February 19, 2008 11:02 AM PST

Blu-ray victory means royalties, royalties, royalties

by Michael Kanellos

Forget about customer satisfaction or superiority of image quality. The real issue in the war between Blu-ray and HD DVD was about royalties.

With the competition gone, the Blu-ray consortium now has the opportunity to persuade PC makers and consumer electronics makers to adopt Blu-ray drives as their optical drives of choice. It will also get studios and disc makers to deliver Blu-ray discs to consumers. And every time one of those drives or discs leaves a factory, the Blu-ray Disc Association will get a royalty.

The numbers add up quickly. Look at DVD, for example. To make a DVD player legally, manufacturers recently had to pay around $4 per player or drive, according to some estimates. A few years ago, those fees were around $15 to $20. Fees get paid every time a DVD drive gets included in a PC. Nearly every PC in the world has a DVD drive these days and roughly 250 million PCs get shipped every year. Companies that legally make DVD discs also pay fees. The DVD6C licensing group dropped the per disc fee in January to 4 cents per disc. Years ago, it was 7.5 cents per disc. Then there are verification fees.

The royalties, in fact, led to what Chinese leaders call the "DVD mistake," said Zhisheng Niu, vice dean of the school of information sciences at Tsinghua University, in an interview with CNET News.com last year. Because of intense competition, many Chinese companies have lost money, or just broke even, on selling DVD players. The people that have made money, he added, were the patent holders. Chinese manufacturers often got around the licensing issues problem by making illegal players. (The DVD Forum eliminated the royalty for DVD players made and sold in China for a few years, but a lot of those systems ended up overseas.)

The royalties are one of the prime reasons China has pushed for its own optical standard.

"We have to develop our own standards so that we can have our own industry," said Niu. "We have a big DVD industry, but we are probably losing money. The market is big enough so that we can have our own industry."

Now, remember. Niu isn't some pirate off the street. He's one of the chief academics at China's leading university. That gives you a gauge on the feelings there.

The same went for CDs. Philips got about 1.8 cents per CD disc while Sony got about 1.2 cents per disc, according to analysts estimates. When some of the patents expired in 2001, Philips said its royalty revenue would drop by about $42 million. Collecting royalties is a great business.

The Blu-ray camp will likely move more cautiously than the DVD Forum in granting licenses to player and disc manufacturers, said Richard Doherty, principal analyst at the Envisioneering Group, adding that one of the reasons that the studios liked Blu-ray over HD DVD was it is probably easier to set up a pirate HD DVD shop.

Gartner analyst Van Baker, however, said he doesn't believe that Blu-ray will be as lucrative as DVD. For one thing, Blu-ray will have to compete against digital download services, which could prove popular with consumers. Second, the studios have been knocking down the royalty rates.

"This is what a lot of the negotiations were about," Baker said. "My suspicion is that this is not going to be as good as it was for DVD."

We don't know the royalty standards from Blu-ray. The consortium hasn't been aggressive about collecting them yet, but it will likely move into action once the industry gets moving.

The royalties will be split among several players, said Doherty.

Blu-ray has a lot of grandfathers. A lot of people call it a Sony standard but by our estimates Sony doesn't even have 30 percent of the IP," Doherty said. The top four intellectual property holders are likely Sony, Panasonic, Pioneer, and Warner.

Royalties were one of the primary reasons that it took so long to get manufacturers to come out with players that could handle both HD DVD and Blu-ray discs. Manufacturers with dual-format players have to license technology from both camps, which boosts costs.

"There are so many players. There is a lot of intellectual that went into this, and companies like Philips and Toshiba and Sony will all look for a return on investment," Rudy Provoost, the then-CEO of Philips Electronics told News.com in 2006. "That is what makes it a challenging debate. It's like the CD days. Everybody looks for a fair reward."

When a combo player did come out, it ended up being more expensive than buying separate Blu-ray and HD DVD players.

Originally posted at News Blog