• by Diane Mermigas , December 1, 2008

The recessionary holiday shopping season will teach us a few things about consumers and their digital ways. Many will do more with the gadgets they have than buying the latest big-screen TVs and smart phones. They will learn to be satisfied with free content. There will be consumption without monetization.

Amid the worst consumer confidence and negative GDP in decades, and an economic recession unprecedented in its depth, people are finding more ways to consume their favorite music, movies and videos without paying for it. That trend will adversely impact the balance sheets of media and entertainment companies hoping that pay-for-play or pay-for-access will offset reduced ad spending.

Unlike previous recessions, consumers have countless alternatives for accessing entertainment and other content through virtually "free" broadband platforms and devices. In fact, a modern-era depression would actually stimulate in-home entertainment consumption on subscription-based television, laptops and other Internet-connected devices, says Barclay's Capital analyst Anthony DiClemente.

Consumers will increase their dependence on DVRs and other time-shifting devices to watch more television at home, while increasing their use of Internet-connected devices to access low-cost or free content on social-networking sites, free broadband video site and online information and gaming sites.

Entertainment companies will sell fewer DVDs and Blu-ray packaged media as consumers opt for in-home video-on-demand or rentals. So far this year, total DVD sales are down about 4% Y/Y through the end of October. In the third quarter alone, overall DVD sales declined 9%, and the sale of higher-priced titles fell 22% from the previous year, according to Nielsen. However, that does not reflect the 40% of all DVD sales that are generated by Wal-Mart.

The only high-priced device that could prove to be relatively recession-proof is Apple, which is expected to sell more than 15 million portable video-enabled devices by 2009 that offer flexibility and portability of digital TV and film content. The irony is that even as studios like NBC Universal reduce film production by $500 million or 3% next year, they still will not make as much as they traditionally hoped from conventional releases in a digital marketplace.

That's why analysts like DiClemente remain guarded about the financial outlook for the entertainment and media sector--much less specific companies.

"Given the new dynamic of widespread broadband deployment (an added cost for many consumers to begin with), the cyclical pressures of the economy could exacerbate the more recent secular shift to the Internet/digital, and cheaper and easier Web content," DiClemente explains.

In other words, much of digital media is about to turn into a freebie. The entertainment and media players banking on profits from discretionary purchases and high-margin extras are being confronted by more than recessionary pricing and cost concerns. This could be another dramatic about-face for digitally empowered consumers with easily accessible and cheap alternatives.

There are ways that producers and distributors of digital content can save themselves from a monetization malaise. DiClemente's recommendations are: Lower wholesale costs to retailers on SD-DVD and iTunes downloads in order to drive and maintain unit volume; provide easier access of TV and movie content for online users; slash operating expenses for home video sales and distribution channels; consolidate marginal networks and studios; accelerate the shift to "day-and-date" video-on-demand for new digital titles simultaneous with the DVD release; and seek a swift resolution to the Screen Actors Guild's new contract negotiations.

The biggest unknown for media and entertainment players is how strained consumer behavior will impact their fundamental business models. More than 70% of a film's profits are generated by home video--mostly comprised of the $24 billion DVD industry, which also boosts the back-end profitability of TV series. In this stressful economic environment, it is likely that more consumers will opt for the living room DVR or laptop viewing.

That could mean that generally, HDTV (already in 42% of households), cable TV subscriptions and high-speed Internet access are in, while retailed DVDs and fancy digital hardware are out. The question for filmed entertainment divisions is not whether revenue from Blu-ray, VOD and digital will continue to grow steadily--but whether Blu-ray, VOD, and digital will grow fast enough to offset declines in traditional media such as standard-definition DVDs. If newspaper, music and local TV content are any indication, fragmentation and monetization challenges can be devastating.

DVR penetration in 34% of households and broadband penetration in about 84% of all U.S. homes already make it cheaper to access entertainment. Even as the broadcast networks' combined prime-time ratings continue to fall 13% this season, Americans are watching more so-called "television" than ever before--an average 142 hours per TV monthly, according to Nielsen Media--but it's more diverse entertainment than standard TV programs.

Ubiquitous, free broadband has expanded conventional "TV viewing" on universal screens to include streaming videos on Hulu and YouTube or Facebook and MySpace, online games and even illegal movie downloads.

Google--including YouTube--has a 44% share of online video viewing, according to October 2008 figures from comScore. It may be that social networking will become a substitute for more traditional TV and movie viewing. Other free Web alternatives abound--from free audio (Pandora), free video (YouTube), free news (NYtimes.com), and free sports (Espn.com) to information (Wikipedia), and games (MSN and Club Penguin Games). The audience for individual game sites is an estimated 375 million worldwide (as much as 125 million in the U.S.), representing an exploding, ad-supported free alternative to conventional TV viewing.

The bottom line: the global economic crisis will sharply accelerate incrementally free content consumption that will send media and entertainment companies, already vexed by digital change, into a monetization meltdown.