Mozilla and I have a long and not-so-storied history together. I first began running what was at the time called the Mozilla App Suite with the "Milestone 10" release in October 1999. I was (I believe) one of the first people outside of the core team to build (as in compile) the browser that would come to be known as Firefox. It was called Phoenix at the time and the team hadn't released any binaries. I remember talking to the core team on IRC getting instructions as to what build flags to add to build Phoenix rather than the app suite. For a time, I released unofficial nightly versions of Phoenix (then Firebird) compiled with Xft support for anti-aliasing on Linux that were distributed through MozillaZine. Long story short: I've contributed only slightly to the project; but I've supported it as long as anyone and generally my ideals match up nicely with the Mozilla team.
I'm a huge supporter of open formats; I always have been. One of the main reasons Microsoft was able to rise to its Monopoly-level dominance was the proliferation of the proprietary MS Office file formats. However, I have reason to believe that Mozilla's decision not to support H.264 encoded video via the HTML5 video tag due to the "patent encumbrance" of the codec, is a wrong decision and one that, unless they change their mind, will kill any hope of ushering a new era of online video distribution that exists without plugins. Mozilla has always been an organization willing to take a stand for what they believe in; and they believe in the open web.
Three of Four
With Microsoft announcing support for H.264 video in IE9, three of the four "big name" browsers will be supporting H.264 video. Truthfully, this move surprised me when it was first announced; I had assumed, like others, that Microsoft would choose only to support their own proprietary format. The success of Office taught the team in Redmond that simply using proprietary formats isn't good enough; you have to completely own the format. However, without support from Mozilla, H.264 can never be the "encode once, deploy anywhere" format that people and businesses need it to be.
Encoding is slow and expensive
Video encoding is a very processor-intensive process; it's time consuming, expensive, and the resulting files are large which lead to bandwidth and storage costs. The current Flash implementations on the web are already H.264 capable, and much of the video content for the web is already encoded in H.264. It's nothing but an expense to create and maintain additional encodings. And even if we as web developers can create a robust fallback system that prevents the user-experience of online video from regressing to the days of "choose your format," the added costs are something most companies simply cannot ignore.
I say that harboring no ill-will towards the very talented engineers who have sunk countless hours of their time into Theora. But as numerous comparisons have shown, it simply can't keep up with H.264 in terms of quality; especially at low bitrates. MPEG2 was once considered great; but in the face of the current top-dog codec, it (like Theora) sucks. People and businesses are willing to embrace free software when it provides an equal or better product than the proprietary alternatives (see the success of Linux on the server). However, when free software doesn't keep up with the best non-free products, people stay away (see the lack of success of Linux on the desktop). Simply put, there just aren't that many people who share the same moral imperative as the Free Software Foundation; most of just want it to work.
There's a Precedent Too
Mozilla has a track record of not sharing the stance of "nothing proprietary," which implies that as an organization, Mozilla is willing to pick it's battles. If it wasn't, it wouldn't allow proprietary plugins like Flash. Imagine also if Mozilla had taken the same stance against GIF images in the early 2000's when the format was patent-encumbered just as H.264 is today; the browser barely would have gotten off the ground. In that instance, pragmatism and the need to not break the web won out over a desire to only support free and open formats.
Don't Break the Web
Team Mozilla: I understand your desire to show support for free and open formats and I empathize with your belief that the best way to advance the web is to truly embrace those formats. But I wish this fight was one in which you'd lay down your sword. I disagree that "being idealists" is your reason for being. I believe that your first responsibility as a browser vendor is to make the web a better place; it's certainly what you've strived to do since your inception. But honestly, from the view of a realist, the only thing you're going to accomplish is making the HTML5 <video> tag unusable.
Two Proprietary formats
What's worse, you'll force people to continue to use Flash as the preferred delivery platform for video on the web (which, as covered above, already uses H.264 for video). Instead of one proprietary format, people will now be forced to use two simply because of your refusal to accept that sometimes you have to take a few small steps to get to your goal. I hope you can at least agree that going from two proprietary formats to one is a marked improvement.
...don't do this to one of the most exciting and promising technologies being delivered in HTML5. You're voluntarily creating another format war and the only result of format wars is people avoid both alternatives because it's too much work to support both. Help us continue to make the Web a better place and move it forward one step at a time; even if those steps aren't quite as long as you'd hoped they'd be.
Update (8:20 am EDT)
I've created a response post that addresses some of the points in the comments titled Mozilla's Not Non-Profit (and Other Thoughts). Thanks to everyone who read this and considered its content and has an opinion to share. Disagreement builds great conversation!
Update (March 22)
I've written a follow-up piece about browsers supporting Theora and my belief that despite the its shortcomings, it has a real place in the future of the Web. Please check out Dear MSFT and AAPL, Embrace Theora!