DivX Declares War On Video On Demand

November 15th, 2006 Davis Posted in DivX, Media, VOD, Microsoft |

DivX let their CFO, John Tanner take a break from his usual stuffy day to day activities of dealing with Sarbanes Oxley requirements, so that he could give a presentation at the UBS Paine Webber Global Technology conference on November 14th. During his presentation he gave a detailed overview of DivX’s business prospects and described an industry that was fighting a war between open standards and proprietary systems.

In addressing the audience of financial professionals, Tanner started out by giving some background information on the history of DivX and their goals over the next year. While the presentation was largely geared towards investors, during his talk, he made it clear that despite the success of their recent public offering, DivX was committed to staying true to their community roots and pointed out that none of their success would have been possible, if consumers hadn’t created billions of DivX files in the first few years that DivX was released.

In looking at the future of the industry, Tanner painted a picture of a video industry that is locked in a crucial format war that will set the stage for how VOD will operate in the future. With many businesses trying to force consumers into a closed system, it offers little interoperability between various consumer electronic devices. The most striking example of this has been Apple, who has obtained a stranglehold on the music industry and now refuses to licence their iTunes music files to outside mp3 developers. DivX believes that this proprietary approach is the wrong one and that, particularly when it comes to video, that it will fail. To highlight the importance of this issue, Tanner said that at DivX, “there is a maxim that open systems win. We’ve seen a number of expamples of closed systems and open systems at war, especially in high technology over the years and we believe one is being waged right now.”

He later went on to compare the current battle over the VOD codec to the battle that Apple Computer first lost against the more open Wintel. He also pointed to Compuserve’s attempt to lock their subscribers into their own internet vs. the competition of the World Wide Web, as an example of how proprietary systems won’t work in a digitally connected world. In looking at the VOD landscape, DivX is clearly concerned by attempts from Microsoft and Apple to lock their customers into proprietary formats for video, yet they seem to feel that neither company has acheived very much traction to date.

Because of Microsoft’s size, they’ve made little to no progress in licensing their own .wmv file to DVD manufactuers. Other then a few cell phones and their own proprietary products, there has been little demand for .wmv outside of the Zune and Xbox 360. Apple has had some success with their iTunes movie downloads, yet they still don’t offer a way for consumers to easily bring this entertainment to their television sets. To a certain extent, there was some irony in Tanner calling for a more open standard because of DivX’s own proprietary codec, but his point that they are willing to licence their technology to multiple manufacturing partners was not lost on his audience.

In discussing the future direction for DivX, Tanner highlighted that there were several different ways in which he felt the company could grow, “We talk about growth within the company in three different ways. Across new devices, across new georgraphies and across new device categories.”

When it comes to new devices, DivX is currently focused on bringing their technology to the digital camera. They are doing this, in part, to earn licensing revenue, but also to help create more DivX content that will ultimately drive demand for other DivX supported products. Instead of focusing on video camera manufactuers themselves, Tanner instead believes that the company can offer a greater benefit to traditional digital camera makers because their DivX codec, allows consumers to compress video content onto limited capacity memory cards and still leave room for photos. In discussing their progress on this front, Tanner pointed out that Canon and Pentax are currently licensing their technology and that they expect to add two more digital camera partners by the end of the year.

As far as increasing DivX’s growth in terms of geography, it’s important to note that while DivX has had strong success in Europe and Japan, they’ve received limited support here in the US. Tanner estimated that approximately 25% of all DVD players sold incorporate the DivX brand. If you break this down to North America, this percentage drops to 14% at the time of their IPO, but it is now 19% after just a few short months. Part of DivX’s growth strategy will be to continue to try and build support from OEMs in geographic areas where they are not satisfied with their penetration levels.

In reference to new device categories, Tanner specifically mentioned that he believed the DVD player was a fading technology and that it would eventually be replaced by the DVR. While none of the major DVR players currently support DivX, Tanner sees a real value opportunity for them to utilize DivX technology and claims that by using their codec to directly record television onto a hard drive, that they can offer DVR manufacturers 10 times more storage capacity then what their current codec allows.

One of the more interesting comments that Tanner made during his presentation, was in regards to the company’s partnership with Google and now YouTube. While it’s been no secret that Google makes up approximately 20% of DivX’s revenue, 17% of that has been from advertising. During the company’s last conference call, DivX CEO Jordan Greenhall had said that while they were optimistic that YouTube would consider using DivX’s codec, their current agreement only extended to Google Video, yet during the presentation Tanner specifically said “YouTube, we believe, is going to be a solid endorsement of DivX Tech, Uh it already is a solid endorsement of DivX technology.” He then went on to add that “Google pays us for the exclusive right to use our website to download their toolbar, in addition to having YouTube recommend DivX on it’s website.”

While Tanner didn’t clarify his statement and no one at UBS asked any follow up questions on the statement, I can tell you that I’ve never seen a DivX advertisement on YouTube and found the comment to be very puzzling. While it would make sense for Google to incorporate DivX’s technology into the hottest video sharing site on the net, I could only scratch my head and wonder if Tanner’s comments alluded to something that was going on behind the scenes or if “YouTube endorsing DivX’s technology” really meant something more benign. Google’s payment for the use of DivX’s codec was a one time licensing event in the third quarter, but management did say that if YouTube decided to also use their codec, they would be thrilled by this.

During the half hour investor presentation, Tanner also warned investors to keep in mind that their revenue and net income was highly seasonal. Because they don’t recognize revenue until their OEM partners report their sales, it means that that their 1st quarter is typically the biggest because it reflects the 4th quarter holiday sales from their partners. The second quarter of each year is typically the slowest time of the year. While this situation is hardly unique to DivX, it still seemed strange to think of DivX’s business as a lagging indicator of the consumer electronic industry.

While the UBS’ dog and pony show didn’t offer any major new insights into DivX’s strategy in how they plan on fighting the VOD format wars, it was still nice to have another opportunity to hear DivX publically comment on their business plans. Yet again, no one asked about the potential of the Xbox 360 or PS3 licensing questions and surprisingly Tanner did not mention their plans to offer a direct competitor to Apple’s recently announced iTV product.

Whether or not DivX will be able to take on industry giants like Apple and Microsoft is still a big question mark for the company, but after surviving the guerrilla war of the P2P revolution and emerging from this environment with a successful business built around a single codec, DivX has proved itself to be a survivor. While there are limitations as to how far they can take their business on a single codec alone, plans by the company to expand their product offerings into media distribution and alternative products could go a long way in diversifying a very concentrated revenue stream.