Microsoft Makes Its Move

When Microsoft ( MSFT) invested a cool $1 billion in Comcast ( CMCSA) more than eight years ago, Chairman Bill Gates talked up a grand vision for a world of connected PCs and TVs.

Since then, his company's tentacles have spread in all directions in hot pursuit, acquiring WebTV, launching the Xbox video-game console and Media Center PC, and creating a new platform called Microsoft TV IPTV, or Internet Protocol TV.

And yet, the digital living room still remains a thing of the future -- an affliction of sorts for Microsoft, given the vast sums it has spent trying to realize that vision.

Though Microsoft has misstepped, other factors have postponed the arrival of the connected home. But because of Microsoft's ubiquitous PC presence, opportunity is still rife -- if the company can fend off expected competition from Sony ( SNE), Apple ( AAPL), Google and Yahoo! ( YHOO).

Windows of Opportunity

"There's an opportunity bigger than Windows ... if they Microsoft can make it work," says Steve Perlman, who heads tech and media incubator Rearden.

That's because the universe of television sets -- an estimated 250 million in the U.S. alone -- is far greater than that of PCs, where Windows dominates, says Perlman.

Perlman and many others in the industry believe that through IPTV, which delivers television programming via broadband networks, Microsoft can gain a position on the TV. What the technology has over cable and satellite is greater programming variety, faster channel changing and easier integration with other devices.

"IPTV is inevitable," says Perlman. "It will become the dominant form of information delivery, just as the Internet is becoming the dominant form of music delivery."

The big question, however, is when. Bandwidth and competition from cable and satellite providers are among the obstacles. Multimedia Research Group estimates that there will be 8.8 million IPTV subscribers in the U.S. by 2009, out of 28 million DSL subscribers.

Microsoft began peddling its IPTV software for set-top boxes in 2004 and signed up primarily telephone companies for trials in 2005. This year AT&T ( T) and Verizon ( VZ) plan to roll it out commercially, Gates said earlier at the Consumer Electronics Show (CES) held earlier this month in Las Vegas.

Adoption of IPTV is catching on in places such as Hong Kong, where a majority of consumers weren't getting cable or satellite before IPTV came in, says Media Research Group senior analyst Bob Larribeau.

By contrast, the U.S. is a saturated paid TV market, with about 80% of households subscribing to satellite or cable, he says. Cable companies aren't flocking to Microsoft's IPTV service because they're afraid of Microsoft strong-arming the user experience as it's done on the PC, and they want as much as of the tens of billions of dollars they spent on their current networks as possible.

AT&T and Verizon, however, are jumping on the bandwagon, looking for new revenue to supplant their maturing wireline businesses. "The DSL guys have all the motivation in the world to innovate because telephony is being absolutely destroyed by Internet phones and cell phones," Perlman says. "It's do-or-die for them at this point."

Cost and easier connectivity to other devices than cable or satellite TV will be major factors in wooing consumers to IPTV, says analyst Kurt Scherf of research firm Parks Associates.

"Microsoft's advantage is it sits on 90%-plus of computers," Scherf says. "Bring in the game-console platform, and all of a sudden you get a network where the PC talks to the set-top box and the console."In addition to competition in the IPTV arena from Siemens ( SI), as well as smaller pure-plays such as SeaChange International ( SEAC), industry observers say other tech bigwigs are poised to enter the fray.

Jobs Action

"If there's one guy who is going to try to put everything together ... Steve and his team have one of the unique opportunities," Tim Bajarin, president of tech consultancy Creative Strategies, said of Apple CEO Steve Jobs at a recent digital living room conference.

"Look at the Front Row interface they created -- you can see digital living room written all over it," he added, referring to Apple's interface for viewing digital media.

And then, of course, there's Apple's huge success with music and recent deals to sell video content from NBC Universal at its iTunes music store.

Similarly, Sony is in a unique position to take over the digital living room, given its position in the consumer-electronics space, the success of its PlayStation video-game console and its music and movie businesses.

And finally there's Internet search leader Google, which announced also at CES that it will begin allowing consumers to buy videos from major content partners through its Web site.

Before IPTV, Microsoft's rolled out the Media Center version of its Windows OS to connect TV and PCs. But Media Center PCs have gotten off to a slow start in part because they were bundled with a preinstalled TV tuner, which increased their cost, Scherf says.

Microsoft recently announced that 6.5 million Media Center PCs have shipped in three years, with 5.5 million of those shipping in just the past year.

"The important thing to understand about that is that the majority of those units are not going into the living room," adds Gartner media analyst Van Baker. He estimates that fewer than 10% of Media Center PCs are connected to a TV set. And adds that they're still a "pretty tiny" portion of overall PC sales.

The problem: PCs simply aren't stable enough to take over the role of the beloved TV. "If you're in the middle of your favorite TV show and you get the blue screen of death, you're going to go crazy," Baker says.

Despite that, Microsoft is still aiming to bring television to the PC, with announcements last week about connecting DirecTV ( DTV) video onto Windows Media Center PCs.

Playing Games

Another piece of the puzzle is Microsoft's Xbox 360 video-game console, which can function as a media extender between the PC and television. Microsoft has spent billions to develop Xbox, which is widely viewed as more than just a way to get into the lucrative and growing video game-software market.

"If you start to dig into the functionality of that video game box you can turn it into a DVR, you can play games on it," says Ken Papagan, of home-video tracking firm Rentrak. "It really becomes a Trojan horse into the home that could bypass the network operators."

And analysts agree that Microsoft's new Xbox 360 console connects nicely to Media Center PCs.

"If you want to download movies ... and stream them from the PC to the television, the Xbox is a great high-definition media adapter," Gartner's Baker says. Trouble is, the average consumer is not willing to do the tinkering to make that work, he says.

Xbox is not a "mainstream product; it's a niche product," Baker adds. "But it's a healthy niche, and it's a growing niche."

"Xbox first and foremost is a gaming platform," says Ed Graczyk, director of marketing and communications for Microsoft TV. "As great as it is, chances are my grandmother will never have an Xbox."

She may not have a PC either, and therefore is unlikely to be a candidate for Microsoft's Media Center PCs. But, Graczyk adds, "she does have a TV."

This explains why Microsoft is reaching in so many directions in its quest to gain a spot in the living room.

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