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Microsoft May Be A TV Star Yet


History will remember Microsoft Corp. (MSFT) as one of the greatest business success stories. But the company has suffered its share of ignominious failures, too. There has been no business where Microsoft has spent so much for so long and achieved so little as its foray into television technology.

Until now. After more than a decade of trying to crack the TV software business, Microsoft's persistence is starting to pay off. The first sign came last November, when cable-TV industry leader Comcast Corp. (CMCSA) rolled out set-top boxes running Microsoft's TV software to its Seattle customers. Since then, Microsoft has landed deals with two Bells -- BellSouth (BLS) and SBC Communications (SBC) -- as they charge into competition with cable operators. And BusinessWeek has learned that Verizon Communications (VZ) Inc., the Bell that's making the most aggressive foray into television, plans to use Microsoft's technology for its TV service, beginning with its initial rollout in the second quarter. "We have a shared vision of how the world is evolving," says Shawn Strickland, director of Verizon's new service, FiOS TV.

Microsoft's burst of progress comes just as the TV business is on the verge of massive change. Deep-pocketed telecom companies are starting to move into the market, challenging cable players that are offering telephone service over their networks. The resulting battle has both sides racing to roll out new, sophisticated TV services, including vast libraries of movies on demand and personal video recording.

ENORMOUS POTENTIAL

The key technology for delivering these services is something called Internet protocol television, or IPTV. The technology can be used to offer a dizzying array of options: Desperate Housewives anytime you want it, the Super Bowl from a dozen different camera angles, and a nearly limitless number of channels. Telecom companies are embracing IPTV since they're building their TV systems from scratch. Cable companies, which use older technology, are likely to begin migrating to IPTV over the next five years. Analyst Hervé Uteza with the Diffusion Group Inc. estimates that 15.3 million homes will subscribe to IPTV services worldwide by 2008, compared with 184 million using traditional cable technology.

Microsoft, if it plays its cards right, could end up smack dab in the middle of this emerging business. Its IPTV software is only in small trials and in telecom company labs, but experts say it's the early leader in this nascent market. "Microsoft's platform is the most promising," says analyst Josh Bernoff of Forrester Research Inc. (FORR) "There will be a lot of Microsoft software on set-top boxes five years from now."

Initially the payoff may not be huge. Microsoft gets $2 to $5 for each set-top box that uses its software, which manages the electronic program guide, digital video recording, and other aspects of the viewer's experience. Right now the bigger-ticket item is the software to power the mondo servers that do everything from dishing up programming to managing anti-piracy protection for video content. Analyst Rick Sherlund of Goldman Sachs & Co. (GS) estimates that Microsoft's total TV revenues will be less than $1 billion for the next several years. Yet the growth potential is enormous. With 1.7 billion TV sets worldwide -- more than double the number of PCs -- Microsoft's television initiative could ultimately blossom into a mega-business.

NO SURE THING

The bid's strategic importance may trump its revenue potential. Chairman William H. Gates III is betting that Microsoft will land enough TV deals that it will play as significant a role in the living room as it does in the office. Gates envisions a time when set-top boxes snap into a network of digital products -- with the PC at the center, of course -- that shoot video, music, and photos around the house. He declines to predict specific revenues but says Microsoft eventually will recoup the nearly $500 million it spent on TV software over the past decade. "It will absolutely pay back those early years," he says.

Yet Microsoft's success is far from a sure thing. Building technology for the next generation of TV is tricky. There's no certainty that Microsoft's products will outpace those of its competitors -- which include equipment makers Siemens (SI) and Alcatel (ALA) and smaller companies such as Kasenna. In addition, some potential customers have reservations about doing business with the company that thoroughly dominates the PC industry. They're either steering clear of Microsoft altogether or avoiding lock-in by mixing and matching technologies from Microsoft and others. "There's a certain level of caution companies have when they work with Microsoft. It won't be in the monopoly position it has had with the PC business," says Verizon's Strickland.

Shoddy technology, arrogance, and poor timing derailed Microsoft's earlier efforts. In 1994, with great fanfare, Microsoft unveiled its first advanced TV project, Tiger, which stored video on computer servers and shot them to viewers at their request. At the time, the cost of the technology made the system prohibitive. Microsoft kept plugging away through acquisitions and new products but never managed to get any traction. One reason: It tried to push its own brand in front of viewers, alienating cable operators.

To claw its way back into contention, the company has had to rethink its strategy -- and eat a bit of crow in the process. Since taking over the TV business two years ago, Vice-President Moshe Lichtman has toned down Microsoft's efforts to promote its own brand. "They understand that it's an SBC service. It's not Microsoft," says Lea Ann Champion, senior vice-president for information-processing operations and services at SBC, which gave Microsoft the largest IPTV software deal ever, agreeing to pay the company $400 million to provide TV software for the next 10 years. Subscribers won't see any Microsoft branding at all in SBC's offering.

Most surprisingly, Microsoft no longer insists that set-top boxes run a trimmed-down version of Windows, known as Windows CE. Instead, while Microsoft's first IPTV product runs on Windows, later versions will be designed to run on operating systems from Motorola Inc (MOT). and other rivals.

JUST-IN-TIME CHANNELS

While the scope of Microsoft's opportunity is still in question, there's little doubt that IPTV will change the way couch potatoes get their programming. Today's cable systems were designed to have every channel they offer flow to each set-top box at the same time -- ready for the viewer to select one. But with all of that programming clogging the cable into a home, cable operators can offer only a limited number of channels.

IPTV does away with that design. Only one program shoots into a set-top box at a time. When a viewer clicks to a new channel, the set-top box notifies a computer server at the IPTV operator's facilities to instantly send a new stream of programming. This superefficient design gives viewers no end of choices. Down the road, IPTV providers expect to be able to let customers roam the Internet in search of interesting video too -- whether it's news clips, blockbuster films, or a blogger's home movies.

Gates is confident that consumers will want IPTV. "People care about the TV viewing experience. If you can really make it better, it has a really profound impact," he says. If Microsoft can pull this off, it might be able to turn its decade-long slog in TV technology into a sprint. This show is about to get interesting.

By Jay Greene in Redmond, Wash., with Heather Green in New York and Andy Reinhardt in Paris


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