Monday, Anthony DiClemente, a Lehman research analyst, downgraded expectations on major media companies including CBS, News Corp, Disney, Time Warner, and Viacom. DiClemente noted the impact of digital media on the traditional business, and made comparisons to the music industry. DiClemente went on to question Hollywood’s preparedness for the coming environment in digital.

DiClemente’s point is well taken. In fact, we believe that the history of the newspaper and music industries are great predictors of the challenges Hollywood will face. Whether or not Hollywood can better tame the momentum of its physical media business to react differently remains to be seen.

Hulu is certainly a good sign, an indication that a couple studios are willing to make unconventional, aggressive moves in the new arena. The studios’ position on Net Neutrality, however, is not.

Let's take a look at Hollywood's position, but let's start with two definitions:

Net Neutrality refers to the source side… those who send bits. The issue centers around whether network operators should be able to secure fees from websites like Google, Hulu, NetFlix to prioritize bit delivery. Those favoring Net Neutrality are against such fees and in favor of an unfettered, open Internet.

Download Caps refers to the consumer side… those who receive bits. The issue centers around whether network operators should be able to charge higher fees to heavy downloaders for their excess usage. Those against Download Caps are in favor of an unfettered, open Internet.

While I believe that Net Neutrality (and avoidance of Download Caps) are in the public’s best interest, I also believe that the network operators have the right to monetize their assets. And, it is up to consumers and 3rd parties to advocate strongly for an open Internet, using all their wiles and persuasiveness to convince network owners to rethink these strategies.

Strangely, of all the players that I’d expect to line up for Net Neutrality (and against Download Caps), Hollywood is going the opposite way. It is supporting the network operators and opposing Net Neutrality.

Hollywood’s reasoning goes something like this… If we support the cable companies on this, they’ll support us on implementing anti-piracy measures. (Here’s a link to an article that further describes the MPAA’s position.)

Uhh… sure. The cable companies crossed their hearts and double pinky swore, so it’s a done deal. Right?

The experience of Virgin Media should be educational. Last month, Virgin Media paired with the BPI to send out warning letters to its broadband customers who appeared to be engaging in illegal file sharing. After consumer backlash and a PR mess, Virgin was forced to backpedal and state that they would not cutoff their users. (For those interested, here’s a link to an article about the Virgin Media situation.)

The CEO of Carphone Warehouse, a Virgin Media competitor, distanced himself from Virgin’s move and quickly responded to the situation,

“I cannot foresee any circumstances in which we would voluntarily disconnect a customer's account on the basis of a third party alleging a wrongdoing."

That’s instructive of how this might play out in the US. Hollywood may be banking more heavily on support from the network owners than it should. Worse, download caps may actually end up giving the network owners incentives to “support” P2P, which generates traffic and thus $$.

The possible insincerity of network owners aside, Hollywood’s position against Net Neutrality is also problematic because it dampens development around digital video.

If DiClemente’s report underscores anything, it is the need for Hollywood to embrace the digital world aggressively and deal with the disruptive technology head-on. To do that, Hollywood needs to invest in next generation services like Hulu and drive innovation in the area.

Hollywood owns the “heaviest bits” on the Internet, getting even heavier as we move to HD. To spur innovation, Hollywood needs an open Internet where those bits move as cheaply as possible. Maintaining Net Neutrality is important to services like Hulu, NetFlix, Vudu and CinemaNow, who would otherwise face much less attractive margins.

By lining up against Net Neutrality, Hollywood is effectively agreeing to a tax on bits and constraining growth of the digital business. Can you imagine WalMart or trucking companies getting behind a highway tax based on load weight? I can’t.

It’ll be interesting to see this evolve. The cable companies are pushing hard to preserve their position in the future, and you can’t fault their capitalistic incentives. But, from where I sit, Hollywood doesn’t appear to be doing the same.