metlawgroup

When Grand Theft Auto IV can hit $500 MM in revenues for the first 24 hours on the shelves compared to Iron Man’s $100 MM weekend box office debut, it must surely have Hollywood studio execs scratching their heads. Despite declining box office receipts in the recent years, the entertainment industry is not dying, it is shifting. In fact in recessive economies, the entertainment industry has historically fared well and actually saw a boon to market share because the lure of distraction from misery has always played a fundamental role in American culture.

But what does this fragmentation of audience share mean to traditional entertainment and the studios? With more choices, audiences are tougher to capture and more difficult to maintain as fads and interests of Gen Y are elusive to the slow moving corporate environments of old media. 

So how does one explain the massive increase of gaming in this country over the past decade which is surpassing the movie industry? Its a simple answer, one that I have been talking to people about with my film school friends since 1994, motion picture narratives are missing one key component, the immersive experience. People want to actively engage in their entertainment. Look at American Idol, a primitive, but effective interactive television program, giving its audience a voice or power to change the outcome of the game.

While my interpretation in 1994 involved ideas of narratives along the lines of “choose your own adventure” book series, it was based upon the premise of some of the coolest arcade games on the market (back then in-home gaming was pretty much limited to Atari and maybe PC games on my Apple IIe). In any event, when an audience has a stake in the characters or the outcome, they are much more willing to spend their time, attention and money in it. There is the old saying, the chicken is involved, but the pig is committed in making ham and eggs. The same goes true in entertainment. I can only speculate as to what the future will hold, but I am confident that video gaming is not simply a passing fad, but rather, will have a significant increase in the entertainment market share during the US recession.

I think Microsoft saw the error in their strategy with the recent bid for Yahoo’s ad venture. This puts Yahoo in a bidding war between Google and Microsoft, which is the most fortunate situation for Yahoo, Jeffrey Yang and the Yahoo shareholders. The pressure from Icahn may have helped in this situation, but certainly Microsoft is now trying to steal the victory from Google in a last grab. 

I don’t think Yang could have foreseen any of this, nor could he be able to predict the coordinated moves by Microsoft and Icahn, but certainly Yahoo is sitting much prettier now with two potential dates to the prom. f cats had nine lives, Jeff Yang is certainly the beneficiary of some feline luck. Now it is up to Yahoo to play this out carefully because Microsoft has more to lose here than Google. 

There are only four potential scenarios here that can play out, absent something coming in from way out in left field: 

1. Google wins the marriage with Yahoo and the JV is successful, taking Yahoo off the chopping block for Microsoft to acquire, trumping Microsoft’s aggressive move into the Internet.

2. Google wins the marriage with Yahoo, but the JV fails miserably…Google ruins the prize and maybe Microsoft will pick up Yahoo for a song, or if Yahoo is too far gone, no one will touch it.

3. Microsoft wins the courting with Yahoo, and the JV relationship is successful, leaving Yahoo vulnerable to a Microsoft acquisition. It is arguable that Yahoo will be acquired at a discount based upon Microsoft’s control over ad revenues. This would at least help Microsoft make some move towards Google’s position, although many at Microsoft would probably confirm that integration would be a likely failure.

4. Microsoft wins the courting with Yahoo, and the relationship fails miserably, again leaving Yahoo’s price in the bargain basement and giving Microsoft the discretion to take it or leave it.

Absent Icahn throwing a hail mary to take some other direction, one of these four likely scenarios will occur. 

Microsoft pulling out of the Yahoo acquisition last week has had the media industry talking. No one knows for sure if the integration would be successful, or if it would have been another AOL-Time Warner disaster. For sure, Jerry Yang was asking for way too much a premium ($37-$38 per share) relative to fundamental economic considerations for Microsoft. Steve Ballmer did what was seemingly prudent for Microsoft and its shareholders, but are expected to come back to the plate if and when Yahoo fails in execution and their price drops.

Under the circumstances, this seemed like the right strategy, but what about Yahoo’s new strategic partner Google? How does this new love interest play into the triangle? My assessment is that Google played a brilliant strategic coup that makes Yahoo damaged goods, and steals away a major opportunity for Microsoft to come back on a bargain hunt. By outsourcing all of its ad placement to Google, I assess Yang effectively made Yahoo unpurchasable by Microsoft and gave Microsoft’s biggest threat complete control over its revenue base. Microsoft could never make such a significant acquisition when Google is controlling Yahoo’s primary revenues.

Obviously, Yahoo was a rook in the very high stakes media chess game between Google and Microsoft. Google faced significant risk to make an acquisition play at Yahoo for a number of reasons including anti-trust hurdles as well as high risk of M&A integration. What makes this particularly powerful for Google is that they blocked Microsoft’s key acquisition in its Internet strategy, at a very low cost to its business. They don’t have to enter a competitive bidding war, they don’t have to pay a premium for Yahoo, nor do they have to take a hit to their own stock price for paying too much. All they have to do is be a service partner for Yahoo, and Google wins not only in terms of increased revenues,  but could also keep the number one traffic portal from falling into the hands of its biggest competitor.

So what does this mean for Yahoo? While Yang got what he wanted by avoiding being gobbled up by the Microsoft giant, he has many angry shareholders to deal with. Mr. Yang will be forced to make the Google deal work, because if he can’t recover from the drop in stock price or tries to pull out of the Google deal later, Microsoft can come in and sweep up Yahoo for a bargain, leaving Yang, the Yahoo Board and possibly Microsoft to face the onslaught of class action lawsuits by shareholders. I don’t think that Google will let this happen, however, at least as long as Yahoo holds some value as an Internet property for Microsoft. I speculate, however, this is not the last we have heard of this love triangle.

In the battle for the living room, current discussions between Sony and major studios regarding the distribution of full length motion pictures over the internet through the Playstation 3 is a counter-move strategy that could give Microsoft’s XBox a run for its money. With over 10,000,000 units of the X-Box sold, this move would wipe out the marginal utility of the X-Box, which recently was hit with a loss from the HD-DVD v BlueRay format wars.

From a business and economic standpoint, this move is a logical tactic by Sony to mitigate X-Box’s competitive advantage and produce higher demand for its P3 product. But I don to think it is the sale of movies or content that Sony is after. Rather, I think they are just trying to stay in the game of audience control and data mining. The battle for the living room has historically been owned by the cable operators, telco, satellite operators. Now, the hardware manufacturers are trying to get into the fray, with Microsoft’s X-Box, AppleTV and the P3 as a mechanism to aggregate data and viewership patterns across its network. 

Knowing and targeting the audience is key to driving marginal value for advertisers. So the question that remains from a legal standpoint is where does the Internet regulation stop and where does traditional television regulation begin? Clearly, if the screen in your living room has the same functionality as the screen in your office or at your desk, do the rules of the Internet prevail? If so, how does that affect privacy concerns for children and individuals? With DVR’s does that mean we will see more integrated advertising and in-program e-commerce capability? As more features drive technology and consumer buying the latest and greatest, what is the cost relative to their actual utility?

I ponder these questions when thinking about how the living room wars will play out. Regardless of device, however, I think that mechanistically, the organization that owns what is scarce (e.g. the last mile to the living room (e.g. telcos and cable cos) by virtue of government sanctioned local monopolies) will be able to monetize on all fronts because they own access to the customer, they own the bandwidth and control pricing and finally they own the data flow. Absent a big disruption technology like Google with its Wimax initiatives to counter tiered pricing for media rich content and circumvent the wired network, the incumbents will continue to control the game no matter how good the hardware or the available content.