Zenith and the HDTV Challenge This case was written by Will Mitchell at the University of Michigan’s Business School. “Zenith is committed to establishing an American leadership position in high definition television,” commented the CEO,, Jerry Pearlman, in 1988. High resolution flat tension mask (FTM) color monitors, a technology in which Zenith has uncontested leadership, is a cornerstone in Zenith’s strategic thrust. Now it was February 1993, and the Federal Communications Commission (FCC) had just announced that more tests would be necessary before deciding on the high definition television (HDTV) standard. Japan’s analog system had already been rejected. Europe’s strategy was having a myriad of problems, the most recent being Philip’s announcement to suspend plans to mass produce TV sets compatible to the European Community’s (EC’s) preferred HDTV standard. Ironically, the United States, which abhors formalizing industrial policy, may end up with the most advanced (digital) standard. Japanese and European policy makers worried more about setting a homemade (analog) standard than about achieving a world class (digital) standard. Adopting an advanced standard and doing advanced research does not, however, guarantee significant industry participation. The success of the HDTV industry depends not only on the TV manufacturers, but also on the simultaneous adoption of the new technology by broadcasting stations, program producers and transmission companies. Zenith lost $51.6 million in 1991 and $106 million in 1992, even though operating expenses were cut by $38 million in 1990 and $59 million in 1991. At the same time the company had committed nearly it’s entire display R&D budget to FTM ($65 million over 5 years). In 1989 Zenith teamed up with AT&T, and in 1991 with Scientific Atlanta, to consolidate its position in the emerging HDTV industry. A number of critical questions needed to be answered. Should Zenith’s technological lead in FTM’s be further developed or should Zenith begin developing new technologies? Even if new technologies were pursued for the long run, how could Zenith best capitalize on it’s superior FTM technology today? Would HDTV really be a breakthrough product or would it remain an “amorphous” technology? Were the consumers really “asking” for a clearer picture? Would the Japanese eventually adopt the U.S. standard? Was it pragmatic to assume that the U.S. could really gain an up to five years head start by quickly adopting a digital standard? And should Zenith capitalize on its superior HDTV technology and enter into alliances with leaders in the Japanese electronics industry in order to learn and strengthen its future position in consumer electronics? HDTV For the first time in almost fifty years the definition of American television was about to change with the development of HDTV. Today’s television will be replaced by a system that offers sharp, clear and larger images with excellent audio and is “smart” like a computer. Initially, HDTV sets will probably be large screen models. However, HDTV will require the integration of a number of technologies: semiconductor, software, multimedia, displays, compression, VCR, compact disc (see Exhibit 1 for details). The HDTV standards winner would gain the right to royalties on any HDTV set or broadcasting system using its technology. Dale Cripps, editor of the HDTV newsletter, estimates royalties at $5 a set or about $110 million/year assuming 22 million HDTV’s will be sold at the peak of acceptance. Royalties from broadcasters could amount to a few million more. The head of the Advanced TV Advisory Committee, former FCC Chairman Richard Wiley, encouraged contenders to combine forces to move toward the standard faster. Thus, contestants may be forced to share their bounty. Electronics Industry and HDTV In 1992, the consumer electronics industry was waiting for a new growth stimulus. U.S. annual sales of consumer electronics were $33 billion, Japanese sales were $35 billion and European sales were $42 billion. Historically, the industry has been driven by major innovations and life cycles of the gramophone (1920s), the radio (1930s), the B/W-TV (1950s), the color TV (1960s), Hi-Fi (1970s) and the VCR (1980s). Recent product introductions such as CDs, DAT and 8mm camcorders, however, have not presented major technological breakthroughs, nor has the trend toward product proliferation refueled sales. Table 1: World Electronics Industry1 Product 1991 World Sales (in $ billions) TV Hardware 7.0 VCR 3.0 Camcorder 3.0 TV Advertising 29.0 Movies 6.0 Video Cassette Rental 14.0 Video Games 5.0 PC Hardware 50.0 PC Software 12.0 2 In 1991, annual sales growth rates of consumer electronics have decreased from 50% to 3.5% with 99% of all Japanese and U.S. households having at least one color TV, 80% a VCR and 65% a stereo system. Unfortunately, many fear that the move to HDTV will be far less successful than the move from black and white to color. In response to lower margins, shorter product life cycles, lower sales growth and competition from Taiwan and Korea, the industry has been consolidating. In Japan, Akai was taken over by Mitsubushi and Aiwa became a subcontractor for Sony. Thompson, the French company (82% owned by the state), took over Thorn. Major German manufacturers, Blaupunkt and Telefuken have also been acquired by Thompson. Both firms are dependent upon product, process and competent technology from Japan. For example, DAT and VCR technology are supplied by JVC, video-disk player technology is supplied by Pioneer and comcorder technology is supplied by Hitachi. Philips, a global electronics firm of Dutch origin, reported a loss of $2.5 billion in 1991. In 1992, three firms, Sony, Matsushita and Sharp held the strongest position in the emerging HDTV industry. Unlike their weakened world competitors, these companies sustain their R&D spending at more than 6% of sales. As a result, HDTV may be the opportunity for a few Japanese companies to take a major lead in consumer electronics. Distribution Trends During the 1980s, the users of VCR’s and CD players drew annual increases of 15% to 20% in sales for retailers. Traditionally, manufacturers have used a two step distribution process in which the distributors provide after sales service through parts availability, advertising support and warehousing. However, this distribution system has become too expensive due to shorter product life cycles, lower margins and increased product variety. Further, as cost reductions in manufacturing have become more elusive, producers have focused their attention on distribution costs. Labor, for example, only accounts for 10% to 20% of manufacturing costs. Thus, manufacturers of late are enforcing minimum order requirements from retailers. Hitachi, for example, requires a $15,000 minimum order. As a result of their distribution economies and purchasing power vís-a-vís manufacturers, electronic superstores have replaced small retailers, distributors and department stores. They enjoy large advertising budgets and an assortment of 2,000 to 2,500 stock keeping units (SKU) along a large continuum of price points. In addition, they receive price discounts for early purchase commitments. In 1991, Circuit City (a leading U.S. retailer), had sales of $5.5 billion through 200 stores. It dominated the metropolitan areas and offered extensive customer service, such as home installation. In 1990, 220 retailers accounted for 70% of total consumer electronic sales in the U.S. Twelve accounts alone represented 65% of Thompson’s sales in the U.S. 3 HDTV and Multimedia Trends As a digital system, the TV will change from a passive receiver to an integrated interactive entertainment center. As a telecomputer with multimedia capability, HDTV will affect electronic products and entertainment markets. While digital HDTV is being developed, intermediate technologies have arisen. Large monitors with integrated video recorders and CD players are a case in point. These intermediary systems are lower in both price and quality. Offering systems at this intermediate stage of industry evolution, however, educates consumers, establishes brand names, develops distribution systems, influences standards and produces feedback for future HDTV designs. Further, alliances in this market might develop standards in software and hardware which might become important in HDTV. A computer attached to a HDTV could, for example, customize a movie’s sound track, colors and ultimately the viewing perspective. Furthermore, the high demands that video processing poses on semiconductors has accelerated the rate of semiconductor innovation benefiting all areas of computing. In 1991, total world semiconductor sales were $55.5 billion per year. By the end of the decade, the consumer electronics portion of semiconductor sales alone is forecast to reach $48 billion in annual sales. Japanese HDTV Initially, Japan led the world by pursuing an analog transmission technology: MUSE (multiple sub-nyquist sampling encoding). This technology—developed in 1965 as a hybrid digital-analog system—is already obsolete according to some analysts.1 HDTV is still relatively expensive in Japan. Sharp has announced a low-end HDTV which will cost one million Yen, compared to current HDTVs for Y3-Y5 million. This price reduction has been achieved at the expense of picture quality. Sharp bases its strategy on a market forecast that at a price of Y1 million, 16% of all Japanese households would buy a HDTV set. Given the trend toward large screen TVs in Japan (50% of TV screens are 32-inches or longer), the ministry of Post & Telecommunications (MPT) projects that 40% of all Japanese households will own a HDTV set by the year 2000. This represents a market value of $9.6 billion.2 Sharp’s product introduction was backed by the Japanese broadcasting organization (NHK), which increased HDTV broadcasting from one hour to eight hours in November 1991. Sony and Matsushita Electric Industrial have already spent hundreds of millions of dollars developing manufacturing facilities for HDTV.