At the end of the entire ordeal, the senior TWC representative that was with us turned to us and asked us what this system could do. We explained, to which he responded with the most priceless of facial expressions. It was an expression that needed no explanation; his reaction asked the question “why on earth would you go through this when you can just rent an HD-DVR from us for $9 a month?”

The Anandtech review illustrates the complexity of the problem; most if not all of the issues involved hardware and network integration problems between Time Warner’s network and the HTPC. The problems were not the ones typically associated with integrating Microsoft (MSFT) software with generic OEM hardware.

It is clear that cable operators need to be equally incentivized to get 3rd party hardware up-and-running as quickly and efficiently as their own set top boxes and DVR’s. Otherwise, the 3rd party hardware model will never succeed. Given Cable’s reluctance to hand over control of their user interface to a 3rd party and forfeit any resulting indirect revenue streams (advertising, downloads, user viewing data) this is not a problem that is going to resolve itself.

One thing is clear, Microsoft has a potential winner with their Media Center software. The interface is universally seen as very user friendly and represents a quantum leap over the first generation of DVR’s such as Tivo (TIVO). Tivo has been stagnant while Microsoft has poured investment (albeit unprofitable) into this segment.

It remains to be seen if Microsoft will port this software to a dedicated hardware platform such as the Xbox360 and integrate the HDTV tuner. This would eliminate any potential hardware/software integration issues and deliver a great experience to a consumer. It appears to me that this is also the only way Microsoft will see any appreciable ROI on their Media Center investment.

Microsoft has already forged a roadmap with AT&T (T ) to use the Xbox360 as an IPTV tuner. It isn’t a big leap to see them work with Time Warner or Comcast (CMCSA) and modify the Xbox360 hardware to emulate a traditional set top box. This would be a winning product for everyone.

The real issue remains – in the not-too-distant future when I can download all of my content over a broadband connection, exactly what purpose will the traditional cable broadcast model serve?

I’m here in Vegas and Microsoft (MSFT) has announced that the Xbox 360 will be morphed into a set-top box, delivering IPTV like functionality. This is something I predicted almost a year ago, based on the fact it made sense and Microsoft appeared to telegraph this.

I’ve always viewed Cisco’s (CSCO) acquisition of Scientific Atlanta negatively for this exact reason. Cisco bought a stupid, cheap, commodity box with no backing service infrastructure. Microsoft can deliver a hardware product 10x superior to the set top box you and I have today, and tie it into all of the other computing and service products they offer- from Xbox Live to your windows desktop to your Outlook email.

I anticipate that this announcement will continue to bring focus to the Nyquist concept of the Third PC, as consumers begin to expect more from the hardware they connect to their living room televisions.

Microsoft has a raft of other interesting announcements. I predict that 2007 is the year the media stops kicking Microsoft and starts respecting them again as a consumer force.

Aside: As a result of my ceaseless focus on this issue this blog is the #1 search result on Google for Xbox IPTV. Use the search box at the upper right to dig through the archives.

I’m off to CES!

Engadget has the details. WSJ reports here.

It is abundantly clear that the center of power in video content distribution is moving from Cablecos to next generation set top boxes using high speed broadband connections.

In the absence of incumbent Cablecos unbundling the content, new providers of set top boxes will.

This is fundamentally why cable companies are over valued, and operators of content platforms (like Microsoft, Sony (SNE), Apple (AAPL) and Tivo (TIVO) ) superbly positioned.

It is the basis for why I think Cisco (CSCO) overpaid for Scientific Atlanta, an operator of legacy hardware tied to the fortunes of the incumbents. From January 2006:

As each day goes by, the Scientific Atlanta (SFA) shareholders who complain $6.9BB wasn’t enough for their commodity box company should shut up and cash their checks. What would you rather provide to subscribers as a cable operator- an Xbox 360 or a glorified radio tuner for video?

Apple will need to ensure their platform supports HDTV, as I postulated earlier.

First impression of the Apple iTV media extender- what marketing guy cooked up the term ‘near-DVD’ quality? What does that mean?

If I am going to go through the trouble of buying and provisioning a media extender for my TV, it better do HD. The venn diagram of people who will go through the trouble to install a media extender and don’t care about picture quality is a null set.

Their silly “near-DVD” marketing description will no longer fly.

Tivo, among other problems, has now completely lost their potential first mover advantage. It will be interesting to see what tricks Sony has up it’s sleeve with the PS3.

If you thought the loss of fixed line voice was giving Telcos a hard time, wait until you see what these new platforms do to Cableco revenue streams.

More later. This was such a big piece of news it needed immediate comment and distribution.

Photo Courtesy of Engadget

The amount of ink spilled about the (AAPL) and Microsoft (MSFT) Zune announcements earlier this week was nauseating. The WSJ has the best summary. If you can take more, read on.

First impression of the Apple iTV media extender- what marketing guy cooked up the term ‘near-DVD’ quality? What does that mean?

If I am going to go through the trouble of buying and provisioning a media extender for my TV, it better do HD. The venn diagram of people who will go through the trouble to install a media extender and don’t care about picture quality is a null set.

Both the Xbox 360 and the new Tivo series 3 can do HDTV. Once Microsoft decides to do movie and TV downloads through the Xbox Live service to the embedded hard drives of XBOX 360′s (which, by the way, only cost $100 more than the Apple media extender), why would anyone want the Apple service? It’s about being able to access your media in a platform independent way, and Microsoft should have the upper hand here, given they control more platforms than anyone.

OK, I’ve got my Vista PC, and the bundled Windows Media Player 11, I have my URGE music subscription service, I have my Xbox 360 which can serve as a media extender, and I have my Xbox Live subscription. Great! Now, I can buy a Zune, and it interfaces via wifi with my Xbox and my Vista PC and my URGE service so I can go mobile. Right? Wrong.

It appears Zune is YET ANOTHER independent brand from Microsoft. Rather than concentrate their firepower on a few brands, like Xbox and Media Player, and leverage those users into Music, Microsoft has chosen to spawn a new software portal called “Zune Marketplace” where Microsoft points can be spent to buy music (what are these? Are they the same as Xbox credits? Why not?). What happened to Windows Media Player? The URGE online service? The millions of Xbox LIVE subscribers? Why start from scratch? Raise your hand if you are confused too.

An in depth interview with J. Allard serves only to obfuscate what the strategy is here.

I confess to previously being excited about the Zune. I anticipated a strategy to use the multiple ubiquitous Microsoft platforms to gain leverage in the mobile platform. I figured the same move was inevitable with the Xbox.

Microsoft used to be able to make moves like this without effort and has a decent rap sheet with regulatory agencies to prove it.

I don’t know where this leaves us. I do know one thing. I want the evil, menacing monopoly Microsoft back. Microsoft used to be so money. Microsoft used to be the Big Bear with the Big Claws. Now, it reminds me of Mike, the depressed loser from Swingers…

TRENT (to Mike): You’re so money, you don’t even know it.

TRENT (pulling him aside, dead serious) Now when you talk to her, I don’t want you to be the guy in the PG-13 movie that everyone’s pulling for. I want you to be the guy in the rated R movie who you’re not sure if you like.

-Swingers (1995)

I want the R rated Microsoft to come back.

And Brown? Am I only one that thinks the Brown Zune is fugly?

I am long Microsoft.

The market appears to be viewing this positively. As investors in Tivo, we won’t complain, but fundamentally the two companies have not changed their relationship. DirecTV continues to develop and market their own set-top with homegrown DVR software and not market the Tivo version.

From the Reuters Article:

DirecTV is a top TiVo customer and the extension of the deal was initially greeted positively on Wall Street, where there had been concerns that DirecTV would transition their TiVo customers to its own service if an extension was not reached.

This is silly. Extending the agreement is much cheaper and easier than replacing 3 million set top boxes. The reality is DirecTV could have done nothing, and their customers with Tivo boxes would have continued to work. From the most recent Tivo 10-Q:

While DIRECTV would have the right to continue to service existing DIRECTV receivers with TiVo service without payment to us, it would not have the right to add new DIRECTV customers with TiVo service. And while TiVo would no longer be able to generate additional revenue from the then-current DIRECTV customers with TiVo service, we would have no further obligation to provide upgrades, fixes, new features, or software support.

Tivo currently gets about $1/month per box from DirectTV, or around $36MM a year in revenue. The announcement indicated that the new agreement has very similar pricing.

In short, we’re a little stumped why the market thinks this is such a great deal beyond protecting a recurring revenue stream. If DirecTV had agreed to use Tivo exclusively and stop in house development, that would be big news. All that has really happened is a further extension of the status quo. Regardless, if this brings more attention to Tivo and the strong value they provide, I’m OK with it.

The consensus opinion on Tivo is that they are in a death spiral, attacked by low-end commodity DVR’s from all sides. Their ‘only hope’ is to hit the litigation jackpot with Echostar and land a big wad of cash. We disagree vehemently with this opinion. Tivo is an exceptionally strong brand and commands incredible user loaylty. The Tivo software provides a significant differentiator in a future of commoditized video delivery by Cablecos and Telcos.

Our worst case scenario for Tivo assumes that they transform themselves into a software-as-a-service company, selling subscriptions to run on set-top-boxes from a multitude of hardware suppliers. A $12/year income stream from 20 million households (roughly 20% of US market) would yield $250M/year in revenue at substantially higher margins than the company enjoys now.

A more optimistic future would have Tivo turn their hardware devices into content delivery systems, utilizing the broadband connections available in homes to deliver content to the hard drive in each Tivo. Instead of recording a show from the tuner, content would be downloaded and stored on the Tivo. The new Series 3 Tivo will have HDTV capabilities and provides an ideal platform for storing and delivering content. DirecTV is working with Microsoft to potentially use the Xbox 360 as a content delivery platform, it’s unclear why they wouldn’t pursue a similar agreement with Tivo.

The problem with both scenarios is that they are totally incompatible business models. The first would require strong relationships with the content delivery folks, and an implicit agreement that the second model would not be implemented as a way to compete with the video delivery mechanisms of their customer. The second would require significant partnerships with content owners and distributors to provide them with an alternative way to distribute content. Disney’s recent decision to make shows via the web could just as easily be an agreement to make shows downloadable to Tivo, with an agreement from Tivo that the commercials could not be skipped.

Our frustration with Tivo, something I voiced in my post titled “Tivo Should be Sold” is that the company doesn’t appear to be pursuing either outcome. There has been little in the way of innovative hardware, software, or business models from Tivo in recent months that would indicate a move in either direction. The pursuit of the current business model of selling hardware DVR’s on retail shelves implies a future move to scenario two- the high risk/high reward strategy. However, the lack of any announced partnerships, as well as the vaporware Netflix agreement would indicate it isn’t being pursued aggressively enough.

If the company is not driven strongly in one of these two directions, it should be sold to a company that will. Some market and technical leadership needs to emerge from Tivo in the near term, because the market has priced in what we feel is a very reasonable 600M-800M acquisition value, based on continued pursuit of their original business model.

The problem is those same carriers would never allow the broadband enabled Tivo service to be an alternate mechanism for distributing content. Why? It would catalyze the destruction of their content broadcasting business.

The only significant growth path I see is for Tivo to become a content portal, not just a DVR. Tivo should be aggressively courting content providers as a distribution platform that eliminates middlemen and guarantees content security. Otherwise, Tivo is destined to be a niche provider of consumer electronics software to the set-top-box industry.

Unless Tivo starts moving in this direction, more sophisticated products and content portals from Apple (AAPL), Sony (SNE), Microsoft (MSFT) are going to enable broadband content distribution. This is the end game, and Tivo cannot compete against the kind of capital, in which case the company should be sold to one of the above. Other bit players like Netflix (NFLX), Yahoo (YHOO), or Google (GOOG) might be interested as well.

If the company was put up for sale, any of the above companies would pay a significant premium to secure the Tivo Brand and 1.4MM loyal subscribers. Those subscribers would provide the critical mass needed for getting the attention of content owners to implement a broadband based distribution strategy.

If no one stepped up to the plate, a carrier/broadcaster (Comcast / Verizon / AT&T / DirecTV) would buy Tivo to differentiate their service from the other carrier. “Don’t buy Verizon FiOS TV because only Comcast has Tivo!”

Tivo is much more valuable as part of a larger company at this point and should be sold. There are a lot of buyers. Let the bidding wars begin.

Some information appeared today that reinforces this trend. The March issue of The Official Xbox Magazine has a small blurb indicating that DirecTV (DTV) may provide downloadable HD content for viewing on the Xbox 360 platform. This follows on the heels of a partnership announced at CES in January. From Joystiq:

A scan of the March 2006 issue of Official Xbox Magazine reveals “that a DirecTV blade might be added to your Xbox 360 Dashboard to accompany the Xbox Live, Games, Media, and System blades. In that blade, you could download TV episodes in high definition, HD movies on demand, and standard-definition streaming DVR (i.e., TiVo) functions.”

It’s clear to us the Microsoft has extensive plans to grow the Xbox 360 platform horizontally to encompass the set top box business (starting with DirecTV), the PVR business (aka Tivo (TIVO) ), and eventually the handheld PMP business, potentially through a partner like HTC (2498.TW) and the use of Windows CE 5.0 and Windows Vista Sideshow functionality.

Note, I link to several other other opinion pieces I have written on the subject. Feel free to explore.

The Stalwart follows up on the news that Dell (DELL) is abandoning the MP3 player market and makes a case for the mobile phone being the ‘next threat’ to Apple (AAPL). They make the observation that the fight for market share in dedicated MP3 players could be pyrrhic, and that the real battle is moving to other markets. We agree.

Still perhaps these mp3 competitors aren’t so much worried about Apple as they are about their overall product segment. The stand alone mp3 player’s days could be numbered as mp3-capable mobile phones multiply.

Meanwhile, Apple is starting to use another, deadly weapon that their market scale has given them. Price. The Dell DJ Ditty at 512Mb now sells for the same price as a 1Gb iPod Shuffle. Perhaps Dell can still revise their press release and scrub the Ditty as well.

I agree the mobile phone is the next logical place for Apple- it is easily re-tasked as an MP3 player, and the costs wash out if you use removable flash. I don’t see barriers to this convergence other than applications where people want micro-sized players, and in that situation they will probably have two players – a phone player for everyday and micro-player for exercise etc.

The problem is they don’t control the infrastructure. Jobs has called the wireless carriers the “Four Orifices” in the past ( a rather graphic description of the way they roll out new phone hardware)- it’s unclear if they would allow Apple to set up an MVNO. The release of the Motorola ROKR device was a joke, as carriers forced Motorola to cripple the capabilities of the device so that it wouldn’t compete with upcoming music delivery services they want to launch. Sony Ericsson has some slick new Walkman phones that are the best example of hybrid phone/MP3 players.

Slick MP3 Phone hardware alone won’t dent the iPod lead. It’s the user experience Apple brings to the table via ease-of-sync and iTunes, and increasingly the content they have on iTunes. I hate the walled garden Apple products force upon their users, but the iPod system is very tempting. If they had a subscription service I would convert to Apple in an instant – if Apple did this the game would be over, at least for a while.

I think Microsoft (MSFT) is trying to address the user experience issue with new Vista features. I offered my opinions here in a highly controversial post that was well commented on at Seeking Alpha. History shows that when Microsoft is backed into a corner they come out swinging. I came across a good post from Bill Grosso, an Entrepreneur in Silicon Valley.

Microsoft scares me. When I look at what’s in .NET, and I look at what’s going on in Vista, and I look at the overall platform strategy that Microsoft is embarked upon, I see three things: long-term planning, coordinated action, and fundamental innovation.

When I look at the valley, I see a lot of innovation. But it’s surface innovation instead of deep innovation. To dramatically overstate the case: we’re focusing on building better event calendars and better blog aggregators. And on bringing the same functionality, slightly tailored, to all the nooks and crannies of the long tail.

Microsoft is focused on changing the game entirely.

I also see a lot of bright people in the valley swarming after the same things. And that’s really dangerous because we’re taking a generation of entrepreneurs and technologists and training them in the art of short-term thinking (when a swarm of people are pursuing the same goal, there’s going to be a lot of small releases and jockeying for incidental advantages. Which means customer-driven and surface innovation, not deep innovation).

It’s time for companies to take the battle with Apple onto more favorable terrain and stop fighting incremental battles (Creative (CREAF) seems focused on a head to head slugfest that makes no sense to me). The next logical battlegrounds are phones and cable set top boxes. Microsoft is running hard with the Xbox 360 and Xbox Live – my detailed thoughts on those endeavors are here and here.

Apple has never had a problem innovating, but last time they were this far in the lead hubris got the better of them. Jobs better find a way to play nice with carriers, stop referring to them as waste outlets, and get Apple’s superior user experience extended to more consumer items. Or someone else more willing to share the spoils with the infrastructure providerswill.

People seem to underestimate the level of investment needed to build a beachhead into the home and the potential return it might bring. Think of the preparations that went into Operation Overlord (D-Day June 6, 1944) – an equivalent effort will be necessary to make the digital home a reality.

An upcoming magazine article clearly shows that Sony sees the Xbox Live service as a threat and is moving to one-up Microsoft. This seems to be a pattern by Sony (SNE) – the PS3 has always been positioned as technically superior (Cell Processor, Blu-Ray drive) and now they claim the online capabilities will be ‘better than Xbox live’. Looking at this article it is clear that Sony views Xbox Live as a threat equal to or larger than the Xbox 360 hardware itself. And I’ll save all of the anti-Sony readers a need to comment on this post by agreeing they need to put-up-or-shut-up with a launch date.

There are now 3.2M Xbox Live subscribers ($50 a year to join) who also can pay extra for new content. $150MM a year in revenue doesn’t even begin to cover the massive investment Microsoft has made in this service ($250MM last year to upgrade Live for Xbox 360), and it is but a small fraction of the $5BB a year Xbox business. However, Xbox Live is by far the most strategic component of Microsoft’s thrust into the living room. As I’ve written before, Xbox is destined to become much more than a gaming console, and will morph into a set-top box and media center for the home. Xbox Live will be the infrastrucutre for content to be delivered and billed.

The Playstation 3 is another such device, so is Apple (AAPL) iTunes (with iPod and derivatives being the hardware), and even devices such as Tivo (TIVO) have this capability if connected to a broadband home network.

Companies whose business relies on the old model of broadcast will wake up one morning and find that their delivery mechanisms have been depreciated by new media transport networks, built on the backbone of FTTH, DSL, and Cable modem infrastructure. We see the Telcos waking up to the fact that there may be a way to extract value from making sure the user experience is protected by charging for QoS. My bet is Microsoft will be happy to pay Verizon or Comcast to ensure their user’s experience is not compromised.

The titanic effort to build these networks and deliver superior system integration is one of the reasons we continue to believe that the consumer future will be shaped by large cap companies, and not the Web 2.0 riff-raff.

Forbes interviewed Michael Moritz, a VC at Sequoia Capital. Here’s a snapshot:

“Consumer-tech businesses, he says, are a pit of “muck and mire.” They have low margins, require massive marketing budgets, compete with monster retailers’ house brands and face Asian copycats. Though he has helped fuel the consumer craze, he laments the rise of handheld gadgetry: “The march of consumer technology will spell an end to tranquility,” he says. “Most of the venture money going into consumer-related companies will be squandered, and the rest will be lost. It will be brutal.”

I think he’s right.

Engadget: There’s been some speculation about the Xbox 360 as a platform for IPTV. I know IPTV is something I asked you about back in April, primarily as a platform for set-top boxes and things like that, what do you see as the 360′s potential as a means for delivering video to the home?

Gates: Well, the Xbox 360 obviously has the ability to do high definition and that’s what makes it such a fantastic extender for the Media Center. That’s another thing I set up, and just the speed of it, the fidelity of it is really better than the previous generation of extenders that we had.

It’s rich enough that, yeah, it can do set-top box like things. If you just want a set-top box, [the Xbox 360] is somewhat overkill, the graphics power that we’ve got there is for the world’s best games. Now that the cost of the chips in Xbox will be coming down over the next three, four, five years, it could get fairly cheap, but I still think you’ll see dedicated set-top boxes. You can always think of something like the Xbox 360 as a super set-top box that can do everything the set-top box does, but then have the graphics to do the games as well.

With the Xbox 360 we have the first device with a big hard drive, big processor, Ethernet connection, and HDTV output. At $300 it doesn’t cost much more than the ‘dumb’ Scientific Atlanta or Motorola boxes deployed by cable/telco carriers today. And whether you believe it or not, MSFT is shaping up to be the leading vendor of IPTV middleware. It isn’t a big leap to say an Xbox-Lite (no videogames, MOCA connectivity) would make the perfect set top box.

I think Gates is playing country bumpkin here, sounding like “Gee, the Xbox is kinda overkill but yeah I think it could work”. Realpolitik requires Gates to keep his mouth shut long enough to continue to lull his set-top box hardware partners (Motorola and Scientific Atlanta) into partner bliss. Then you’ll see Gates show up at Comcast headquarters with a $100 Xbox 360. Instead of HELLO MOTO it will be BYE-BYE MOTO.

As each day goes by, the Scientific Atlanta (SFA) shareholders who complain $6.9BB wasn’t enough for their commodity box company should shut up and cash their checks. What would you rather provide to subscribers as a cable operator- an Xbox 360 or a glorified radio tuner for video?

Just to drive things home, here is an excerpt of a speech made by Robbie Bach, Sr. VP and “Chief Xbox Officer“. He could just as easily be describing Xbox hardware, not IPTV software. (full transcript here)

I want to talk about a second one, which is Microsoft TV, and Microsoft TV again is a place where the company has been investing for quite a while. It’s a place where we see a real opportunity in the future and we’re really going to the next cutting edge. Many of you know we have a product called Foundation Edition, which is primarily designed to work with the cable industry and their existing hardware and new hardware they’re coming out with. Our current version of this is called Foundation Edition 1.7. Comcast is our biggest customer in North America; we have a 5 million subscriber deal with them. We also have a lot of business actually in Latin America, where we’re the leading digital set-top box software provider. This is a product that we’ll continue to invest in and continue to work with the cable industry as they make the migration over to the digital world.

But in some ways where the new cutting-edge work is happening, is in what’s called IPTV, Internet Protocol Television. And IPTV Edition is our product that’s entering in that space, and I want to talk a little bit about what that means and then we’ll take a moment to show it to you. Basically what IPTV Edition enables you to do, regardless of whether you’re a cable provider or a telco or any net operator, you can take live media, on-demand media, across an IP network and put it into the home on a high-definition television, and you can do multiple streams of that content without having to have multiple tuners in the set-top box. You really can produce an amazing TV experience. You get better TV just in basics, and then you get a better-connected TV and a better platform.

And I want to point out from a Microsoft perspective what’s very cool about this is not only is this a new product and a new business for us to sell, but it also is fundamentally based on our other technologies. This product sells SQL Server, it sells Commerce Server, it sells the rest of our backbone into these operators, and really helps broaden our business.

Hey Robbie! You forgot to mention Xbox!