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DIVX Post Mortem

By Rob Landley (TMF Oak)

AUSTIN, TX (June 21, 1999) -- Every once in a while I see an advertisement from some Wise-guy telling me how I can't possibly understand market forces, and that I should trust all my money to someone with expensive hair. Then, I watch people with expensive hair pull a stunt like DIVX.

Back in April, I wrote a column that called Circuit City's "DIVX" technology an "impending disaster." Last week, Circuit City Stores (NYSE: CC) paid $114 million to effectively bury it in a deep sea trench with a stake through its heart. Now, drawing upon my bottomless reserves of arrogance, I'd like to gloat for a bit. But more to the point, I'd like to review exactly what was so obviously wrong with DIVX in the first place, and why Circuit City's management didn't see it.

The best way to understand DIVX is to imagine a VCR that has to be hooked to your phone line and requires your credit card number every time you want to watch the tapes you got for Christmas. And while it's dialing up to Big Brother and recording your viewing habits so you can get more junk mail, it also downloads advertising to display on your screen. Replace the videotape with a digital CD and you have DIVX. Obviously, a "service" like that would take the world by storm, right?

If you read my April article on DIVX, you'll know I think Circuit City's management was blinded by greed and saw so many benefits for themselves that they ignored the obvious gaping holes in the plan. DIVX was an exercise in wishful thinking from the start, and it probably couldn't have successfully competed with VHS videotape, let alone DVD. (After all, the pizza-sized video laserdiscs that have been around as long as the audio CD have never been particularly popular; being digital doesn't guarantee success.) So first, let's ask ourselves, why has DVD been so successful?

Consumers are used to audio CDs. They're convenient to carry around, relatively durable, don't wear out after repeated use, provide high quality playback, and they've been around for 20 years. A "Video CD" would have an obvious psychological niche within most American minds. Any product that met the obvious expectations would be instantly familiar, and thus an easy sell.

A Digital Video Disc (DVD) is a Video CD. All a salesbeing has to do with a DVD disc is drop it in the player, show us the picture, tell us the price, and we consumers can take it from there. DVD was the first such product on the market; it is available from multiple manufacturers; and it has dropped neatly into the waiting "Video CD" niche. This is important: it works just like a CD. Established customer habits make for easy transfer to the new product.

DIVX did NOT work like a CD or a VCR. Nobody has to hook a CD up to a phone line or supply it with personal information. Most people still have clocks on their VCRs that flash 12:00 all the time. Even that is asking way too much. And if we were buying the discs, why did we have to pay to see them again? With pay per view cable, we don't have disks lying around cluttering up the place. Similarly, with a video rental, we pick what we want from a thousand title selection and take it back when we're done with it. This strange "buy then rent" relationship made you pay for the same thing twice. Further, it combined the limited selection of ownership with the limited access of renting, but worse than that, it was unfamiliar!

Most of the DIVX players that Circuit City did manage to sell were actually DVD players that could also play DIVX discs. Rather than explaining that DIVX was a proprietary way that Circuit City could charge customers for movies again and again, management relied upon a consumer mentality of "DVD and DIVX together must be better than just DVD, right?" This is not the same thing as widespread consumer acceptance of the product. I'd call it deceptive advertising. Management must agree considering that Circuit City is now mailing $100 rebates to the people who bought DIVX players.

The important lesson to take from all this has nothing to do with the relative technical merit of digital video products or arguments about market psychology. It's the realization that corporate managers sometimes do really stupid things that are obvious to anybody marginally familiar with the situation. We as consumers often have a better idea of how consumers will react to a product than corporate managers could ever get from focus groups or surveys. The buyer makes up half of every sale, and that fact is a powerful tool working on behalf of the individual investor.

- Oak

06/21/99 Close
Stock Change    Bid
AXP   +1 11/16  126.31
CHV   -2 1/2     90.69
CSCO  +3 3/4    123.13
EK    +  3/8     71.50
GM    +  15/16   63.75
GPS   +1 3/4     71.00
INTC  +1 7/8     56.81
KO    -1 15/16   61.56
MSFT  +3 15/16   88.94
PFE   -1 3/4     97.50
SGP   -  1/32    45.88
TROW  +  11/32   35.34
XON   -2 1/8     78.25
YHOO  +14 7/16  158.88


                  Day     Month  Year    History
       R-MAKER  +1.94%   3.50%   8.36%  37.11%
        S&P:     +0.45%   3.62%  10.32%  36.46%
        NASDAQ:  +2.61%   6.47%  19.96%  59.13%

Rule Maker Stocks

    Rec'd    #  Security     In At       Now    Change
    2/3/98   48 Microsoft     39.13     88.94   127.26%
   6/23/98   34 Cisco Syst    58.41    123.13   110.79%
    5/1/98   55 Gap Inc.      34.37     71.00   106.58%
   2/13/98   44 Intel         42.34     56.81    34.19%
   2/17/99   16 Yahoo Inc.   126.31    158.88    25.78%
   5/26/98   18 AmExpress    104.07    126.31    21.38%
    2/3/98   22 Pfizer        82.30     97.50    18.47%
    2/6/98   56 T. Rowe Pr    33.67     35.34     4.96%
   8/21/98   44 Schering-P    47.99     45.88    -4.41%
   2/27/98   27 Coca-Cola     69.11     61.56   -10.92%

Foolish Four Stocks

    Rec'd    #  Security     In At     Value    Change
   3/12/98   20 Exxon         64.34     78.25    21.63%
   3/12/98   20 Eastman Ko    63.15     71.50    13.23%
   3/12/98   15 Chevron       83.34     90.69     8.81%
   3/12/98   17 General Mo    72.41     63.75   -11.95%

Rule Maker Stocks

    Rec'd    #  Security     In At     Value    Change
    2/3/98   48 Microsoft   1878.45   4269.00  $2390.55
   6/23/98   34 Cisco Syst  1985.95   4186.25  $2200.30
    5/1/98   55 Gap Inc.    1890.33   3905.00  $2014.67
   2/13/98   44 Intel       1862.83   2499.75   $636.92
   2/17/99   16 Yahoo Inc.  2020.95   2542.00   $521.05
   5/26/98   18 AmExpress   1873.20   2273.63   $400.43
    2/3/98   22 Pfizer      1810.58   2145.00   $334.42
    2/6/98   56 T. Rowe Pr  1885.70   1979.25    $93.55
   8/21/98   44 Schering-P   2111.7   2018.50   -$93.20
   2/27/98   27 Coca-Cola   1865.89   1662.19  -$203.70

Foolish Four Stocks

    Rec'd    #  Security     In At     Value    Change
   3/12/98   20 Exxon       1286.70   1565.00   $278.30
   3/12/98   20 Eastman Ko  1262.95   1430.00   $167.05
   3/12/98   15 Chevron     1250.14   1360.31   $110.17
   3/12/98   17 General Mo  1230.89   1083.75  -$147.14

                              CASH     $70.09
                             TOTAL  $32989.72

Note: The Rule Maker Portfolio began with $20,000 on February 2, 1998, and it adds $2,000 in cash (which is soon invested in stocks) every six months.

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