Picture imperfect for Netflix, TiVo

A report in Newsweek on Monday revived speculation that the digital darlings are close to a partnership that would enable subscribers of TiVo's personal video recorder service to download movies from Netflix via the Internet and watch them on a television. TiVo stock shot up 15 percent on Tuesday and climbed a further 3 percent on Wednesday, while Netflix jumped 7.3 percent and then fell back slightly over the two days of trading.

Both the DVR provider and the online DVD renter denied that a deal is imminent, but the logic of such a pairing seems undeniable. The companies have talked about a distribution partnership before; TiVo Chairman Michael Ramsey is a Netflix board member; and both are looking for ways to bolster pioneering businesses that have come under pressure from bigger rivals.

TiVo spokeswoman Kathryn Kelly confirmed that the companies have talked in the past but said TiVo has nothing to announce at this time. "We don't comment on rumors or speculation," she said. "Such a partnership would be understandable, and while the companies do brainstorm together, no time frame or plans have been set."

Echoed Netflix spokeswoman Lynn Brinton: "We brainstorm with them all the time, and their CEO has been on our board since 2002. There is no relationship at this time, and there is no time line for one."

On the verge
Video-on-demand services have been on the verge of breaking it big for the better part of a decade. But they have yet to make it over the hump, thanks to Hollywood's complex licenses and to technology limitations.

Cable companies now offer pay-per-view programming alongside subscriptions, and a handful of companies such as CinemaNow and Movielink offer films over the Internet via download and streaming. Walt Disney, meanwhile, is testing a new service called MovieBeam that sends digital movie files to a hard drive over unused portions of the TV broadcast spectrum.

Netflix has said it plans to debut an Internet product next year, and TiVo has announced similar features without specifying a time frame. Representatives from TiVo and Netflix in the past have said they didn't expect an Internet service to be material to their revenues.

Although the idea of an Internet video-on-demand service is tantalizing, hammering out the details is a bruising process, industry insiders said.

"There is precedence now from the movie industry to allow DVDs to reside on personal video servers. See www.kaleidescape.com and their $27,000 product!! I presume the price had something to do with it... if TiVo were to sell for that much, they'd be licensed, too."
--Indra Singhal

Before going to market with a video-on-demand product, Netflix and TiVo would need the support of Hollywood movie studios, which hold the keys to all-important distribution licenses. Even if the studios are receptive to such a deal, cooperation won't be forthcoming until TiVo can offer a viable content security system to protect the downloadable films in transit from being pirated--an area where TiVo has clashed with Hollywood in the past.

"It is clearly a positive for both sides. There are a lot of movie companies eager to sniff around that area, and it's not just movies--it's anything that helps consumers get content faster," said Tim Hanlon, senior vice president of emerging contacts for Starcom MediaVest Group. "But the success of this venture revolves around digital rights management."

Building new services is crucial for both TiVo and Netflix as they confront growing competition from deep-pocket rivals.

In recent weeks, both have tested their 52-week share price lows, after investors cooled on the prospects of these innovative companies. Netflix's business is being threatened by larger rivals, including Blockbuster and Wal-Mart Stores, while TiVo, which provides both DVR hardware and service, faces similar challenges from cable companies and a potential loosening of its partnership with DirecTV.

For both, movie downloads would provide a distinguishing feature and reduce the chances of their services being commoditized. The move would also help popularize digital video content, something that has happened for audio but not video. However, any download service would face a number of business and technology hurdles.

Currently, TiVo offers a handful of set-top boxes with Internet connectivity. But next year, the company plans to introduce digital TV boxes that enable people to store and transfer content from a PC hard drive to a TV set. Assuming that the digital rights management system is in place to ensure that content doesn't escape the consumer's ecosystem of secured devices, that system would be a winner, analysts said.

TiVo has developed an internal security technology called TiVoGuard, which it plans to build into software and set-top boxes for release in 2005. Those devices will allow subscribers to record TV programming and then send it to up to nine other TiVo boxes they own, which could be in remote locations, TiVo representatives said.

Earlier this year, the Motion Picture Association of America lobbied federal regulators against approving the use of TiVo's content protection technology with digital television. The FCC ultimately gave TiVo a thumbs up for its sharing system, but movie studios remain skeptical.

The problem, according to Hollywood, is that TiVo's system allows file sharing without enough control over who is allowed access. In order to win licenses for a video-on-demand service, TiVo and Netflix would have to assure piracy-shy movie studios that their content protection system is as bulletproof as possible.

"The digital rights management issue is definitely tricky--the studios are wary of anything that allows the transfer of their content," said Aditya Kishore, an analyst at research firm The Yankee Group.

TiVo's Kelly said that because the Federal Communications Commission has approved the technology, the system is secure for use in any movie download service.

"If a TiVo-Netflix deal came to fruition, the content protection technology would be TiVoGuard," Kelly said.

In an interview in February with CNET News.com, Amir Majidimehr, the vice president of Microsoft's Windows Digital Media division, said the software giant has held talks with Netflix, among other companies, to license Microsoft's content protection technology for secure movie downloads.

Licensing hurdles
While content security is a crucial piece of the pie, relationships are everything in Hollywood, and negotiating licensing contracts with the studios can take years.

For example, Starz Encore Group, which only recently introduced a subscription service for online film downloads, said it took more than four years of talks with the studios to expand its film rights to the Internet.

And budding Internet service Akimbo Systems, which has had to delay plans to introduce a video download service from this summer to October, is still in negotiations with studios for first-run films. Akimbo founder Steve Shannon attributed the delay to the complexities of securing contracts, encoding video and labeling content properly.

Representatives of Sony said that to their knowledge, no talks were going on between its Sony Pictures Digital studio and Netflix or TiVo. A representative of NBC Universal, a part-owner of Universal Studios, said it has no Internet download deal with Netflix or TiVo. Calls to Metro-Goldwyn-Mayer and Paramount Pictures were not immediately returned.

The studios may be reluctant to grant Netflix rights for digital downloads. The movie rental company already has contracts to deliver DVDs to subscribers' homes via the postal service. The studios end up taking in between 70 percent and 80 percent of the revenue in that DVD home rental market. But they only receive between 50 percent and 60 percent of the pay-per-view market, the sector that includes digitally delivered films.

But the studios are not totally gun-shy. They have a Web site joint venture called Movielink, which allows users to download movies and watch them on their PC, laptop or TV. They have also granted rights to rival download services Starz Encore and CinemaNow.

"Some of the water has already been tested," a source close to Netflix and TiVo executives said. "But all the rights issues are not completely clear yet."

Also, the market they're targeting is still relatively small. TiVo reported 1.9 million subscribers in its second quarter, and many of those came from DirecTV, which would likely be unwilling to cannibalize its own movie-on-demand efforts. Netflix had just more than 2 million subscribers as of June 30, according to its latest earnings report.

Cable companies have also made a big push to offer video on demand and currently offer it to about 14.6 million consumers, according to Kagan Research.

Release schedules
Netflix and TiVo could also run into trouble over release timing with a download service, according to one potential rival.

Bob Greene, senior vice president of advanced services for Starz Encore, said his company secured exclusive rights for a subscription movie download service when it launched Starz Ticket with permission from studios such as Sony, Universal and Disney. The service, available online through partner RealNetworks, allows people to watch up to 150 movies a month for $12.95 as many times as they want via electronic download.

The Starz Ticket service licenses films for screening in the window set up for subscription or pay TV showings, which is timed to follow the home video and pay-per-view movie releases.

Greene said HBO and Showtime could negotiate with studio partners to get the same rights for online delivery that they have for the pay-TV window. But under Starz's studio partnerships, Starz Ticket is the sole licensee for the Internet. "We would vigorously defend our rights up to and including litigation," Greene said.

In translation, that likely means that Netflix and TiVo would be relegated to rights in the pay-per-view market, which cable and satellite services dominate today.

CinemaNow, Movielink and others have licenses to release movies in the so-called pay-per-view window, which DirectTV and on-demand television services hold rights to as well. The pay-per-view window follows release into the home video market, which Blockbuster dominates, but it precedes the subscription pay-TV services of HBO, Showtime and Starz Encore.

Curt Marvis, CEO of CinemaNow, said he is working with the studios to try to secure rights to earlier release windows, to make the service more enticing.

Given the complexities of the industry, he said, rumors of an imminent Netflix tie-up with TiVo are likely overblown: "As with all these sorts of things, the devil's in the details."

CNET News.com's Richard Shim and John Borland contributed to this report.