Wal-Mart enters the battle of TV vs. the Internet

While everyone else was watching the Olympics on TV this week, TV and movie industry executives were watching a deal between Wal-mart and a little-known Silicon Valley startup.

That’s because Wal-Mart said Monday it is buying Vudu, whose embedded technology enables viewers to buy or rent HD movies from a catalog of 16,000 titles via a broadband connection.

Wal-Mart’s previous foray into web-based video delivery was a flop. Launched in 2007, its service shut down less than a year later when Hewlett-Packard discontinued the technology platform on which it was built.

The retail giant had to give it another shot. The largest seller of DVDs in the U.S., Wal-Mart (WMT) has watched its business decline as viewers switch from buying discs to renting them from mail-order services like Netflix, or ordering movies on demand from cable providers.

Speculation has risen about what the Vudu deal will mean for the nascent Internet-connected television business. Most industry watchers suspect that Wal-Mart, which made a big push into consumer electronics over the last two years, will prod manufacturers to embed Vudu’s technology in the products that line its shelves.

Such a move could give Wal-Mart direct access to consumers in their living rooms and give its service a leg up over those offered by Netflix (NFLX), Amazon (AMZN) and Apple (AAPL). Through a partnership with Sonic Solutions, rival Best Buy (BBY) already has a plan to offer Roxio CinemaNow movie-downloading software in all its web-connected devices in U.S. stores.

But while Wal-Mart may have sway with electronics makers, its pull with studios and networks is less certain. Some industry watchers believe the retailer’s status as the top DVD seller gives it favored status. Still others say Apple’s struggle to gain the movie industry’s cooperation portends challenges ahead for Wal-Mart as it tries to build its catalog.

An even bigger test for Wal-Mart may be a pricing model that wins over consumers. Vudu currently sells movies for download the same day the DVD becomes available, but at $20, the new releases are more expensive than most physical DVDs. Meanwhile, the films are not available for rental until after the industry-established 28-day waiting period, when they go for around $4 (and must be watched within a 24-hour period).

In contrast, Netflix’s subscription service starts at $9 a month and includes unlimited streaming of the 17,000 films in its catalog as well as DVDs of new releases the day they become available for purchase (with the exception of Warner Brothers films). Viewers can watch streaming video on their PCs or TVs with a range of devices including Tivo (TIVO), gaming consoles, and Internet-connected Blu-Ray players and TVs.

Wal-Mart could take a page from its rivals, says Michael Greeson, research partner at The Diffusion Group. “We’ve always been big believers in the subscription model,” he says “It’s in Wal-Mart’s interest to pursue that strategy as soon as possible so they can compete with Netflix.”

While Greeson believes that Wal-Mart’s massive DVD sales confer power to negotiate with the movie studios, he notes that a shift to a subscription model could negate that leverage, since the studios prefer the more profitable pay-per-view model.

Although Vudu claims to offer superior visual quality thanks to its HDX video format, this factor alone is unlikely to outweigh pricing and access to new releases available from Netflix, not to mention its sophisticated recommendation engine. For evidence simply look at Netflix’s growth: the service added over one million new users in the fourth quarter of 2009 alone to hit 12.4 million total subscribers.

Several industry watchers are wondering exactly what Wal-Mart got for the rumored $100 million it paid for Vudu. Some suggest it comes down to Vudu’s studio deals, and to the talent and culture of its team, which Wal-Mart may have struggled to assemble on its own. At the very least, it’s a foot in the door for the biggest of the big-box stores.