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Cashing advanced set-tops

Sun, 06/30/2002 - 8:00pm
Craig Kuhl, Contributing Editor

Can HDTV, PVR and other new services help more powerful
(and more expensive) boxes pay their way?

Advancing the business case for next-generation set-top boxes and the services they will enable is emerging as a top strategy for cable operators and the vendor community in the drive to fresh revenues, better cost efficiencies and the growing pressure to gain a competitive edge versus DBS.

Building the business model that allows interactive and advanced services such as PVR (personal video recording), high-definition (HD) television and interactive TV via brainy, software-laden advanced set-top boxes is pushing operators and manufacturers to new levels in their efforts to find untested revenue streams and reduce costs–all while adding value to their bundled packages of video, data, and in some cases, telephony service.

And the stakes are rising. Customers are showing increased interest in PVR and HD-type services, and the economics of driving advanced set-tops deeper and wider into their homes are gaining appeal, particularly as the costs of key set-top components drop, and the emphasis on competition and new revenue streams emerges.

Add in the high cost of losing and re-acquiring a subscriber, and the importance of leveraging value-added services to retain valuable customers spikes even higher.

Where's the demand?

"Consumers want these services. In fact, even more than we've acknowledged," notes Howard Horowitz, president of Horowitz Associates Inc., a market research firm. "There's a robust consumer market for these services, and it follows the same numbers as digital. But, does the ROI (return on investment) justify the capital investment? It's debatable."

The debate is whether emerging services and applications such as VOD, subscription-VOD, PVR and HD can pay their own way, and justify the cost of the edgy–and pricey–software and technical horsepower embedded in advanced set-top boxes that enable them. The numbers appear to indicate that a compelling business model is taking shape, albeit one still in its infancy.

For example, 40 percent of digital customers report an interest in VOD, and 50 percent say they're willing to pay $7 a month for PVR service, while 33 percent would pay $13 a month for VOD and PVR on top of their $10 to $12 digital service nut, according to a new Horowitz Associates study, "State of Digital and Interactive Television."

"The broadband connection business is closing in on 30 percent penetration. But can operators structure their business to meet the demand? The business models are just emerging," Horowitz maintains.

Where's the money?

The emerging business models aren't exactly on a fast track, however. Most major MSOs are nudging their models forward, and are painfully aware of the financial investment needed to deploy advanced set-top boxes to a developing market.

"These services have value to our consumers and can deliver incremental value and revenues and solidify the digital platform in the home. That's where the revenue is," says Lynne Elander, vice president of video product management for Cox Communications Inc. "We want to provide this suite of services, but we need to generate an ROI. Just because there are new advanced set-tops available doesn't mean we'll buy them."

Cox, Elander adds, will invest first in VOD, followed by HDTV, and finally PVR/iTV. "There's lots of talk, but a small number of HD households exist, and we're intrigued by PVR but haven't launched it," she says. "Once it's in consumers' homes, however, it's very sticky and could give us an advantage versus DBS. It will be an amazing retention tool once we get the customers to understand its value. But right now, we really don't know what the incremental revenues will be with PVR, so we need to test it in the market."

The market for broadband applications–including PVR, HD and VOD–is expected to reach roughly $32.4 billion by 2005, predicts McKinsey Quarterly. And, more than 60 percent of current PVR owners want PVR functionality in every TV in their homes, reports NextResearch.

"Multiple TVs with services like PVR can generate additional revenue and is a competitive edge versus DBS because it can attract and retain the most profitable customers," says Paula Giancola, vice president of marketing for Ucentric Systems, a provider of on-demand software. "We've found PVR service can reduce churn by as much as 30 percent and can add about $10 a month of revenue. But in the end, there must be a payback, and it's about two to three years, so the advanced set-top boxes can pay their own way."

At more than $600 per box, in some cases, they'd better be able to pay their way.

"HD and PVR are the drivers to advanced set-tops, and they seem to be selling pretty rapidly, and the economics become better when there are multiple TVs in the household," says Adi Kishore, analyst for the Yankee Group. "If an advanced box is $600 and breaks across three TVs, the economics become compelling with PVR, HD and interactive TV. And there's no investment needed for a home network system."

For both the buyers and sellers of advanced set-top boxes, the operative words are capital investment and cost reduction. "Products like PVR, HD and VOD don't create truck rolls," says Mike LaJoie, vice president of corporate development for Time Warner Cable. "You only add software, and SVOD is even a better story. Advanced boxes allow more than a basic network and a full gamut of products, which increases the value of the subscription. So, the real economic model is evolving, with some value-add and some revenue. But the real win is a better product, and that means more customers."

A growing number of those customers will want advanced services such as HD and PVR, experts say, and those require next-generation boxes, which are typically twice the price of the currently deployed models. But it's revenue potential and value-add that count, they insist.

"Operators get $12 to $14 for digital service on today's set-tops, which cost about $300 with margins of about 60 percent," offers Dave Davies, director of strategic marketing for subscriber networks at Scientific-Atlanta Inc. "Our Explorer 8000 is $650 [per unit] and will offer HD and PVR. Operators keep the entire $9.95 a month for PVR, and the entire $12 to $14 a month for digital and any HD revenue. It's an offensive weapon for cable and an opportunity to grow top-line revenue and reduce churn, with a faster payoff than with entry-level boxes. PVR and HD are definitely driving the advanced boxes."

Where's the ROI?

Some experts maintain that before a workable business model can be developed, however, the cost of advanced set-tops must be driven lower.

"If the cost of advanced set-tops is low enough versus payback, yes, they make sense," says Peter Jarich, director of research for the Strategis Group. "But if costs are much higher for advanced boxes, it isn't worth the investment as a marketing tool for cable. At what point do the equipment manufacturers cut the cost of advanced boxes where they can't make them work? But, there's definitely an argument to make for advanced set-tops. They can reduce churn and help the bottom line–and they'll free up bandwidth for high-speed data. The business models just aren't there yet."

For most vendors, however, the market for advanced boxes is heating up as the cable industry explores the revenue and value-added potential of services such as HD, PVR and iTV. Just how hot it gets is likely to take years to determine. In the meantime, costs and ROI are the most pressing issues.

"Cost is always a big threshold, along with ROI and capital expenditures," says Dan Ward, director of marketing for Pioneer Electronics Inc., maker of Voyager-branded digital cable set-tops. "It's a sensitive issue, especially with DBS competition. That's why our ability to reduce costs and hit our cost targets is crucial. Sometimes we can, sometimes we can't, but we're always within 10 percent on either side."

Pioneer's Voyager 3000 is now priced between $240 and $320, Ward notes. "We've dropped the price $100 in just 18 months. By installing a new chipset, reducing the set-top's size and increasing its connectivity, we've lowered the cost by 33 percent, and other costs are falling, too," he adds.

Pioneer will trial its Voyager 3511 HD set-top, priced at about $400 per unit, later this year. "There's greater demand for HD and PVR, so we've shifted our business plan to focus on those two products," Ward says.

For many set-top makers and cable operators, however, demand for HD and PVR services has been a surprise.

Figure 2: Customer adoption of digital cable.

"Most people didn't expect the demand for HD to be as high as it is," says Bernadette Vernon, director of strategic marketing for Motorola Broadband Communications Sector. "The cost of [an HD television] is still expensive, and HD requires decoding technology–that's where the cost is. But once HDTVs are priced under $1,000, people will start making the commitment," she predicts.

Motorola has a PVR-ready HD product with its DCT-5200 and DCT-2600 series set-tops. It's also pushing the DCT-501 (an integrated audio/video box) to retail outlets with a suggested retail price of $899. And in May it demonstrated its new BMC-9000 "media center" that can push HD and PVR content to multiple TVs in a household.

The business model for advanced set-tops, with HD and PVR technology being key components, is not only gaining attention as a potential revenue generator, but some say its real advantage, at least in the short term, lies in its competitive edge versus DBS and its value as a retention tool.

"HD may not be a revenue generator now, but it allows operators to retain customers and reduce churn, and those are very valuable to operators," says David Novak, director of marketing for Pace Micro Technology Americas, a set-top maker that's making inroads in the U.S. via deals with Time Warner Cable and Comcast Corp. "They feel the competition and know they need to find a way to reduce churn."

For set-top manufacturers, that means more advanced boxes at lower prices to meet the cable industry's insatiable thirst for cost reductions.

"Some operators may not be ready to deploy advanced set-tops, so our challenge is to make them cost-efficient and compelling in content for all types of operators," Novak says. "But remember, there's only a certain amount of revenue derived from one TV, so spreading the revenue around to different devices in the home is the future for revenue generating services. And it can lower programming costs as well because of the economies of scale."

Whether or not that translates to a landslide of advanced set-top box orders by cable operators, or a significant spike in customer demand for HD, PVR and similar products, is the puzzle looking for pieces. But the business model for these services isn't likely to be built anytime soon.

Concludes Kishore: "Satellite hasn't gained a huge advantage with its PVR service, so there's no overwhelming pressure for operators to roll out advanced services. Operators have stepped back to review what customers are interested in, and PVR is driving that. But it's economies of scale that will drive MSOs to advanced set-top boxes."

 

Incremental costs:

One-time costs, including:

  • Capital cost of ASTB
  • Capital cost of back-end equipment for authentication and security
  • Marketing costs

On-going costs, including:

  • Maintenance cost on hard drive in ASTB, roughly 20 cents per month over base
  • Customer support of new services like multi-TV PVR.

Incremental benefits:

One-time capital cost savings, including:

  • Lower capital cost for TVs beyond the first, roughly 50 percent less than current standard set-top boxes
  • New revenue streams from new services, including approximately $9.95/month for multi-TV PVR
  • Monthly subscription for multi-speaker digital music, approximately $9.95/month
  • Advertising fees for targeted/personalized advertising
  • More revenue from existing digital TV services
  • Lower churn, from 10 to 30 percent
  • More VOD and PPV buys, approximately one additional each month.

Source: Ucentric Systems

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