The software required for digital media playback on PCs isn’t free. In the United States and in many other countries, popular digital media standards, including MP3 music and H.264 streaming videos, require software decoders for playback. The rights to those decoders are secured by licenses that cover the use of underlying patents for those formats.
The dollars and cents required to secure those rights on Windows PCs seem like chump change, until you consider the size of the market. When you add up all of the licensing costs, the cost for Microsoft and its PC OEM partners is as much as $800 million per year. Where does that money go? Who pays, and who gets paid?
In my post over the weekend (“If VLC can ship a free DVD player, why can't Microsoft?”), I looked at a few of those costs. In this post, I want to provide a much more detailed breakdown of the economic costs involved.
Let’s start with Microsoft’s original announcement last week, which listed the decoders that will be included in Windows 8:
Video: H.264, VC-1/WMV, MPEG4 Part 2
Audio: Dolby Digital+ (non-disk), AAC, WMA, MP3, PCM
As the post noted, Metro style apps can use any of these decoders, which “cover all key playback scenarios for mainstream content such as YouTube video, Netflix video, Amazon audio/video, H.264 web browsing/streaming, Hulu video, MP4 video, AVCHD video from camcorders, Ultraviolet video, and the HTML5 video tag. Metro style apps can also include additional decoders (such as FLAC, MKV, OGG, etc.) in their apps package for use within the apps.”
Every Windows PC can use any of those features, and most PCs—even those used in business—will probably do so at some point. There are lots of business applications for video and audio decoding, including playback of streaming media and downloaded files as well as online communication.
So what does that collection cost Microsoft and its partners over the course of a year? For the sake of simplicity, let’s assume that 20 million Windows 7 PCs are sold each month, for a total of 240 million over the course of a year. Here’s the (somewhat oversimplified) bill:
|Decoder||Cost per unit||Total annual cost|
|AVC/H.264||up to $0.20||$6.5 million (cap)|
|VC-1||up to $0.20||$8 million (cap)|
|MPEG-4 Visual||up to $0.25||$4.75 million (cap)|
Most of the companies that administer these licensing programs publish their rates for all to see. MPEG LA, which administers many of the programs on this list, offers only summaries of the licensing terms on its web site; you have to supply a written request for a full license agreement.
The Windows Media format, of course, is owned by Microsoft, which doesn’t have to pay licensing fees to itself.
That makes the total bill for Windows 7 for those decoders just a sliver under $200 million. That works out to about $0.83 for every copy of Windows sold through an OEM.
Dolby DigitalAs the Microsoft post notes, Dolby Digital+ audio technology will be included in Windows 8. But the license only covers streaming media. The Dolby Digital+ audio technology used for playback of disks, which is included with premium Windows 7 editions, will be included as part of the add-on Media Center Pack.
The only number I couldn’t fill in on the chart above is the cost of the Dolby Digital+ (non disk) license, which allows playback of Dolby-encoded surround sound on streaming high-definition content. You have to fill in Dolby’s license agreement application to get a quote. Dolby has a separate application for its Windows 8 licensing program.
The Dolby 10-K report filed with the SEC in November of 2011 offers some clues as to what Microsoft is currently paying for the Dolby technology included in Windows 7:
Microsoft Corporation is one of our licensees and accounted for approximately 10%, 12%, and 13% of our total revenue in fiscal 2009, 2010, and 2011, respectively. Most of our Microsoft revenue is generated from the Windows 7 operating system, which contains our technologies. We face the risk that Microsoft may not include our technologies in the commercial version of the Windows 8 operating system or future Microsoft operating systems. If our technologies were not to be included in the commercial version of the Windows 8 operating system or future Microsoft operating systems, we intend to support the playback of DVD, Blu-ray Disc, Broadcast, and online content on PCs by licensing our technologies directly to OEMs.
It didn’t take too much work on my part to do the math based on that disclosure. In FY 2009, Microsoft paid Dolby $72 million. In 2011, Microsoft paid $124 million to Dolby. That’s a 72% increase in just two years, which I suspect is the result of Windows 7 Professional including Media Center (Windows Vista Business did not). As the annual report notes:
In 2007 Microsoft introduced its Windows Vista operating system, which included our technologies within two of its operating system editions to enable DVD audio playback. In fiscal 2009 Microsoft released its current operating system, Windows 7, which includes our technologies within four editions to enable DVD audio playback. As a result, since 2007 the mix of our PC licensing revenue from operating systems has increased relative to that from OEMs and ISVs. Currently, we license our audio codec technologies directly to OEMs such as Apple, Toshiba, and Sony to support optical disc playback on PCs…
By not purchasing the license for disk-based playback in Windows 8 and including only the Dolby technologies related to streaming, Microsoft’s bill to Dolby will go down substantially. How much? We won’t know for certain until we see Dolby’s 2013 and 2014 annual reports.
DVD Playback via MPEG-2And now we get to the last and most interesting number: the cost of licensing MPEG-2 software for DVD playback. Most of the decoders in the table above have caps on the total amount any enterprise has to pay (MP3 is a noteworthy exception). If Microsoft had to pay the full cost of all those decoders based on their per-unit price, the total royalty bill would be $451 million per year. But the license caps keep the actual cost down.
The MPEG-2 standard for DVD movie playback is a flat $2.00 per PC, with no cap. Two other oddities in the license agreements are worth noting as well:
Under the MPEG-2 Patent Portfolio License the party that offers MPEG-2 Royalty Products (Section 1.18) for Sale (Section 1.22) to the End User is responsible for royalties…”
In other words, it’s the PC maker that has to pay that royalty. (Microsoft pays the royalty on shrink-wrapped software it sells as upgrades and full licenses, and for copies of Windows delivered electronically—as part of TechNet and MSDN subscriptions, for example.)
In addition, the agreement includes a “most favorable royalty rates protection” clause, “to assure Licensees that no Licensee will get more favorable royalty rates than another (Section 7.7).” So, even if a company with the market clout of Microsoft wanted to negotiate a better deal, they’re prohibited from doing so.
If the code that enables playback of DVD movies is included in the base operating system, the PC maker must pay $2 in royalties for each device it sells, even if that device has no DVD drive. Over the past three years, I have purchased four notebooks—two from Dell, one from Samsung, one from ASUS. In each case, the PC maker had to pay $2.00 per notebook even though none of those notebooks included a DVD player.
That’s an increasingly common situation. More and more consumer notebooks are being delivered without any kind of optical disk. Look at Dell’s XPS 13, probably the best current example of the Ultrabook category. It has no internal optical media. An external drive ($80) includes Roxio CinePlayer for DVD movie playback and Roxio Creator 10 for disk burning. Apple’s MacBook Air line, which defined the standard for small and light PCs, has no DVD drives, only flash storage. Similarly, beginning with the 2011 release, Apple’s Mac Mini is also completely free of optical disks unless you buy a separate external drive.
In 2013, the first full year that Windows 8 will be generally available, I would bet that at least half of all consumer notebook PCs will ship without a DVD drive, and that number will go up over time.
So there’s your answer. By including DVD playback support in Windows 8, Microsoft would put its PC-building partners on the hook for a total of $480 million a year in payments, in addition to the millions of dollars Microsoft would pay to Dolby for its technologies.
If you’re Dell and you sell a million Ultrabooks, do you really want to write a $2 million check for DVD licensing rights that none of those customers will ever use? If you sell 50,000 PCs to an organization that orders them with no DVD drives for security purposes, do you really want to write a check for $100,000 for the DVD rights that none of those customers will ever exercise?
I didn’t think so.
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Disclaimer: Although I have exercised care in researching this information, it is by definition not complete and subject to change, and it is possible that some portions may contain errors. You should not use this information to make any business decisions without seeking independent confirmation and legal advice. See the note at the end of this post for additional details.
Sources:AVC/H.264 (summary, PDF)
An Enterprise selling branded OEM for PC OS may pay for its customer
- 0 ‐ 100,000 units/year = no royalty (available to one legal entity in an affiliatedgroup)
- US $0.20 per unit after first 100,000 units/year
- Above 5 million units/year, royalty = US $0.10 per unit
- Enterprise cap: $3.5 M/year 2005‐2006, $4.25 M/year 2007‐08, $5 million peryear 2009‐10, $6.5 million per year 2011‐2015
Includes right to manufacture and sell AVC encoders and decoders with the right of End Users to use them for personal and consumer (including internal business) purposes without remuneration but not for other uses
An Enterprise selling branded OEM for PC OS may pay for its customer
- 0 ‐ 100,000 units/year: No royalty (available to one legal entity in an affiliatedgroup)
- US $0.20 per unit after first 100,000 units/year
- Above 5 million units/year: US $0.10 per unit
- Enterprise cap: $8 million/year 2006‐2012
Includes right to make and sell VC‐1 encoders and decoders with the right of End Users to use them for personal and consumer (including internal business) purposes without remuneration but not for other uses
Decoders sold to end users and/or as Fully Functioning for PCs
- 0 ‐ 50,000 decoders/year = no royalty (available to one legal entity in anaffiliated group)
- US $0.25* per decoder after first 50,000 decoders/year
- Annual cap per Legal Entity: $1M per year prior to 2009; $1.1M in 2009; $1.2Min 2010; $1.25M after 2010
Enterprise cap ‐ $3M per year prior to 2009; $3.3M in 2009; $3.6M in 2010;
$3.75M after 2010
mp3 patent and software license
This patent and software license license [sic] covers patents and mp3 software (Windows, MacOS object code libraries) developed by Fraunhofer IIS-A.
Decoder US$ 0.75 per unit
There is an initial fee of $15,000 due upon execution of the license. This fee is a one-time charge and not an annual fee or an annual minimum. Small entities, defined as those with fifteen or fewer employees and with annual gross revenues of less than US $1 million, qualify for a reduced initial fee of $1,000. The initial fee will be waived for existing MPEG-2 AAC, MPEG-4 AAC, or MPEG-4 HE AAC licensees that take the AAC license.
Consumer PC Software
Decoder Products, Per Unit Fee $0.48
Maximum Annual Payment, $32,000 per PC Software Product
Section 3 of the License provides the schedule of royalties that apply to the sublicenses granted under Section 2:
For MPEG-2 Encoding Products in hardware or software, the royalty is … $2.00 under the new extended License…. This sublicense does not grant a license to use MPEG-2 Encoding Products to encode/produce DVDs or other MPEG-2 Packaged Medium for other than personal use of Licensee’s customer.
No license is conveyed unless applicable royalties are paid. Therefore, only products on which royalties are paid are licensed.
Under the MPEG-2 Patent Portfolio License the party that offers MPEG-2 Royalty Products (Section 1.18) for Sale (Section 1.22) to the End User is responsible for royalties on the various categories of end product (in hardware or software) sold or placed into the Licensee’s stream of distribution to the End User. In other words, a product made by a Licensee that carries the Licensee's customer's brand name or is otherwise controlled by the Licensee’s customer is not a licensed product under the Licensee’s License; if the Licensee’s customer has also executed the License, such product would be a Licensed Product under the customer’s License once the applicable royalty has been paid. This is because the product is not Sold in accordance with Section 1.22 of the License to an End User through Licensee's chain of distribution (rather, it is Sold through Licensee's customer's chain of distribution). [emphasis added]
A most favorable royalty rates protection is included to assure Licensees that no Licensee will get more favorable royalty rates than another (Section 7.7).
Note: All links and excerpts were collected in early May, 2012. Some of this information can and undoubtedly will change over time. I am not a lawyer, and nothing I this post constitutes legal advice. Do not make any important decisions based on the summary information in this post without doing your own homework, including consulting with your own attorney before executing any contract.