Digital cinema and video on-demand (VOD) are poised to outpace the Internet and change the way movies are distributed, according to a new Report by Forrester Research (Nasdaq: FORR). Movie studios, theater circuits, cable companies, and technology vendors will each play a part in the development of business models that take advantage of digital technology; they will also share in $6.5 billion in increased movie-industry revenues by 2006.

“The Internet will never be an important venue for the distribution of mainstream feature films,” said Eric Scheirer, analyst at Forrester. “Rather, it’s two other digital technologies — digital cinema and cable-based video on-demand — whose rapid development will fuel strong industry growth. The transition to digital cinema is in its early stages, but by 2004 it will be on a fast track to long-term commercial viability. And cable operators are moving aggressively with the rollout of next-generation digital services.”

Digital cinema’s development has been stymied by exhibitors’ financial woes and studios’ security concerns. Forrester believes that technology vendors will step in to break the funding stalemate, investing heavily to support the deployment of the necessary digital infrastructure. By 2006, one-third of the nation’s big screens will be digital. Digital cinema will also provide theater chains with new revenue opportunities in merchandising, in-theater advertising, and nonmovie presentations, such as premium sporting events.

“While digital cinema transforms theaters, cable and satellite VOD will overcome their sluggish start to transform the home-video industry and smother IP-based movie services,” added Scheirer. “Although Internet-based movies and their production companies enjoy the limelight now, movie fans prefer watching films on TVs — not on PCs. In order to succeed as a revenue-generating service, VOD must move onto the TV screen. Cable TV will win the race to bring VOD services to the mass-market home viewer, beating out the competition from DSL and digital broadcast satellite (DBS) providers.”

Between 2003 and 2004, studios will initially lose money as the digital conversion continues and studios experiment with confusing pricing models, while cable VOD begins to cause a drastic decrease in video and DVD rentals. Today, home-video chains generate 65% of movie studios’ revenue. But by 2006, when more than 25% of US households will have digital cable with VOD services, VOD will erode home-video’s market share to 40% and lead to a new model of transaction-based release windows. The result will be soaring growth in home-movie viewing — and stronger profit margins for movie studios.

Instead of consumers paying different prices for a movie based on its delivery as either a new theater release, a video or DVD rental, or a pay-per-view program, the new transaction-based model will focus on payment type rather than delivery medium. For instance, Forrester believes the industry should offer rent rather than purchase release windows or ad-supported windows versus premium tier ones to replace the medium-dependent model.

“The danger of cannibalization doesn’t come from one media type versus another,” warned Scheirer, “it comes from one pricing model versus another. Transaction-based windows will enable innovative distributors to identify the highest price a consumer is willing to pay for viewing a film. But the model also benefits viewers who will gain from a wider array of film choices, viewing options, and pricing packages.”

For the March 2001 Report “Movie Distribution’s New Era,” Forrester surveyed 50 companies involved in the distribution of motion pictures — major studios, independent distributors, TV and cable networks, and video rental chains — to find out how they think technology will change movie distribution. Forrester also conducted in-depth interviews with 40 leading experts from technology and content companies involved in the movie business. Consumer behavior data was drawn from four surveys: Mail-based studies of 90,946 and 9,034 North American households in fall 1999 and spring 2000, respectively, and online surveys of 11,000 US consumers and 5,616 US consumers conducted in fall 2000 and October 2000, respectively.