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What Plug-and-Play Means for TV

For most homeowners, hooking up to cable TV can be a maddening process. First you wait a week for the installer to show up with the cable company's set-top box. Then you anxiously wait an hour as he programs and connects it. After that often comes a shakedown period of calling the cable company to figure out why the thing isn't working.

All of that may soon be less frustrating thanks to a new generation of TVs that essentially have the cable box built in. Buyers of these sets -- called plug-and-play TVs -- eventually will be able to simply slide a specially encoded card, about the size of a hotel key, into a slot on the set to start viewing cable channels. After the Federal Communications Commission signed off on the technology, the first such TV was introduced last year by Matsushita (MC) -- and most of its rivals are following suit this year.

Over the next six months, Sharp, Pioneer (PIO), and Motorola (MOT) will introduce cable-ready TVs. And such sets will account for 500,000 of the 7 million or so flat-panel TVs that will be sold in the U.S. this year, up from nearly zero in 2003, estimates Michelle Abraham, an analyst with tech consultancy Cahners In-Stat in Scottsdale, Ariz.

TIME TO ADJUST. Cable companies like this just fine. They can imagine sending new subscribers an activation card in the mail, which of course is preferable to buying millions of set-top boxes and hiring people to install them. Plus, they won't have to deal with the 30% of customers who never return their boxes after dropping cable service, says Vamsi Sistla, an analyst with ABI Research in Oyster Bay, N.Y.

For makers of set-top boxes, however, the story is different. Motorola Broadband, Scientific-Atlanta (SFA), Pioneer, and Pace Micro Technology will have to adjust their strategies or wither.

This may not happen right away: Today, Scientific-Atlanta, for instance, is doing reasonably well: After a major dip in 2003, when its revenues fell by double digits, sales for the second fiscal quarter ended Jan. 2 grew 5% vs. the first quarter and 18% year-over year, to $416 million. And analysts polled by Thomson One expect Scientific-Atlanta to book $408 million in sales in the current quarter, vs. $383 million in the same period last year.

FIVE-YEAR PHASE? For the longer term, however, the emergence of plug-and-play TVs could potentially make revenue growth problematic. The set-top-box industry has shrunk from $2.5 billion in revenue in 2001 to $1.5 billion last year, as prices slipped from $250 to $100 per box, says Mike Paxon, another Cahners In-Stat analyst. The bulk of the price-cutting was on basic boxes, which viewers need to see channels and to order pay-per-view -- and which now account for about 60% of Scientific-Atlanta's sales. Those could be displaced by cable-ready TVs within five years, says Rob Sanderson, an analyst with American Technology Research in San Francisco.

To avoid a setback, set-top-box makers will have to diversify into advanced set-top boxes, cable cards, and even TVs. Problem is, the cards will likely sell for only $60 to $80 -- far less than the basic set-top box, says Sistla. And only two manufacturers -- Motorola and Scientific-Atlanta, which together hold 85% of the world's set-top-box market -- can likely make money on them. They own the proprietary technologies for conditional access, or secure streaming of video to subscribers. Other players would have to license this knowhow and probably couldn't afford it, experts say.

So, a movement toward open standards for these devices is developing, which would give more companies an opportunity. In late 2002, Sony (SNE), a minor player in set-top boxes, introduced a technology called "Passage" that works with older cable boxes. In February, Comcast (CMCSA), the nation's largest cable operator, finished a successful trial of Passge.

PRESSURE ON PRICES. An open standard could also be a curse for the industry, however, since it would lead to more price competition. Even though that might take years, mere discussion of it is already putting pressure on prices, says Don Dulchinos, a vice-president at cable industry consortium CableLabs, in Louisville, Colo.

Another solution for box makers would be to concentrate on fancy set-top models that cost up to $450 and allow for video on demand, among other capabilities. Many suppliers already are releasing devices that also contain hard drives a la TiVo (TIVO) for recording shows. And Pioneer is working on boxes that would contain a cable modem for broadband Net access and wireless networking between PCs and TVs, says Matt Dever, a vice-president for product planning at Pioneer.

These strategies, however, might protect set-top-box makers only temporarily. The cable industry and TV makers already are negotiating an agreement to build two-way communication into TVs -- essentially, functionality for ordering video on demand. This technology, which is expected to debut within 18 months, could displace advanced set-top boxes. And chances are, cable companies will push for that sooner rather than later, as they fight off phone companies and broadcasters that distribute video over their systems.

LESS GRAND GROSS. Box makers have a third option: Some might try to get into the TV business -- or back into it, in the case of Motorola, which will release its first Motorola-branded, cable-ready home-theater system this year. It's also working on cable-ready TV monitors, says Larry Robinson, a product management director at Motorola.

The weakness in such a strategy is that the TV marketplace is packed. PC makers Hewlett-Packard (HPQ) and Gateway (GTW) are already selling TVs. And satellite-TV provider EchoStar (DISH) has been reselling TVs under its own brand to new subscribers at a discount. With more competition, the 200% to 300% gross margins that TV manufacturers now enjoy could start to slip.

Until that happens, TV makers will be sitting pretty. An FCC rule stipulates that 50% of the large-screen TVs each manufacturer makes after next July 1 must contain digital tuners -- by far the most important component required to enable cable-readiness. Adding the remaining parts needed for box-less hookups will cost only about $10, says analyst Abraham. Many TV makers expect the new feature to fetch a premium initially, but that's unlikely to last. Already, Pioneer has decided not to charge extra, says Jeff Dickson, a marketing manager at Pioneer.

"NO NEGATIVE IMPACT"? The threat to set-top-box makers won't fully materialize for another year or two. And Motorola, for one, expects advanced boxes to drive revenue growth for the near term, says Martin Stein, a Motorola senior marketing director.

It's unlikely that set-top boxes will disappear entirely, since customers who want the latest and greatest functionality will need one. "We don't perceive any negative impact," says Bob Van Orolen, a vice-president for strategy and product management at Scientific-Atlanta. He says he has yet to see mass consumer demand for plug-and-play electronics.

What's more, it'll take awhile to get plug-and-play humming: Today, cable company Cox (COX) sends installers to homes of customers with such TVs just to make sure its key cards work correctly, says Lisa Pickelsimer, director of video product development at Cox.

Clearly, however, the industry is at a turning point. And in the long term, this shift will be better for consumers and TV makers than for the makers of set-top boxes. By Olga Kharif in Portland, Ore.

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