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The $25 Billion Dogfight
After plunging into an optical-disk spin, Sony may still shoot down its rivals.
Hans Katayama
<Picture: At Work Logo>
Aoki Teruaki, the unassuming managing director of consumer-electronics giant Sony Corp., sits in his eighth-floor office in the Tokyo suburb of Shinagawa and ponders the intensifying battle for control of the worldwide market for digital versatile disks, or DVDs. Five kilometers away in a 40-story tower in downtown Shiba district, Aoki's rivals at Toshiba Corp. are finalizing plans to introduce in cities such as Hong Kong, Singapore and Kuala Lumpur a DVD player that will sell for little more than half the price of Sony's comparable machine. But the urbane Aoki, 55, barely raises an eyebrow when confronted with this latest threat from Toshiba. "No one," he announces decisively, "can beat us in the DVD market."
Such apparent immodesty might seem extraordinary coming from the softly spoken Aoki -- especially as barely two years ago his company was being ridiculed for its seemingly bungled attempts to dominate a market that is still tiny but in less than a decade could be worth a staggering $25 billion a year.
Aoki's confidence might seem even more strange coming on the eve of this month's launch in Asia of Toshiba's $600 DVD player, which undercuts by $400 the price of machines introduced onto the world market by Sony and other manufacturers earlier this year.
Yet even Sony's opponents admit the once-troubled company may finally be back on course. Acknowledges Hase Koji, general manager of Toshiba's DVD products division: "Sony is the company to beat."
What brought about this transformation in Sony's DVD fortunes? The story goes back to the late 1980s, when Japanese consumer-electronics companies became convinced that DVDs and other next- generation digital products would prove to be a gold mine. They envisioned the 12-centimeter disks becoming as popular in homes as video cassettes and compact disks (CDs) are today.
DVDs are optical disks that can hold 4.7 gigabytes of data, seven times more data than a CD. They can store 132 minutes of video and audio, meaning they can easily handle full-length movies with high video resolution and near theater-quality sound.
Such a disk would appear to be irresistible to consumers. Says Mitsubishi Research Institute digital-technology researcher Akutsu Masahiro: "There's no question that it's going to be a huge business."
Despite such rosy forecasts for DVDs, it has been a long, hard road for Sony. First, Sony and Toshiba embarked on a bitter war of rival and incompatible formats that resulted in Sony being forced to seek standardized technology in 1995. Second, analysts don't expect the market to take off big-time until a substantial amount of movie titles and other software is available, and that is at least another two years away. Recording players, which should be introduced by the end of the decade, are also expected to fuel the demand that is projected to result in the $25 billion-a-year market by 2005.
Sony executives don't like to talk about the format dispute with Toshiba. They show obvious pleasure in pointing out that critics failed to take into account the ability of the company's movie studio and data-encoding facilities to quickly convert box- office hits into DVDs, as well as the company's overall manufacturing prowess. But this is a story about being humbled, too.
Some industry executives and analysts scoffed at Sony for ending its feud with Toshiba by calling for a standardized DVD format. To them, Sony was throwing in the towel, admitting that its researchers couldn't come up with a design capable of outperforming the format being developed at Toshiba.
"Their technology was very good," recalls Yamada Hisashi, Toshiba's Stanford-educated chief technology executive in the company's DVD-products division. "The video resolution was excellent, but the format in which they tried to apply the technology had inherent limitations. It couldn't hold enough data."
This may be true. But no one today is knocking the good technological moves that Sony made then or the strategic direction the company has taken since. Even though Sony's fortunes aren't entirely dependent on DVDs, analysts point out that the large amount of profit they are expected to garner will help the company, which is still smarting from its first-ever loss three years ago. In the last fiscal year, Sony's earnings jumped 57 percent from a year earlier to $2.98 billion. Revenue increased 23 percent to $45.67 billion.
Sony began its bid to develop a next-generation optical disk in the late 1980s, when it quietly teamed up with NV Philips of the Netherlands to develop what the companies would later call the multimedia compact disk, or MMCD. Sony and Philips had worked closely on the development of the CD.
In 1993, according to industry executives and analysts, Sony and Philips had a clear edge over other companies. An MMCD prototype could hold nearly four times as much data as a CD and could play back about 75 minutes of video and audio. By 1995, Sony had increased the data capacity by 50 percent, enabling an MMCD to play back 135 minutes of video and audio. The new video technology resulted in resolution about twice as good as that on a CD.
At the same time, Toshiba's disk -- known as SD, short for super density -- was emerging as the major rival to the MMCD. The SD was designed to hold 5 gigabytes of data, nearly eight times that of a CD, and 142 minutes of video and audio.
Sony executives attacked Toshiba's format because of its incompatibility with CD technology. The SD stored data on a disk half as thick as a CD, making it necessary for two platters to be bonded together before it could be played on a player that could also play CDs. "A thinner disk did mean greater storage capacity," Sony's Aoki explains, "but it also meant higher costs to produce disks and players."
During this period, Toshiba turned to Philips for technological support and a possible partnership, and the Dutch company was willing to listen. Talks, however, didn't lead anywhere as Philips officials decided to stay with the MMCD format. "It was as if they were telling us that we weren't in the same league," Toshiba's Yamada muses.
Although Toshiba failed to enlist Philips to its cause, it had gained what would prove to be a more critical ally: Time Warner Inc., the U.S. publishing-entertainment conglomerate in which it had invested $500 million in 1991.
This Hollywood link would later prove vital to Toshiba's SD efforts. Matsushita Electric Industrial Co., the Osaka-based consumer-electronics company that makes Panasonic and National products, would be another. Matsushita at the time also owned MCA Inc., a company with a vast library of successful movies.
Initially, Matsushita leaned toward joining the Sony camp. According to industry executives and analysts, though, Sony lost any chances of winning over Matsushita when a demonstration of an MMCD-like disk before Hollywood executives ended with a picture break-up. They say MCA refused to support the MMCD format after the demonstration. "Until that happened," one executive says, "Matsushita did not bother to listen to MCA." Meanwhile, Sony was running out of time. Sony and Philips had agreed to introduce the MMCD in December 1994, and Philips was pressing Sony to go ahead with the introduction regardless of Matsushita's decision. After much foot-dragging, Sony relented. "Matsushita was supposed to give us an answer by around October, but it kept postponing the decision," Sony's Aoki recalls.
One day before the MMCD announcement, Matsushita informed Sony that it planned to back Toshiba. A month later, Toshiba introduced the SD.
Matsushita wasn't alone in jumping on the SD bandwagon. There was a groundswell of support for the format, especially from movie studios in Hollywood that didn't want to be left behind by Time Warner. "There was a sense of crisis on our side," Aoki says. "We knew we were in for a dogfight, and we were the underdog."
Analysts say the failure to secure the support of Hollywood's movie studios was a major misstep by Sony and Philips. Hollywood's SD preference hinged on two technical specifications: First, the format was capable of storing 35 percent more data than its rival, enabling it to hold longer films. Second, it boasted a higher bit rate, 4 megabits per second versus 3 megabits. The latter specification was especially important because a higher bit rate results in better video resolution.
Sony executives tried to counter these preferences by arguing that the higher costs of making SDs -- up to 20 percent more than manufacturing an MMCD -- was unacceptable and that the format missed the boat by not being CD-compatible. "Sony's corporate culture has always been, 'I'm the best; follow me,'" Toshiba's Hase says. "That proved to be their undoing."
Not quite. In February 1995, Sony and Philips agreed to change tactics. Rather than making an untenable stand on movies, they would concentrate on the personal- computer industry. Casting MMCDs as a large-capacity format for computer software to replace CD-ROMs made sense because applications were requiring much larger amounts of memory each year. The companies were betting that the new strategy would succeed because Sony was a major supplier of personal-computer components and peripherals. They were right. Unlike their counterparts in movie studios, executives in the personal-computer industry were more interested in the MMCD's capability of near error-free data reading than its storage capacity.
In the next few months, Sony and Philips pitched the format on every possible occasion. By mid-1995, the MMCD was endorsed by 19 leading CD-ROM drive manufacturers.
This strategy forced a stalemate -- and a clamor in the U.S. for a single DVD standard and an end to the impasse. Analysts say major players in the movie and personal-computer industries, who were becoming increasingly agitated that the new technology wasn't being applied quickly enough, forced the two sides to sit down and talk.
In August 1995, Sony -- despite resistance from its engineers -- sought a truce by calling for a standardized DVD format. One month later, a standard was adopted by all parties, and the DVD war was over.
Sony executives insist that the company's move for a standard wasn't a sellout. They point out that the key device in the DVD format, the optical pickup, was designed by Sony's engineers. But they admit that management wasn't confident that MMCDs would be profitable enough if Sony had to wage a running battle with the competition.
Moreover, Sony stood to benefit no matter which format was used. This element of the equation was mostly ignored by critics two years ago.
Indeed, Sony is plugged into every facet of the DVD spectrum. Not only does it operate Sony Pictures Entertainment Inc. with its large movie library, it owns two data-encoding laboratories. These facilities alone are capable of bringing in a significant portion of Hollywood's business. Matsushita, Sony's main competitor, has only one data-encoding laboratory.
If that's not enough, any company interested in selling DVD software is likely to turn to Sony because of its 11 production facilities. These factories currently churn out nearly 700 million CDs annually, or 30 percent of worldwide demand. They can be easily converted to make DVDs.
Sony's edge doesn't end there. It produces 100 million optical pickups each year, or 50 percent of worldwide demand. And within two years, video-game machines and car-navigation systems are expected to be manufactured with the DVD format. Sony already makes both, using the CD format. "Sony is extremely well-positioned," says Allan Bell, senior technology analyst at Schroders Securities (Japan) Co. in Tokyo.
It isn't clear what lessons, if any, Sony has learned from its DVD venture. Managing Director Aoki still believes the company's traditional insolence is an asset. "You need people who won't compromise in order to develop new products," he says.
Nonetheless, the consumer-electronics business is becoming increasingly competitive and cost-conscious, making compromise more than ever the name of the game. Analysts say the next test for Sony may come when it decides on a format to replace the DVD. The company's engineers are already working to increase data capacity on DVDs.
Perhaps Aoki has already given an indication of how Sony would respond to stiff competition: "It would have been ideal if we could have won the MMCD-SD battle," he says, looking out a window of his executive suite at Sony's headquarters. "But we decided to share the kudos and win the business. " |
