Beleaguered by technology costs and content issues until 2005, video on-demand (VOD) won’t take off in Europe, according to a new report by Forrester Research B.V. (Nasdaq: FORR). After 2005, improved market dynamics will brighten the business case for full VOD deployments.

“Early trials indicate that VOD can help Europe’s debt-ridden telcos and TV operators because it reduces subscriber churn and increases the average revenue per user (ARPU),” said Forrester Analyst Hellen K. Omwando. “But with user numbers in the tens of thousands spread over fewer than a dozen rollouts across Europe, the region’s VOD market is stuck in first gear. Today’s business case fails in every dimension: demand, investment, operating costs, and distribution margins, and it won’t improve until 2005.”

With a 155 percent increase in DVD player sales over the past year in Europe, DVD presents a huge new revenue source for movie studios — and the biggest competition to VOD. Forrester expects consumer penetration of standalone DVD players to increase from 19 percent today to 53 percent in 2005. Crucially, without blockbuster movies, European VOD operators will struggle to attract a large number of consumers. Only in 2005, when an estimated 2 million European consumers will have access to VOD, up from fewer than 100,000 today, will VOD become viable with key market advances — in particular, the availability of blockbuster content.

“By then, video file sharing on sites like Kazaa will have improved in quality and download times,” Omwando added. “These factors will convince the studios to properly serve legitimate VOD users. Studios will shift from today’s distribution model of block agreements by channel to more profitable dynamic transaction models — taking their share of sales, rentals, subscriptions, and even advertising commissions. Also, DVD features, such as choice of audio language and subtitles, will gradually arrive on VOD. By 2005, services like recording via advanced set-top boxes will reach Europe, making VOD competitive with DVDs.

“Finally, by 2005, manufacturers like Alcatel spinoff Envivio and Fujitsu Siemens Computers will mass-produce MPEG-4 set-top boxes, which require less bandwidth. IBM’s new cable video delivery system will improve server performance by up to 40 percent, and nCUBE’s server will multiply the number of concurrent streams by 10 — to 53,000. Cheaper technology will make it possible both to deliver blockbusters to tens of thousands of concurrent users and also serve content niches like children’s movie reruns with a few thousand viewers.”

For the report “VOD Isn’t Ready For Prime Time In Europe,” Forrester spoke with 15 cable TV operators, satellite TV operators, and ADSL operators that have either launched VOD to consumers or plan to, as well as 13 VOD technology vendors.