• Illustration: TV Division Changes Signal New Realism About Market

Responding to low demand for interactive TV (iTV) services, Microsoft has reorganized its TV Division, eliminated its UltimateTV business unit, and introduced higher prices for its iTV developer program. Although the UltimateTV service will continue to exist, the moves signal Microsoft's growing reluctance to subsidize the iTV market by operating its own services, creating and licensing hardware reference designs for set-top boxes, and maintaining low prices on its iTV software and development tools.

What the TV Division Did

Microsoft's TV Division encompassed three lines of business:

Microsoft TV (MSTV) platform. MSTV consists of client software for set-top boxes, which is based on Windows CE and technology from Microsoft's 1997 purchase of WebTV, and iTV server software, which runs on Windows 2000 and SQL Server. Microsoft sells MSTV to cable and satellite network operators such as AT&T, the Netherlands' United Pan-Europe Communications (UPC), and Portugal's TV Cabo, often investing in these operators. The operators then use the platform as the basis for iTV services, often incorporating applications and content developed by other parties. (In Feb. 2002, Microsoft sold its entire stake in UPC.)

iTV services. Microsoft also owns and operates its own iTV services, sometimes in conjunction with a network operator. The most prominent of these is UltimateTV, a digital video recording and Internet-on-TV service that Microsoft launched with much fanfare in Mar. 2001, and which is available exclusively to subscribers of the DirecTV satellite network. Other Microsoft-owned and operated iTV services include TAK, a European joint venture with Thomson Multimedia, and WebTV, which was moved out of the TV Division into MSN and renamed MSN TV in 2001.

Hardware design. The TV Division also created reference designs for set-top boxes. For example, it designed the "Solo" graphics chips for processing digital video streams in the WebTV Plus and UltimateTV set-top boxes. Microsoft licensed its designs to set-top box OEMs such as RCA Thomson and Sony.

UltimateTV Unit Split

The TV Division was reorganized in Jan. 2002 and lost the service and hardware design businesses, keeping only the MSTV platform.

Most significantly, the UltimateTV business unit has been eliminated. Of its 420 workers, 252 will be reassigned; the other 168 will lose their jobs if they cannot find another position at the company. The UltimateTV service will continue, and its remaining operations and business development staff will become part of the MSN organization. Software engineers who were working on UltimateTV will be reassigned to the MSTV platform.

The Advanced TV Services unit for iTV joint ventures will also become part of the MSN organization.

The TV Division's hardware engineers will move to the Xbox Group, where they will work to improve the gaming console's efficiency and lower the cost of manufacturing. These engineers might also work on Xbox-based home entertainment units and Internet gateways reportedly under development, although Microsoft insists it has no such plans.

The leader of the TV Division, Jon DeVaan, has taken an administrative leave and is being replaced by Moshe Lichtman, a 10-year Microsoft veteran who consulted on the company's early TV efforts. Lichtman most recently oversaw the company's consumer and device strategy outside the United States. In addition, WebTV cofounder Phil Goldman has left the company, leaving Bruce Leak as the only original WebTV executive still working for Microsoft. (For a complete overview of the organizational changes, see the illustration "TV Reorganization, Mar. 2002".)

Developer Program Adds New Levels

Shortly before announcing these organizational changes, Microsoft overhauled the MSTV Developer Program, adding new features and raising prices for most partners. Previously, the program had only one level, which cost US$1,000 per year and offered a standard set of development software, technical information, and support. Now, there are three levels:

• A free Introductory Level for content developers and ISVs to build prototype applications. It includes a content development kit, a new MSTV simulator that runs on a PC, new add-ins for Visual Studio .NET, and limited training and support.
• A Client Level for content developers, ISVs, and hardware companies that are interested in developing for the MSTV Advanced set-top box client. For US$3,000 a year, these partners receive everything in the Introductory Level plus five licenses for the client software; the right to buy set-top boxes or CE development PCs; a new JumpStart Kit with documentation, sample code, and examples; discounts on training and developer events; and other benefits.
• A Server Level for organizations that want to develop client-server iTV applications or test their products in a full client-server environment. For US$7,000 a year, these partners receive everything in the Client Level plus five licenses for MSTV Server software and a higher level of training, information, and support.

Although the Introductory Level could attract some new organizations to explore the platform, the other two levels represent significant price increases for companies already developing MSTV solutions.

What the Changes Mean

Microsoft never reported sales figures for UltimateTV, which suggests that the product did not meet expectations. Sales might have been hampered by several highly publicized glitches, including one that caused its hard drive to mistakenly register as full.

The failure of News Corp. to buy DirecTV also played a part in the decision to downsize UltimateTV, according to a Wall Street Journal interview with DeVaan. If News had succeeded, UltimateTV might have found a place in its large overseas satellite market. (See "UltimateTV, Sky Networks Agreement" on page 27 of the Sept. 2001 Update.)

More generally, the changes reflect low consumer demand for iTV. For example, TV Cabo rolled out an iTV service based on MSTV in June 2001; six months later, executive Abilio Anca Henriques claimed that the service had only 2,500 customers, far below expectations of 100,000 subscribers by the end of 2001. Even the most popular iTV service, TiVo's personal video recording service, had only 280,000 subscribers at the end of Oct. 2001, more than two years after its launch. This is paltry compared with more established consumer markets—by way of comparison, Microsoft sold 1.5 million Xbox gaming units in the six weeks ending Dec. 31, 2001.

The following recent changes in the TV Division reflect this reality:

• Unless clear customer demand emerges, Microsoft will not create, operate, and market new services, and will instead leave this business to network operators. Microsoft will try to recoup costs on its existing iTV services by using them to guide viewers to other fee-based services (e.g., messaging, e-mail storage) being created by the MSN and Personal Services Group.
• Microsoft will no longer create and license hardware reference designs for set-top boxes, but will instead leave this work to hardware vendors. Microsoft’s own hardware engineers will work in a market with proven demand—console gaming.
• Microsoft will attempt to recoup some of the costs of developing its iTV platform by charging partners higher prices to participate.

Platform Development Continues

In spite of the unproven market, Microsoft must remain in the iTV business partly as a hedge in case the TV set-top box usurps the PC as the preferred consumer device for Internet access and interactive entertainment, and partly because set-top boxes represent a closed environment that is very seldom upgraded or replaced—if Microsoft can get into homes in this fashion, it will be difficult for a competitor to oust it.

With these business reasons in mind, Microsoft will continue to improve and market the MSTV platform. In Jan. 2002, it released MSTV Advanced 1.5, which allows IP traffic and TV broadcasts to travel over the same cable connection, eliminating the need for a separate dial-up or DSL modem in the set-top box. In Nov. 2001, the company entered an agreement with cable operator Charter Communications to test and deploy MSTV in 1 million homes. (See "Charter, MSTV Sign Deal" on page 10 of the Jan. 2002 Update.) In short, Microsoft is not abandoning iTV, but it will no longer subsidize the market as much as in the past.

Resources

Details about the MSTV Developer Program are available at www.microsoft.com/tv/DevProgram/levels.asp.

UltimateTV is at www.ultimatetv.com.