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Free Markets vs. Corporate Greed - Analysis of the HD Format War

by July 10, 2007
Free markets have issues too

Free markets have issues too

There seems to be a bit of misunderstanding as to the nature of true competition and the nature of government intervention in the free market. As our model for discussion, let's take the European Union's (EU) recent decision to start a preliminary investigation into the HD DVD and Blu-ray Disc situation. We'll focus on some recent forum commentary that outlines some of the thinking surround free market economics and corporate irresponsibility.

I don't see how forcing companies to do the bidding of the government is a good thing. Good business comes from proper competition

- Audioholics Forums

Proper competition is the point.

Free market economics, to function properly, requires that economic entities, companies, act independently to forces applied by the marketplace. With the goal of maximizing profit, companies do not always act in concert with the free market concept and will seek ways to minimize or circumvent free market action upon their business and eliminate competition. When successfully implemented, such actions will lead to monopoly, in the case of an individual company, or oligopoly, for collusion between several companies, which ultimately limits the availability of competing products and gives such companies ability to set pricing independent of market demands.

It is a common function of almost every democratic government, in representing its people, to develop economic policy and laws defining competition and common rules of acceptable and ethical behavior by which companies must engage to maintain competition and police the actions of companies for compliance. Because not every company adheres to the law, deliberately or incidentally, and some attempt to stretch interpretation to gain competitive advantage and fatten profits at the expense of consumers, it is at this unfortunate point at which government steps in.

One type of anticompetitive practice occurs when individual companies make explicit or implicit agreements to limit market pressures by acting in concert or colluding. Two basic forms of agreements can occur: horizontal and vertical.

Horizontal agreements are agreements between direct competitors to limit market forces acting between them. These agreements occur between similar levels in a supply chain, such as between several retailers or several suppliers.

Vertical agreements are between different levels of a supply chain. Here, such agreements might occur between a group of suppliers or retailers. Competitive forces might be limited by an agreement restricting interaction between a retailer and other possible suppliers or a supplier with other retailers.

In the case of the next generation optical disk format, vertical agreements are in question. The two competing formats have taken steps to prevent content suppliers from dealing with the other side. This forces a choice, not between Blu-ray and HD-DVD, but between films such as ‘Pirates of the Caribbean’ and ‘The Matrix’ as recently made the headlines.

Exclusive agreements limiting the availability of films to one format or the other is clearly an anticompetitive agreement, now the only question is have these agreements crossed the line of legality. In the end, the winning cartel will stand to make unchecked profits from licensing to all remaining parties not a part of the original agreement.

True competition between the formats would be between the formats, not which movies are available on one or the other.

Government intervention is not preferred, but when companies circumvent competition to corner a market, it becomes necessary.

and seeing as how one of these technologies may be a bit more expensive, but also a bit more technologically advanced

- Audioholics Forums

Blu-ray and HD-DVD are nearly identical in their technological sophistication and neither are in any way revolutionary, as marketing claims. The optical disk, in analog video form, dates back to 1961 and was patented in 1968 by David Gregg. Digital recording methods were applied to the medium in the late 1970’s and early 1980’s. That was the last revolution, the rest is evolution of methods to store, read, and compact data into less space.

Both formats are capable of encoding and decoding the same video compression algorithms, the same audio compression algorithms, and both even use the same blue-violet laser with a 405 nm wavelength. Some differences exist in each format's ability to provide interaction and access online content, but even this is minimal at best (and not yet widely implemented). And one has to remember all of those special features and interactivity we were promised on DVD that never regularly appeared (except perhaps on the fourth released version of a film).

But basically, bioth formats are the same other than higher and lower bit rates here and there.

Oh, and Blu-ray holds more data. However, holding more data comes at a price that the Blu-ray marketers have managed to spin as some sort of revolutionary technical superiority.

Blu-ray simply places the laser physically closer to the disk, requiring a different lens aperture than HD-DVD. Like when something is too small to see well, so one puts their eye closer to see it better.

Genius.

Here is the part where the Blu-ray manufacturing cost difference comes in. In order to stuff in more data, the microscopic pits, in whose dimensions digital data is stored, have to be smaller and closer to the surface of the disk because of refraction of the laser through the clear protective layer. This affects costs threefold: tolerances for physical data storage must be tighter requiring more precise manufacturing, the optics of the laser also have to have tighter tolerances raising cost, and the reduced thickness of the protective layer changes the manufacturing process enough that production lines must be retooled significantly.

There are other side effects as well. The focal distance requirements leave the data layer of the disks more susceptible to physical damage. The aperture difference also makes compatibility between formats an exercise in optical/mechanical gymnastics that has so far left combination player more expensive than buying players from both formats separately.

Both formats support the same picture and sound quality, but one costs more to make and is less efficient with reuse of existing resources to gain a slight advantage in raw data storage capacity. From the standpoint of both economics and engineering, one is technically superior: same performance at less total cost.

I have no belief that this mentality will at all help or support consumer adoption.

- Audioholics Forums

Competition has nothing to do with consumer adoption, it has to do with choice, and if consumers choose neither, which is the current trend, there need be no adoption. The key is that the consumer decides, not cartels of movie studios and hardware manufacturers.

I would call the statement very short sighted for what it would really do and I don't believe that government interference will help consumers to actually have choice.

- Audioholics Forums

There is a distinction to be made between interference and enforcement, these companies would only be doing the bidding of the government if a particular format were mandated, not if the formats are forced to compete on a level playing field.

And right now, one does not have a choice: some movies are only available on one player and some are only on the other, unless one feels that buying both of the players constitutes an acceptable choice. All of this comes about because the two sides could not agree and follow the DVD Forum, of which all the parties are members, everyone participated, and none had an unfair advantage related to licensing fees and royalties.

Afterwards, the winner(s) of the format war will get to charge whatever they want for licensing and the consumer will have bear it.

I for one, support any democratically elected government that will keep greedy companies from cornering and taking advantage of consumers. That is what they are for: public service.

 

About the author:

Professionally, David engineers building structures. He is also a musician and audio enthusiast. David gives his perspective about loudspeakers and complex audio topics from his mechanical engineering and HAA Certified Level I training.

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Recent Forum Posts:

tomes posts on July 12, 2007 20:27
Also from a consumer perspective, without this “war”, hd players would not have become so cheap, this fast. It's a while ago DVD came out, but as far as I recall, it took longer for that hardware to go down in price. In the current scenario, Toshiba has been very aggressive with player pricing, and Sony has taken losses on getting ps3 out to the “masses” (with BR technology).

Also, someone earlier referenced Apple's allowing playback of both mp3 and apple's format. Well, I still can't playback apple's files on my non-apple player. Hmm..kind of like Sony ps3 games not being playable on xbox360. (sure it's great they allow other companies to make ps3 games, and also that those companies can make versions for xbox360, but I still have the same issue that any developer that does not release on both platforms is excluding me from playing their games, unless I buy both). So where is the difference?
BMXTRIX posts on July 12, 2007 15:17
I thnk what this boils down to is that a major advantage, at this time, for Blu-ray is the larger studio support it currently enjoys. HD DVD owners, some, may begrudge Blu-ray this support and wish for studios to be forced to release materials on all formats.

Yet, there is no proof that studios have entered into exclusivity agreements and when questioned, I have not heard of a single studio admitting to such an agreement… that I know of.

Yet, if the playing field is leveled for studio support, then that would likely force Samsung, Panasonic, Pioneer, Sharp, and other companies out of the HD player business, which is anti-consumer. With Toshiba currently manufacturing the only HD DVD stand alone players on the market, they have worked hard to gain market share by cost cutting and subsidizing players from the start. Their primary goal has been cost cutting measures, not necessarily quality improvement measures and no other CE company has joined them in HD DVD only production. Why? Most likely because there is no money to be had unless you hold all the royalty cards as Toshiba does.

Blu-ray has had much more accurate market pricing without a lot of cost undercutting and has had open competition between multiple hardware manufacturers. This cost remains significantly higher than HD DVD, but is likely maintainable because of the direct market competition of stand alone player pricing, and because the exclusive studio support, at this time, helps steer buyers towards their products.

Their product being players manufactured by numerous manufacturers, not just one. I would think that there would be some question out there as to why there is only one CE manufacturer exclusively supporting HD DVD and what anti-competitive measures might be taking place that makes this happen.

Yet, I just think that the govt. needs to stay out of things and that consumers will make their own decisions as they are doing with the real world attach rate figures that clearly indicates Blu-ray to have a higher per-player attach rate rather than the Toshiba fed numbers or the Sony fed numbers. Independent analysis using real world player estimates, show that Blu-ray is outselling HD DVD. Yet, HD DVD is still doing well - so I'm not exactly sure, still, what leads someone to call it anti-competitive.
krihanek posts on July 12, 2007 10:53
Unintended Consequences

The problem with the EU or any govenment regulation that would force a movie to be released in both formats is that less movie titles would be released at all. The studios will decide that the market isn't big enough to benefit from the cost of doing both so all you will get is standard DVD or nothing at all. Only the very largest titles will be released. That's exactly what they do now. You get “Pirates of the …” but not any low volume titles in high definition. Require them to do both and you will get even fewer titles.
sholling posts on July 12, 2007 01:33
David Waratuke, post: 284001
This discussion thread has been an interesting diversion from the point of what is going on or the economic theory involved.
Very well thought out and written. Thank you for your input.
Davemcc posts on July 11, 2007 23:37
David Waratuke, post: 284001
I hope you all recall who Adam Smith is?

The actions taken by the companies we are discussing do not satisfy the free market competition that various forum members have bandied about without full comprehension of the meaning or requirements to satisfy it. The fact of the matter is that exclusive agreements between format hardware manufacturers and content providers such as the studios do not satisfy many of the requirements of perfect competition. This leads to market failure and imperfect competition.

David,
Perfect Competition, as is defined, is a theoretical construct of ivory tower academia. It cannot exist in the real world. Let's make this clear, by definition, all competition is imperfect. Exclusive agreements do not lead to imperfect competition because all competition is imperfect and the lack of perfect competition does not lead to market failure. I hope that you are not trying to interchange the terms free market and perfect competition, since they are very different concepts. Take note in the Wikipedia entry,

"However, while a free market necessitates that government does not regulate supply, demand, and prices, it also requires the traders themselves do not coerce or mislead each other, so that all trades are morally voluntary. This is not to be confused with a perfect market where individuals have perfect information and there is perfect competition."
http://en.wikipedia.org/wiki/Free_market


David Waratuke, post: 284001
The most ironic part of this discussion is that it is circling around: no government intervention let the free market operate. But the conditions do not satisfy free market competition; therefore the market is not operating as a free market.

Quite a conundrum, isn’t it?

Take note of the Wikipedia entry on free trade. I see no part of these exclusive agreements that violate any part of the requirements for free trade. agreements are voluntary, there is no coercion and no intent to defraud. That consumers don't like these agreements and can force lawmakers to criminalize such voluntary agreements would violate the requirements for free trade.

David Waratuke, post: 284001
The market in question is distorted as it currently operates and is not competitive by definition. Limited government intervention to nudge the situation towards properly functioning competition is not a bad thing, as long as it does not go beyond those requirements.

Let's be clear again, properly functioning competition is when there is voluntary agreement without coercion or fraud, but most of all, without government intervention. When the government intervenes, it is a controlled market and it is not properly functioning competition. It is allowed competition according to an arbitrary third party standard that limits the aforementioned voluntary agreements.

David Waratuke, post: 284001
As I said, Sony is an interesting case because they have a conflict of interest, having expanded to owning interests in both hardware sales and software sales. But as the instigator to step away from the DVD Forum and develop Blu-ray while still participating in the forum after Blu-ray was rejected makes their motives a bit dubious.

How is it that owning hardware and software is a conflict of interest.
http://en.wikipedia.org/wiki/Conflict_of_interest
Sony is a purveyor of goods, both hard and soft, physical and intellectual. There is no inherent conflict in Sony packaging these commodities in any combination of formats they choose.

Further, it only makes sense to me that Sony would keep one foot in the DVD business while looking to the future with Blu-Ray.

David Waratuke, post: 284001
Please note the comments by Steve Heckler, Senior Vice President of Sony Pictures:

“The industry will take whatever steps it needs to protect itself and protect its revenue streams…It will not lose that revenue stream, no matter what…Sony is going to take aggressive steps to stop this. We will develop technology that transcends the individual user. We will firewall Napster at source - we will block it at your cable company, we will block it at your phone company, we will block it at your ISP. We will firewall it at your PC…These strategies are being aggressively pursued because there is simply too much at stake.”

How much more anticompetitive can you get? Do the other commentators here really want this guy and his mentality unchecked in its legality?

Please tell me you just didn't write this. You are an editor at an online magazine that relies upon intellectual property protection to prevent its content from being used illegally by others. But, in such sweet irony, you are using this protected intellectual property to advocate that Sony cannot protect it's own intellectual property. Napster has been ruled to be illegal and Sony is clearly stating that it will protect itself and its revenue stream from such illegal activity. Until the law is changed, Sony has every right to pursue its legal rights.


David Waratuke, post: 284001
While there are arguments for and against government intervention, the fact of the matter that too little or too much of either Laissez-faire or government intervention are both bad. And that is a shortcoming of human nature, whether a part of private companies or part of the government, people will take advantage of the system to their own benefit.

But at least the interaction of both represents a form of checks and balances.

Companies left to themselves do not always follow the ideals of the free market, and the government often loses its way as champion of the people and is operated by the same imperfect human beings.

Many of the ‘Well, what about…?’ arguments do entail other possible violations of free market behavior by companies, but limited resources and/or the inability of those in responsible positions to recognize the questionable behavior has lead to these omissions.

Thank you for your opinion on the matter, but unless a company operates by fraud, force or coercion, they are not violating the principles of the free market.

David Waratuke, post: 284001
But if we are going to have a meaningful discussion about free market economics and competition, lets all make sure we understand the full meaning of the terms first, rather than just say them by rote.

I agree and I hope I have helped clarify some of your terms.
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