Introduction
This paper examines the factors that affect market dominance in a standards war by comparing the competition between VHS and Betamax in the 1980s with that between Blu-ray and HD-DVD in the 2000s. As Figure 1 shows, the high-definition home entertainment industry is a huge, evolving industry with rental and sales revenues exceeding US$20 billion in 2009. In industries where standards are important, a firm’s ability to establish its technology as the de facto standard is a critical determinant of its long-term competitive position and success (Hill, 1997). However, technological prowess alone is not enough to guarantee success in a standards war. What matters most may be the firm’s strategy in the timing of entry, alliances with other firms, and aggressive marketing and sales to pre-empt a competitor’s installed base.
US home entertainment rental and sales revenue by type (US$billion) Source: Digital Entertainment Group (2008). (Available in color online).
In the paper, we pay attention to the motives and financial position of the key player in the standards war, namely the Sony Corporation. Sony is not just another Japanese company; it is an icon – creator of the Walkman, PlayStation and the MiniDisc player. Sony is one of the best known Japanese brands and was made in the image of co-founder Akio Morita (Nathan, 1999). It is a multi-faceted firm with 53% of its revenue coming from consumer electronics (TV, home audio/video, digital imaging, mobile products, games), 15% of its revenue from professional services and semiconductors, 15% from pictures and music, and 11% from financial services (Sony, 2012). Its 2011 revenues amounted to US$88.8 billion. And yet, Sony has been under increasing pressure over the past decade to regain its lost luster in the consumer electronics industry (Kunii, 2002; Burt, 2003). Kunii (2002), put it succinctly: ‘The company, in short, is caught between a past that no longer works and a future that hasn’t arrived’.
Several studies have examined the processes and outcomes of a standard-setting competition, including the standards war between VHS and Betamax formats in the late 1970s (Cusumano et al., 1992; Ohashi, 2003; Park, 2004). The VHS format became the standard in the VCR market even though the Betamax format was introduced earlier and was considered technically superior. Recently, the high-definition DVD market was the battleground for an intensive standards war between Sony-led Blu-ray technology and Toshiba-led HD-DVD technology. While the environments were similar to those of the VHS–Betamax format competition, Sony’s technology won the war in 2008.
We compare the VCR competition with the high-definition DVD competition in terms of a firm’s strategy to establish its technology as a standard. Several options are discussed in the literature, and our study focuses on four main aspects: first-mover advantages, network effects with software companies, strategic alliances with hardware companies, and architectural innovation. The paper begins with a brief history of the development of the US home video market. It then recounts the evolution of the home video market from the 1970s to the present, and examines the factors that might have affected success in the standards competition.
Technological developments in the home video market
The US home video market has seen standard-based competitions over the course of three major product generations: VCR, DVD, and high-definition video. Firms in each generation vigorously competed to establish their respective technologies as the standard. While the DVD standards competition ended with a cooperative outcome, the VCR and high-definition video competitions ended with clear winners. Below we summarize the three product generations and their respective standards wars.
First generation: VHS vs. Betamax format
The first generation standards war in the US home video market was the competition for the home video cassette recorder (VCR) between Matsushita’s (Panasonic) VHS format and Sony’s Betamax format. Though Ampex reel-to-reel machines had been used commercially by television stations to rebroadcast live shows, there was no product that recorded or played video for home use. The VCR was thus a new type of product. Consumers had increasingly demanded a machine that could record television shows or sports games and play them at home later (i.e. ‘time-shifting’). With a huge potential market for the VCR, firms competed to introduce products as quickly as possible.
Sony was first to market with the introduction of the Betamax format to the US in February 1976, and Matsushita launched its incompatible VHS format in September 1977. While introduced later, the VHS format took the lead in the market in 1978, capturing nearly 90% of the total VCR market by 1985. One of the technological features that led to Matsushita’s dominance was its longer playing time than Betamax’s one-hour play time. Given consumers’ preference for time shifting, machines with a longer recording time were preferred and many firms supported the VHS format. Though Sony introduced new features to the Betamax format and increased its recording time by the early 1980s, it could not catch up with VHS. It is argued that the format war between VHS and Betamax was already over by 1981–1982 (Ohashi, 2003).
The intense competition led to price reductions. The inflation-adjusted mean price of VCR players dropped dramatically from US$761 in 1978 to US$245 in 1986 (Ohashi, 2003). In addition, each firm also tried to establish alliances with movie companies and provided consumers with free program cassettes. In 1984, VHS sales rose dramatically relative to Betamax sales for the previous year, and many Betamax-producing companies left the market (Park, 2004). Sony announced in January 1988 that it would produce VHS machines instead of Betamax, ending the standards competition in the VCR market.
Second generation: DVD format
By 1990, nearly 70% of US households had VCRs, and several companies were competing to develop the next generation of video product to replace the VCR. Sony and Philips introduced a new technology, the multimedia compact disc (MMCD), in the early 1990s, while Toshiba and its allies pushed a rival standard called the super density disc (SD). The proposed MMCD with a single layer could hold 3.7GB of information, but the SD had a capacity of 9GB using both sides of the disc. The higher capacity of SD technology enabled longer recordings of films and other features, and most movie studios backed it. In 1995, hardware firms and movie studios agreed on a common format, the digital versatile disc (DVD), based on Toshiba’s SD technology with a few features from the MMCD technology. The longer playing time and the movie studios’ support were the main factors that positioned SD technology as a potential common format.
In 1996, the DVD forum of hardware and software firms published DVD specifications, which included open format, forward compatibility, and a sound encoding process. The first DVD players were released in early 1997 with support from most movie studios. Competing with laser disc players and a new technology called DIVEX (digital video express), which entered the market in late 1998, DVD technology became the dominant standard in the digital format home video market (Dranove and Gandal, 2003).
Third generation: high-definition DVD formats
After the common DVD standard was set in 1995, Sony and Toshiba started to work on the next generation of home video technology. The standards competition was between Sony’s Blu-ray and Toshiba’s high-definition digital versatile disc (HD-DVD). The new technologies were intended to deliver high-definition video to television sets by providing more capacity than the DVD. In 2000, Sony developed its alternative format using new, blue lasers in optical disc systems. Blue lasers expand capacity by providing a more detailed high-definition picture because of the shorter wavelength of blue light relative to the red lasers used in DVD technology. A consortium of nine hardware firms (Sony, Philips, Samsung, Sharp, Pioneer, Matsushita, Hitachi, Thomson, and LG) supported the Blu-ray format, and many Hollywood studios also backed Sony’s Blu-ray because of its larger capacity (see Appendix A).
In 2001, Toshiba unveiled its HD-DVD player at the computer electronic show. The HD-DVD technology was based on DVD technology (but with a blue laser), and DVD production facilities could easily and economically convert to HD-DVD disc facilities. However, data encoding differed in two ways. Since the Blu-ray disc has a tighter track pitch, it can hold more information on the same size disc as HD-DVD. In addition, the surface layer has a different thickness; while HD-DVD uses a 0.6 mm-thick surface layer, Blu-ray has a 0.1 mm surface layer. Because of the thinner surface layer, it is more costly to make Blu-ray discs in that their manufacture requires new production facilities and new coating technology. However, Blu-ray holds more information and extra layers can be added.
Toshiba launched the HD-DVD player for US$936 in 2006 in response to the Blu-ray player introduced in 2003 for US$3815. With the help of a lower price, more HD-DVD players were sold than Blu-ray players; however, Sony incorporated a Blu-ray drive in the PlayStation 3 without increasing the console price. Thus, as of 2008, Blu-ray players outsold HD-DVD players by two to one. In terms of standalone players, however, HD-DVD outsold Blu-ray (400,000 to 300,000) because of lower prices (US$499 against US$299). It is argued that Sony’s Blu-ray technology is superior to Toshiba’s HD-DVD. Table 1 summarizes the features of each technology; although both formats have the same level of resolution and audio soundtrack, Blu-ray has a larger disc capacity.
| Feature | DVD | HD-DVD | Blu-ray |
|---|---|---|---|
| Maximum native resolutions supported via HDMI | EDTV (480p) | HDTV (720p, 1080i, 1080p) | HDTV (720p, 1080i, 1080p) |
| Maximum image-constrained native resolutions supported via component video | EDTV (480p) | EDTV+ (960×540) | EDTV+ (960×540) |
| Disc capacity | 4.7GB (single layer) | 15GB (single layer) | 25GB (single layer) |
| 8.5GB (dual layer) | 30GB (dual layer) | 50GB (dual layer) | |
| 51GB (prototype triple layer) | 100GB (prototype quad layer) | ||
| Video capacity (per dual-layer disc) | SD: approximately 3 hours | SD: approximately 13 hours | SD: approximately 23 hours |
| HD: n/a | HD: 5.1 or 3.3 hours, depending on encoding method | HD: 8.5 or 5.6 hours, depending on encoding method | |
| Audio soundtracks | Dolby Digital EX, DTS-ES | Uncompressed linear PCM, Dolby TrueHD, DTS-HD Master Audio, Dolby Digital Plus, DTS-HD High Resolution, Dolby Digital, DTS | Uncompressed linear PCM, Dolby TrueHD, DTS-HD Master Audio, Dolby Digital Plus, DTS-HD High Resolution, Dolby Digital, DTS |
| Manufacturer support (home theater) | All | Toshiba, LG, Thomson/RCA, Onkyo, Samsung | Hitachi, Mitsubishi, LG, Sharp, Sony, Panasonic, Samsung, Philips, Thomson/RCA |
| Manufacturer support (PC storage) | All | Microsoft, Intel, HP, NEC, Toshiba | Apple, Dell, BenQ, HP, LG, Panasonic, Philips, Pioneer, Samsung, Sony, TDK |
| Studio support | All | Paramount, Studio Canal, Universal, Warner (until end of May 2008), the Weinstein Company, DreamWorks Animation | Sony Pictures (including MGM/Columbia TriStar), Disney (including Touchstone, Miramax), Fox, Warner, Lions Gate |
| Compatible video game consoles | PlayStation 2, PlayStation 3, Xbox, Xbox 360 | Xbox 360 (via external HD-DVD accessory, sold separately) | PlayStation 3 |
| Player prices | US$99 and less | US$130 (Xbox 360 accessory); US$150 and more (stand-alone players); US$999 for combo player | US$399 (PlayStation 3); US$499 and more (stand-alone players); US$999 for combo player |
| Movie prices | US$6 and more (retail) | US$20–28 (retail) | US$20–28 (retail) |
| Number of titles available at the end of 2007 | 50,000-plus | about 330 | about 360 |
| Players are backward compatible with existing DVD videos | Yes | Yes | Yes |
| Set-top recorders available now | Yes | No | No |
| ‘Managed copy’ option | No | Yes | Yes |
| Copy protection/digital rights management | Macrovision, CSS | AACS, ICT | AACS, ICT, BD+, BD-ROM Mark |
| Region-coded discs and players | Yes | No (currently; could change in future) | Yes |
| Source: HD-DVD Promotion Group (2007) and Blu-ray Disc Association (2008). |
Hollywood movie studios were very influential in setting a new standard of high-definition video. Most studios backed Blu-ray technology, favoring its larger capacity. In August 2007, however, Paramount Pictures and DreamWorks Animation announced that their DVD titles would be released exclusively on HD-DVD. But, as of October 2007, Blu-ray titles outsold HD-DVD titles by almost two to one (2.6 million against 1.4 million). Movie studio support was balanced between the two formats until 2007. Figure 2 shows that about 45% of movie studios exclusively supported the Blu-ray format, 20% supported both formats, and only 27% exclusively supported HD-DVD. Then, in January 2008, the balance tipped towards Blu-ray after Warner Brothers, which initially supported both formats, announced exclusive support for Blu-ray. In February 2008, Toshiba halted production of HD-DVD players, ending the standards competition. Though the discs are slightly more expensive to produce and the players cost more, Blu-ray technology won the competition mainly because of the support of four of the largest Hollywood movie studios.
High-definition format alliance by studio (2007) Notes: Dark gray=only Blu-ray; light gray=Blu-ray + HD-DVD; mid-gray=only HD-DVD. Source: Box Office Mojo (2008) (boxofficemojo.com). (Available in color online).
Historical significance at Sony
Table 2 is a snapshot of the three standards wars in terms of Sony’s sales. In 1976, Sony introduced Betamax and in 1977 VHS was introduced. The ensuing standards war lasted until 1985, when VHS obtained a 90% market share. We see from the table that, although Sony lost the standards war in 1985, video sales represented a 981% increase over 1976. In 1990, two different disc standards were announced: MMCD (Sony and Philips) and SDD. By 1995, a new format – DVD – was adopted by all. Although, the DVD outcome cannot be called a war per se, it appears as though Sony lost a battle as their 1995 video sales dropped 20% from 1990. This fact is borne out by a comment made by Sony president Koichi Tsujino: ‘With DVDs, we invested a huge amount in development and competitors walked away with the profits’ (Nakamoto and Burt, 2003). A different story emerges when we look at the birth of Blu-ray in 2003 and the explosion of video sales in 2008, representing a 62% increase over 2003 (PlayStation 3 includes a Blu-ray player). If we examine the last two columns in Table 2, we see that Sony’s total net sales jumped 207% from 1976 to 1985, by 24% from 1990 to 1995 and by only 3% from 2003 to 2008. However, Kunii (2002) states that analysts were expecting a 40% reduction in operating profits, while Sony’s market capitalization fell from about US$130 billion in 2000 to US$42.4 billion in 2002. Clearly, the pictures for Sony’s growth, profitability and market capitalization have been questionable for some time. A major issue facing the company is that hardware innovations are easy to copy in a digital environment. Game consoles and music are the most profitable divisions in Sony, while profit in electronics is slim or non-existent (Kunii, 2002). Thus, building market share in consumer electronics is difficult, especially when competitors can copy new products easily and cheaply (Kunii, 2002; Nakamoto and Pilling, 2003).
| Timeframe | Year | Video sales | Change | Total net sales | Change |
|---|---|---|---|---|---|
| Betamax introduction | 1976 | 47,692 | 463,528 | ||
| Standard war winner (VHS) | 1985 | 515,531 | 981% | 1,420,785 | 207% |
| MMCD and SDD announced | 1990 | 908,399 | 3,695,508 | ||
| DVD common format | 1995 | 731,097 | –20% | 4,592,565 | 24% |
| First Blu-ray sold | 2003 | 949,261 | 7,496,391 | ||
| Standard war winner (Blu-ray) | 2008 | 1,540,561∗ | 62% | 7,729,993 | 3% |
| Note: ∗Includes video and game console sales.Source: www.sony.net. |
Strategic options in standards competition
First-mover advantage
First-mover advantage is defined as the ability of pioneering firms to earn positive economic rents (Lieberman and Montgomery, 1988). With its initial resources and learning through production, the first mover can maintain cumulative advantages (or increasing returns) over later movers and establish market dominance. Several sources of first-mover advantage exist. Lieberman and Montgomery (1988) group them into three broad categories: technological leadership, pre-emption of assets, and consumers’ switching cost.
A first mover can gain technological leadership through learning by doing, lead time over later entrants, and patents from R&D races. It can also gain advantage by pre-empting rivals in the acquisition of scarce assets, such as physical resources, process inputs, and geographical space. As consumers accumulate experience with the first mover’s products, they are less willing to switch to other technologies, and late entrants have to invest extra resources to lure customers away from the first mover (Makadok, 1998). Although switching costs are low in some internet-based markets where consumers can easily click away from the first mover’s products (Porter, 2001), they may be quite high for markets with experience goods, such as home video players (Agarwal and Gort, 2001).
On the other hand, late entrants may benefit from the first mover’s experience (second-mover advantage) because late movers can free-ride on the first mover’s investments in R&D, buyer education, and infrastructure development. They can glean better information about buyer preferences and have more time to plan for manufacturing, distribution, licensing, or the use of complementary products and services (Cusumano et al., 1992). If the market is new and uncertain, the first mover faces a high degree of risk, and early introduction can entail compromises in quality and a greater incidence of bugs. The weakness of the first-mover advantage is often enhanced by what is called ‘incumbent inertia’. If a firm is locked into a specific set of fixed assets, the firm may be reluctant to expand product lines or it may become organizationally inflexible (Lieberman and Montgomery, 1988).
VCR market
In the VCR standards competition, Sony aggressively pursued a first-mover advantage by introducing its Betamax format first. Its rival, Matsushita, entered later with a focus on its manufacturing and marketing capabilities by investing in manufacturing capacity to capitalize on rapid market rapid growth (Cusumano et al., 1992). Lieberman and Montgomery (1988) argue that early entry is likely to be a desirable strategy for firms whose relative skills are in new product development, whereas firms with relative strengths in marketing and manufacturing may prefer to enter later. The strategies of the two rivals in the VCR standards competition conform to this argument.
In terms of technological leadership, it is argued that the technological differences between Betamax and VHS formats were minor because both technologies derived from the common u-matic technology (Cusumano et al., 1992). By introducing a premature technology with a short playing time and high price, Sony could not gain a technological advantage in design and manufacturing as a first mover. The follower (Matsushita) could quickly neutralize Sony’s technological advantage by providing a more consumer-oriented product with a longer play time.
Consumer switching costs could have favored Sony’s early introduction of Betamax if the installed base had increased rapidly. However, that did not occur. Though Matsushita quickly dominated the market and captured more than half of the market share in 1978, a year after it introduced VHS, Sony’s sale of Betamax-format product steadily increased until the early 1980s. The increased market of the VHS format was mainly driven by new consumers, rather than switching of existing consumers. Overall, the first-mover advantage does not explain the dominance of the VHS format in the VCR market competition. Sony could not capitalize on its first-mover advantages, such as technological leadership, pre-emption of scarce resources, or switching costs. The standards competition in the VCR market must be explained by factors other than first-mover advantage.
High-definition video market
Sony was again the first mover, ahead of Toshiba, in the high-definition home video competition. As in the VCR format competition, Sony was known for innovation and entrepreneurial vision, with many new products (the transistor radio, Walkman, Trinitron TV). Toshiba’s relative advantage was in manufacturing and marketing. Table 3 demonstrates Sony’s consistent patent filing activity since 2001, while Toshiba is not among the top five patent filing firms for HD-DVD. It is interesting to note that Samsung was the top patent filer from 2000 to 2007 in both formats. Why did Samsung not take advantage of their lead in patents to lead the standards war?1 The reason, as far as we can tell, is related to core patents. While one could argue that Samsung had already caught up with Sony in terms of the number and quality of patents in 2003 (Joo and Lee, 2010), the firm did not invent Blu-ray or HD-DVD. Thus, the patents held by Sony for Blu-ray and Toshiba for HD-DVD pertained to the core technologies of both formats. Furthermore, in the DVD format competition, Toshiba developed the SD format and Sony developed the MMCD format. The DVD standard was something of a compromise in that it used some technology from MMCD, but was primarily based on Toshiba’s SD format (Economist, 2004). So, as a newcomer to the Blu-ray–HD-DVD format war, Samsung was intent on being on the winning team. The company played on both sides, while awaiting the outcome. The proof of this assertion is that Samsung had the greatest number of Blu-ray (61) and HD-DVD (79) patents.2 (Appendix B provides a detailed discussion of how patent statistics were compiled.)
| Year | |||||||||
|---|---|---|---|---|---|---|---|---|---|
| Blu-ray | 2000 | 2001 | 2002 | 2003 | 2004 | 2005 | 2006 | 2007 | Total |
| (patent count) | |||||||||
| Koninklijke Philips Electronics N.V. | 1 | 2 | 3 | 10 | 3 | 1 | 20 | ||
| LG Electronics Inc. | 13 | 11 | 1 | 25 | |||||
| Matsushita Electric Industrial Co., Ltd | 1 | 20 | 23 | 4 | 8 | 56 | |||
| Samsung Electronics Co., Ltd | 16 | 14 | 12 | 13 | 6 | 61 | |||
| Sony Corporation | 3 | 2 | 4 | 11 | 13 | 9 | 1 | 43 | |
| Total | 1 | 5 | 6 | 63 | 62 | 31 | 30 | 7 | 205 |
| HD-DVD | |||||||||
| General Electric Company | 1 | 1 | 3 | 3 | 8 | ||||
| LG Electronics Inc. | 2 | 3 | 4 | 4 | 1 | 1 | 15 | ||
| Matsushita Electric Industrial Co., Ltd | 1 | 2 | 2 | 2 | 3 | 1 | 3 | 14 | |
| Samsung Electronics Co., Ltd | 14 | 12 | 11 | 10 | 11 | 5 | 11 | 5 | 79 |
| Target Technology Company, LLC | 2 | 3 | 3 | 8 | |||||
| Total | 17 | 18 | 18 | 19 | 20 | 9 | 18 | 5 | 124 |
| Source: United States Patent and Trademark Office (2008). |
The two technologies (Blu-ray and HD-DVD) were significantly different. As mentioned, one main difference was storage capacity (Table 1). A higher capacity disc enables software firms to create higher quality home video on disc, and provides some room for innovative software (not limited to director or actor interviews, deleted scenes, etc.). Therefore, storage capacity could be seen as a potential leading factor in the high-definition standards competition. The first mover may attempt to deter entry of late entrants through strategies of pre-emption. Sony was better positioned to establish geographic entry and/or shelf space dominance with an early introduction of the Blu-ray player. However, its high price (US$3815 at its introduction in 2003) limited the adoption of its technology and Sony could not pre-empt easily. The high price also limited switching behavior. When consumers perceive technological uncertainty on experience goods, such as Blu-ray or HD-DVD players, they resist adoption (Kalish and Lilien, 1986; Carpenter and Nakamoto, 1989). In sum, Sony did not win the standards war because of first-mover advantage. Technological leadership through learning by doing or pre-emption of scarce resources was not observed, and switching costs were prohibitive. Other factors played a role (see below) in Sony’s success in the standards competition.
Indirect network effects and software provision
In such industries as information and consumer electronics, a firm’s success in introducing a new product depends on the network effect. Katz and Shapiro (1985) distinguish between direct and indirect network effects. Direct network effects arise where the number of purchasers helps determine the value of the product. A typical example is a telephone network in which the value of a telephone directly depends on the number of other consumers (size of installed base) who have joined the network. For indirect network effects, the value of a product does not depend directly on the physical effect, but indirectly on the availability of complementary products, such as movies or software.
Indirect network effects are pervasive in the computer and home video market because of the interdependence between hardware and software. Church and Gandal (1992) claim that software availability needs to achieve a critical mass for hardware sales to escalate. Furthermore, the size of the network associated with exclusive hardware often influences the outcome of standards competitions (Ohashi, 2003). Indirect network effects give rise to a chicken and egg paradox in which consumers wait to adopt the hardware until enough software is available, and software manufacturers delay releasing software until sufficient consumers have adopted the hardware (Gupta et al., 1999; Caillaud and Jullien, 2003). Hardware firms and software firms need to invest in market creation and break the deadlock, but coordination among firms often proves difficult (Katz and Shapiro, 1994; Gupta et al., 1999).
VCR market
The main objective of early VCR adopters was time-shifting for TV programs or sports (to view programs at a later time). In the United States in the late 1970s, three-quarters of all VCR owners bought no pre-recorded tapes (Cusumano et al., 1992). In 1978, RCA formed an alliance with Magnetic Video Corporation of America and gave each VCR purchaser two free pre-recorded MV programs. Sony matched this move in 1979 by linking with Video Corporation of America. Video rental shops began to expand in the early 1980s, and sales and rentals of movie titles grew rapidly, doubling each year from 1982 to 1986 (Park, 2004). The standards war between VHS and Betamax was already over by 1981–1982, and by the time Sony realized it was falling behind, it was too late to overcome the disadvantage (Ohashi, 2003).
Given this trend in pre-recorded movies, the indirect network effect through the provision of complementary products does not fully explain the dominance of the VHS format, at least not in the early stage of distribution in the 1970s. Since the 1980s, there has been almost no significant difference between the two formats in performance, features, or price. The widespread availability of pre-recorded programs in VHS format since the mid-1980s may have increased the sales of VHS players; in fact, Ohashi (2003) shows a significant indirect network effect during this period. However, the market dominance of the VHS format started in 1978, before pre-recorded movies were widely available. The VHS format overtook the Betamax format in market share in 1978 (57% against 43%), and the gap had widened by 1981 (72% against 28%). Thus, we can argue that the role of an indirect network effect was not significant in the early adoption of the VHS format.
High-definition video market
In an analysis of the standards competition in the high-definition home video market, it is important to examine the behavior of software firms and Hollywood movie studios. Instead of recording, the main use of high-definition video is to play pre-recorded movies. Table 4 shows Hollywood studio market share by year. In 2004, Blu-ray support (from Buena Vista, Sony Pictures, and 20th Century Fox) amounted to 37% of the market, while HD-DVD support (from Paramount Pictures, Warner Brothers, Universal and New Line) was 34%. The studios’ decision to support either format wavered because it was easy for them to use a new format. Consequently, the studios changed their decision several times up to 2008, when a decisive move was made. In January 2008, Warner Brothers announced that it would stop issuing HD-DVD movies, essentially ending the standards competition. After the Warner Brothers announcement, only two major movie studios (Paramount and Universal) exclusively supported HD-DVD, and their combined share in the studio market at the end of 2007 was only 27%. A few days after the Warner Brothers announcement, Wal-Mart announced that it would phase out HD-DVD. When making an adoption decision, consumers form expectations about the availability of software in each format. Movie studio support is critical to the decision, and it is argued that the indirect network effect played a critical role in the high-definition standards competition.
| Distributor | 2000 | 2001 | 2002 | 2003 | 2004 | 2005 | 2006 | 2007 |
|---|---|---|---|---|---|---|---|---|
| Paramount Pictures | 10.57 | 11.00 | 7.46 | 7.09 | 6.73 | 9.28 | 10.21 | 15.67 |
| Warner Brothers | 11.45 | 14.85 | 11.70 | 12.60 | 13.16 | 16.26 | 12.70 | 14.77 |
| Buena Vista | 14.94 | 10.93 | 12.78 | 16.76 | 12.47 | 10.38 | 16.00 | 13.99 |
| Universal | 14.62 | 11.48 | 9.74 | 11.78 | 9.77 | 11.20 | 8.69 | 11.41 |
| Sony Pictures | 11.69 | 8.87 | 16.80 | 12.84 | 14.27 | 8.53 | 16.69 | 10.72 |
| 20th Century Fox | 9.82 | 10.55 | 10.69 | 8.88 | 9.87 | 15.27 | 14.99 | 10.53 |
| New Line | 5.03 | 7.15 | 9.77 | 10.04 | 4.25 | 4.72 | 2.71 | 5.06 |
| Other | 21.88 | 25.17 | 21.06 | 20.01 | 29.48 | 24.36 | 18.01 | 17.85 |
| Total | 100 | 100 | 100 | 100 | 100 | 100 | 100 | 100 |
| Source: Nash Information Services (2008). |
Strategic alliances with hardware firms
While hardware firms in a standards competition strive to capitalize on the indirect network effect by attracting a large network of software providers, they also establish strategic alliances with other hardware firms to gain a larger installed base in the hardware market. This incentive can be explained by the direct network effects in which a firm tries to establish a larger network in the early stage of systems competition. In addition to strategic alliances, heavy promotional spending and deep discount offers were also crucial in creating positive feedback in the home video market.
Competition in network markets is likely to lead to standardization on a single technology because a small initial advantage will influence consumer expectations about the adoption of a particular standard (Arthur, 1989; Gandal, 2002). Consumer expectations are self-fulfilling, and an early lead can be transformed into an advantage that is difficult to overcome. Penetration pricing is a common tactic to build an installed base quickly.
VCR market
One of Sony’s Betamax mistakes was not securing hardware company support, which is akin to ‘family’ support (Morita, 1986). Sony independently introduced the Betamax format player without collaborating with other firms, and it was reluctant to build Betamax VCRs for its licensees to distribute under their own labels. Believing in its own superiority in technology, Sony was unwilling to compromise on the Betamax standard or to support potential licensees with original equipment manufacturer (OEM) shipments (Cusumano et al., 1992). In addition, Sony was slow in licensing its technology to other firms.
On the other hand, Matsushita followed a strategy aimed at forming a large family by aggressively pursuing both licensees and OEM shipments. In 1976 and 1977, the VHS format was supported by Hitachi, Mitsubishi and Sharp in Japan, several small firms in Europe, and RCA in the United States. This allowed partners to share in the development of improved VHS technology in ways that JVC might not have pursued itself. The outcome of collaborative development with other firms provided a model with two hours of play time, in contrast to Sony’s one hour. Strategic alliances enabled low-cost manufacturing and mass distribution capacity, thus supplying lower-priced VHS machines. The aggressive marketing of less expensive VHS machines led to the rapid development of hardware products, contributing to positive feedback with network effects.
High-definition video market
A decade ago, Sony’s new President, Kunitake Ando, was a strong proponent of alliances (Kunii, 2002). Bremner (2005) praised the company for forming alliances with Samsung, Panasonic, Dell, and Disney, stating that ‘partnerships speed up product development’. Sony learned from its mistake of not having an alliance of firms supporting its technology, and took a different approach with Blu-ray. Blu-ray and HD-DVD technologies are similar in function, but they are technically different in terms of manufacturing processes. Hardware firms had to make irreversible capital investments in one technology. HD-DVD players could be made in existing DVD player production facilities, and it was therefore attractive for hardware firms to commit to HD-DVD. Initially, LG, Matsushita, Philips, Pioneer, Samsung, and Sony committed to Blu-ray, and Intel, Microsoft, NEC, and Toshiba committed to HD-DVD. Sony actively formed alliances with hardware firms by providing attractive licensing terms. Since the manufacturing hardware firms assumed significant risk in this standards war, they had an incentive to delay their capital investment. Some firms used a hedging strategy; two manufacturing firms (LG and Samsung) developed a player that offered both Blu-ray and HD-DVD formats. In addition to establishing strategic alliances with hardware firms, Sony included a Blu-ray drive in its PlayStation 3 gaming console, thus rapidly increasing the installed base. By the end of 2007, 400,000 HD-DVD and 300,000 Blu-ray standalone machines had been sold. PlayStation3, however, had sales of 1.8 million units.
Conclusion
Price and quality are the primary strategies in a traditional competitive environment (Porter, 1980). The addition of industry standards and complementary networks significantly complicates matters. Cusumano et al. (1992) shows how competitive strategies can control the dynamic power of the mass-consumer market to the advantage of a second-mover with extensive technological skills, but with a weak starting position in manufacturing and distribution capabilities. This paper presents an historical analysis of the US high-definition home video industry. The paper focuses on first-mover advantages and network effects. The high-definition home video industry and the home video game industry studied in Gallagher and Park (2002) offer great potential for theoretical development and validation of existing theoretical claims. There are clear market leaders and followers, and rapid technological change in the industry. The complex interaction of factors means that there is no easy way to predict the outcome of standards wars.
Our key assertion is that success in the high-definition home video industry required more than just technological innovation or being a first mover. Technological innovation is essential, and a first-mover advantage is helpful, but not sufficient, in establishing a dominant market position. Once a new format standards war begins, the strategic focus shifts from technological innovation to traditional competitive strategies in order to build a network of complementary products and an installed base. Historical evidence shows that Sony created a winning alignment of Blu-ray producers from the beginning because of the way its managers established alliances, which differed from the first home video competition, when Sony pressed commitment and reputation. This alliance resulted in significant added benefits in addition to the network alliance of complementary firms for Blu-ray. Consequently, an effective winning strategy in a standards war appears to be building a network of complementary products and subsequently an installed base.
Our argument partially supports the traditional notion of first-mover advantage, but this is important only until first movers develop a network of complementary products. We conclude that building a network of complementary products and an installed base should be the primary goal. For R&D, network effects were also important in gathering major hardware firms to invest in one technology. Sony began licensing Blu-ray technology earlier than HD-DVD, and the patents filed for Blu-ray were clustered in Japan, where the technology originated. This may have yielded advantages for Blu-ray technology in terms of knowledge spillover. In the final contest, the Warner Brothers decision provided direct evidence to draw conclusions about standards competition. The alliances that Sony formed for production and distribution proved to be the decisive factors in the triumph of Blu-ray over HD-DVD.