DVD Format Wars: Toshiba Surrenders

Hobbled by the defection of Time Warner, the Japanese electronics maker abandons its HD-DVD technology, leaving the field open for Sony's Blu-ray

by Kenji Hall

Toshiba spokesperson Lori Leland gives a demonstration of HD DVD web capability at the Toshiba booth at the 2008 International Consumer Electronics Show at the Las Vegas Convention Center January 7, 2008. Ethan Miller/Getty Images

There was an air of inevitability about Toshiba's decision to bow out of the next-generation DVD format war. On Feb. 19 Chief Executive Officer Atsutoshi Nishida finally said what analysts and industry executives had been predicting for weeks: Toshiba will stop making video players, recorders, and high-tech parts in the HD DVD format that the company had spent years developing and in which it had invested sizable sums to bring to market.

Toshiba's planned exit in March formally ends the two-year standoff between the two competing, incompatible high-definition DVD formats (BusinessWeek.com, 12/6/07). Now Blu-ray disc, backed by a Sony-led (SNE) consortium, becomes the de facto standard for new DVDs featuring clearer pictures and more special functions than ordinary DVDs. "We felt that a quick decision was best," Nishida told a roomful of journalists and TV cameras at company headquarters.

Toshiba's abrupt bailout seems wise. By dismantling the business before the fiscal year ends in March, the Japanese tech conglomerate can write off the assets and investments and avoid the drag on operating earnings for another year. As a result, Toshiba's profitability could rise by $370 million to $460 million next fiscal year, according to Goldman Sachs' (GS) estimates.

A Blow to Morale

And Toshiba showed it's hardly retreating in other areas. Nishida said Toshiba plans to spend more than $15.7 billion on two state-of-the-art plants in Japan where it will make NAND flash memory chips for cell phones, portable music players, and possibly laptop computers, starting in 2010. One of the two plants will be run in a tie-up with Milpitas (Calif.) SanDisk (SNDK). Investors seemed to approve: Toshiba's shares rose nearly 6% the day before on news reports of an impending announcement, though the shares gave up some ground today.

Toshiba had a lot riding on HD DVD's success. Its consumer electronics business, which accounts for nearly 40% of sales but only 6% of operating earnings, could have benefited from sales of video players, PCs, and video game consoles. Instead Toshiba is left with the headache of getting rid of its stockpile of gadgetry formatted for a soon-to-be-discontinued technology. Analysts said it would be a huge blow to morale for the company's researchers and engineers—many of whom are expected to be transferred to other divisions. Some observers wonder how this might affect the company's strategy to hold its own in the digital media business over the next few years. "You really have to doubt the company's ability to execute in the future," says Macquarie Securities' analyst Damian Thong.

Another question facing Toshiba: Will it join the Blu-ray camp? "Absolutely not," Nishida said. Analysts agree that decision makes the most financial sense. Toshiba would have to license Blu-ray technology and then spend more on retooling assembly lines, or hiring a supplier that would make the products under the Toshiba brand. As a latecomer, the company might not even reach high-volume production fast enough to stay competitive on pricing with other electronics makers.

Chain Reaction Among Retailers

Nishida said a string of defections to the Blu-ray side left his management team no choice but to admit defeat. Toshiba previously had lined up several major Hollywood studios, including Time Warner's (TWX) Warner Bros., Viacom's (VIA.B) Paramount Pictures and DreamWorks Animation SKG, and