said it was close to reaching agreements with cable providers for what is known as premium video on demand. Warner Bros. and Disney are also in negotiations with cable providers.

Theater owners say the studios' reaction to the collapse of DVD sales is all wrong. Patrick Corcoran, spokesman for the National Association of Theaters Owners (NATO), said that as film companies look for ways to make up lost DVD revenues, they shouldn't risk box office sales by making them compete with the Web or cable.

Last year, annual box office earnings totaled $9.8 billion while DVD sales generated $8.7 billion. It was the first time since 2002 that ticket sales outpaced disc revenue.

"The problem we see with radically altering the windows model is that it imports the problems from the home market into the theatrical market," Corcoran said. "We're all for them solving their home-market problem...Theater owners don't care how it gets to the home. It's about when."

 

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