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Is Digital Convergence For Real?


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IS DIGITAL CONVERGENCE FOR REAL?

A Microsoft deal redefines an old vision

The announcement on June 9 that Microsoft Corp. would invest $1 billion in Comcast Corp. rekindled hopes that "convergence" might once again be in the air. Back in 1992, Tele-Communications Inc. Chairman John C. Malone set that buzzword in motion when he told a cable-show audience his vision of all-digital, fiber-optic networks that would enable TCI and other cable operators to offer 500 channels, interactive programming, and all sorts of services, including electronic mail and, perhaps, telephony. That picture of digital convergence was so compelling that cable, media, and phone companies promptly hopped on the bandwagon.

Several billion dollars later, it became clear that convergence was a bust. Cable companies, perennially strapped for cash, scaled back on their plans to upgrade their networks to handle huge amounts of interactive data. Phone companies that had hoped to offer television service--on their own wires or in joint ventures with cable companies--went back to their core businesses.

Now, the Microsoft-Comcast deal is redefining the concept of convergence and putting it back on the map. But major questions remain about whether convergence--as redefined by the Microsoft-Comcast deal--will click.

Why should the new wave of convergence fare better than the first?

To begin with, this time the concept of convergence is less pie-in-the-sky. Instead of inventing all sorts of digital services for a new, high-speed cable system, the Microsoft-Comcast deal is aimed at extending to cable the already fast-growing Internet access business. Microsoft teamed with Comcast because Chairman William H. Gates III was tired of waiting for the completion of the so-called broadband network--a digital pipeline that was fast enough to show off current Web offerings such as Microsoft Network (MSN) and would make possible new ones such as real-time video. At the same time, Microsoft is exploring other pipeline possibilities. It has a phone project with GTE Corp. and is working with DirecTV on a satellite system.

Comcast got the cable nod, says Gates, because it's further along than most of its rivals in building a high-speed network--a combination of fiber-optic and coaxial cable. Comcast has recently begun offering so-called cable modems on a limited basis in some cities. The devices feed Internet data to PCs from the cable system at about 25 million bits per second. "It's important to have one company that we have a very close relationship with that we can go out and do the pilot studies and really demonstrate what's possible here," says Gates. Also, Microsoft hopes the deal will prompt other cable companies to speed up their upgrade plans.

What will the Microsoft-Comcast combination produce? "I'm not going to create an expectation that this is going to happen overnight," says Comcast president Brian Roberts. "My hope is that we use this as a catalyst event to change and accelerate the development of products and the development of the [broadband] network."

Will other convergence deals follow? It's hard to identify other likely combos. But, says Robert W. Pittman, CEO of AOL Networks, "We hope the cable network will be a vehicle for us to connect with people. We hope this deal leads the way in doing that."

What is Microsoft really up to with Comcast and other media investments such as MSNBC, the joint venture with NBC? Is Microsoft trying to become a media company?

It says no. But Microsoft surely means to be a major player in the still hazy world of new media. Microsoft's motivation: While the penetration of PCs in the home seems to have plateaued at less than 40%, almost everyone has a TV, and Microsoft sees a chance to expand its market as TV enters the digital age. Says David Card, analyst with IDC/Link, a market research firm in New York: "Microsoft's next $5 billion comes from corporate software, but the $5 billion after that has to come from the home." The Comcast deal also dovetails nicely with an earlier Microsoft digital-TV deal: Its $425 million purchase of WebTV Networks Inc., which sells a setup for connecting TV sets to the World Wide Web.

"Microsoft is probably spending more than any other company to create new media content for the Internet, so they want a channel for that," says David Rader, a consultant at SRI International. So far, it has seen little payback from its content investments. Neither MSNBC, which appears on cable TV and on the Web, nor MSN has attracted a huge following.

Electronic shopping was one of the promised features of the failed convergence projects. Will it be a reality in the new Microsoft-Comcast model?

Comcast owns the QVC home-shopping cable channel, and its iQVC Web site is selling $1 million a month worth of merchandise. Microsoft is keenly interested in creating a revenue stream from online shopping and will likely position itself as a middleman, collecting fees from an explosion of online transactions. "We'll be sitting down and talking out how we can help QVC move and drive forward their interactive activities," Gates says. "It is an example of content that can have a new form in an interactive world."

What does Convergence II mean for the cable industry?

The stocks of the six largest cable companies jumped 17% in the days following the Microsoft-Comcast deal. Investors now figure that if Gates thinks cable has a future, who are they to argue? And there's always the chance that some other lucky cable company will find a sugar daddy, too. Would Microsoft ever take stakes in other cable companies? "It would be foolish to say we never would," says Microsoft's vice-president for business development Gregory B. Maffei. In the meantime, cable companies are upgrading. Both U S West and Time Warner are spending $1 billion this year to do so.

Still, many companies will remain hard-pressed to come up with the huge sums needed to upgrade their systems to broadband speed. Analysts say it currently costs about $250 per home to provide the necessary wiring and switching equipment. Then there's an additional $200 to $300 per home for cable modems.

But facing mountains of debt, competition for high-end consumers from satellite companies, and confusion over what consumers will want from digital-TV networks, cable companies are not about to accelerate their building plans--regardless of the Microsoft-Comcast deal.

Are the technology problems really solved this time?

Technology isn't the big stumbling block this time around. Time Warner Inc. and other convergence pioneers learned a lot about how to send and receive large amounts of data and video over the cable system. "All this stuff is proven out and they know how to do it," says Michael W. Harris, president of market researcher Kinetic Strategies Inc. The stopper remains cost. Because of the high price of cable modems, only 19,000 homes in North America are currently equipped with them. However, analysts estimate that cable systems that can support such technology now reach some 2 million homes. The upgraded systems also make it possible for consumers to shoot data back at broadband rates--a challenge never solved in Convergence I. Another problem in the past was establishing industrywide standards for hardware and software. Now, industry execs say standards for broadband cable should be in place this summer.

When a cable-based broadband network is complete, what sort of content will it deliver?

This is the most fundamental question--and the one Microsoft, Comcast, and other players seem most reluctant to address. For good reason. In Convergence I, starry-eyed predictions of new forms of entertainment--interactive movies, for instance--quickly proved embarrassing.

Still, compelling content remains the missing ingredient. There has to be something to draw millions of consumers--and advertisers hoping to reach them--to a particular corner of cyberspace. Until Microsoft and others do come up with the content that attracts the viewers that advertisers want to reach, they face an enormous risk: Their new vision of convergence could remain as unrealized as the first.By Elizabeth Lesly in New York and Robert D. Hof in San Francisco, with Peter Elstrom and Amy Cortese in New York, Amy Barrett in Washington, and bureau reports


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