Digital Tv: Advantage, Hughes

At General Motors Corp.'s annual meeting last May, shareholders hardly noticed the shiny new cars lining the hall. Instead, they crowded around an oversize television and a pizza-size satellite dish--and marveled at crystal-clear images of The Fugitive accompanied by a thumping, CD-quality sound track. No one had ever seen TV quite like this before.

For once, GM executives didn't mind that their cars went unnoticed. The enthusiastic crowd was the first tangible sign that GM's risky $750 million bet on a new digital satellite-TV venture might pay off. Now, just six months after the national rollout of the satellite service, DirecTV is a consumer hit. More than 700,000 satellite dishes and decoder systems have been shipped--and nearly half a million subscribers pay $30 a month for a high-powered signal carrying 175 channels. Compare that with the VCR, which sold fewer than 300,000 in its first year. "This is the biggest thing since color television," crows DirecTV President Eddy Hartenstein.

BOMB FEAR. Brainchild of Hartenstein and a handful of others at GM's Hughes Aircraft Co., DirecTV hadn't always looked so promising. Indeed, in early 1993, it came under intense scrutiny by GM's board. Rocked by automotive losses, board members feared funding a new-product bomb. But Hartenstein's band of engineers--who had spent their careers building huge communications systems for the Navy and NASA--convinced GM they could create a popular consumer-electronics product.

After a four-year scramble to develop a viable digital-TV system, Hughes and its partner, RCA-Thomson, have done just that. To get there, engineers and marketers overcame technical glitches and programming roadblocks. Hughes also had to surmount skepticism toward satellite TV fed by the failure of half a dozen similar projects. With the early success of DirecTV, Hughes has beaten cable-industry rivals to the punch. DirecTV is outselling Primestar, a competing cable-industry offering, by 2 to 1.

That prospect certainly seemed remote in 1990. That was when Hartenstein, a longtime Hughes executive recently returned to the big defense contractor after a stab at running his own business, asked Hughes engineer Bill Butterworth to outline a plan for digital TV. Hughes had just killed its troubled SkyCable satellite-TV project--a joint venture with NBC, News Corp., and Cablevision Industries. But, desperate for commercial revenues to replace dwindling defense business, Hughes decided to go it alone.

NO CONFIDENCE. Butterworth's challenge was enormous: Hughes would have to develop a new generation of satellites powerful enough to beam reams of digital data to as-yet-nonexistent home receivers. "I sat there thinking: `How will we ever pull all this together?"' he says. And GM insisted Hughes find backers to share the $1 billion cost. Hughes began with the Hollywood studios, but they balked at financing unproven technology. "GM essentially came around begging," says one studio executive. "It didn't exactly inspire confidence."

The first break came in 1991, when U.S. Satellite Broadcasting, a unit of Hubbard Broadcasting Inc., a St. Paul (Minn.) cable company, ponied up $100 million for rights to broadcast 22 channels. After a $125 million deal with the National Rural Telecommunications Cooperative, GM gave its O.K.

The satellite team also fought an uphill battle inside Hughes. Butterworth knew that to succeed, they would have to distance themselves from their parent: The longtime Pentagon contractor is known for high quality--and even higher costs. Yet word that DirecTV would require sophisticated home-decoder boxes and satellite dishes brought heavy lobbying by Hughes units eager for the business. Instead, Butterworth sought a consumer electronics maker willing to help develop the technology to manipulate digital TV signals. Although Hughes's labs had the leading-edge technology, Butterworth knew that not exceeding the $700 price that consumers appeared willing to spend meant he needed an experienced manufacturer.

Access to Hughes's technology brought interest from Toshiba, JVC, and AT&T. But Hartenstein and Butterworth chose RCA-Thomson. RCA had assured Hughes it could hit $700, and its 11,000 dealer retail network guaranteed distribution. To get the TV maker on board, Hartenstein gave RCA exclusive rights for the first 1 million decoders.

Hartenstein still had to fill 175 channels. To lure viewers, DirecTV would need familiar cable fare and more: hit movies that play every half hour and enough sports for the most avid fans. But programmers, who were tied to cable, wouldn't budge. "[There was] lots of talk, but no deals," says James Ramo, DirectTV's marketing head. "Everyone wanted to be the first one to be second."

STRONG LOBBY. Meanwhile, David Baylor, hired from NBC, was working out how to digitize programming. Existing digital-tape machines cost $100,000 a pop--and the tapes they played were $165 each. Since Baylor needed 320 tape machines and a 50,000-tape library, "that would have broken the bank--even Hughes's bank," he says. But Sony Corp. planned to release new digital videotape players in 1996. A $50 million contract persuaded it to move faster. By June, 1993, Sony delivered the $40,000 machines and $85 tapes.

The Cable Regulation Act of 1992 finally provided the needed break.

Hughes's Washington ties came in handy, as it lobbied for a clause requiring programmers to offer shows to rival delivery systems. "Without that, we would have been dead," says Ramo. First came the Disney Channel in January, 1993. Then a deal with Paramount Pictures. Other studios followed soon after.

But trouble was hardly over. In May, 1993, the GM board called Hartenstein in. Wall Street was worried, and board members had doubts about satellite TV. Would it work, wondered GM Chairman John G. Smale? Who would buy it, asked board member Anne L. Armstrong? "The problem," says Ramo, "is we couldn't tout our product, because we still weren't sure what we had."

While Hartenstein convinced the board that DirecTV was on track, DirecTV's market research showed that sports fans would be the most likely to pay $700 for the system. So Ramo's staff began negotiating with the National Football League, the National Basketball Assn., and the National Hockey League. That led to one of DirecTV's most alluring offers: For $139 per season, football fans can choose any of a dozen Sunday games.

By early 1994, Hughes was at last hitting the home stretch. But when test broadcasts into 500 homes produced frozen screens and jumpy movement, Hartenstein delayed DirecTV's launch.

As programmers worked out the software bugs, DirecTV began to deliver its promise: scads of channels, crisp images, and sound far superior to cable. When the system went on sale for the first time, in June at Cowboy Maloney's Electric City in Jackson, Miss., videophiles snaked out the door. Within hours, all 500 units were gone. "It was like selling air conditioners in 120-degree heat," says Chairman J. Con Maloney.

BREAKEVEN. Since then, DirecTV, which Bill Butterworth concedes "could have turned into an unmitigated disaster," has taken off. RCA-Thomson, already running two production lines, will add a third this spring. With Sony hitting the market with competing decoders in June--and with three more manufacturers expected by 1996--analyst Cai von Rumohr of the Boston brokerage Cowen & Co. estimates prices will drop roughly $100 a year over the next four years. Hartenstein expects to have 3 million subscribers by 1996. With each paying $30 a month--all of which Hughes retains--he says DirecTV should hit breakeven next year. And if Hartenstein can achieve his target of 10 million customers by decade's end, he is projecting operating profits of $1 billion on revenues of $4 billion.

But if DirecTV has won the first round, the battle is far from over. Red-hot initial sales are fueled by videophiles and sports addicts, but it will take several years to see if regular TV viewers will also pay a premium for

DirecTV. And DirecTV's success has shaken Primestar, the competing satellite service backed by the cable industry, out of its lethargy: It's improving services and gearing up for a much bigger fight. Eventually, cable and fiber optics may do a better job of delivering even more programming. But for now, there's no disputing that DirecTV has won the first leg of the race to digital television.

A Hit

FEBRUARY, 1990 Sets $1 billion SkyCable venture with NBC, News Corp., and Cablevision for direct-broadcast satellite service. By yearend, strategic disputes lead Hughes to pull out and develop service alone.

MARCH, 1991 U.S. Satellite Broadcasting pays $100 million for 22 channels on Hughes's satellite, providing key high-powered backing.

FEBRUARY, 1992 RCA-Thomson agrees to develop digital decoder

boxes and inexpensive satellite dishes in return for exclusive rights to sell the first 1 million units.

OCTOBER, 1992 Hughes signs a $50 million deal with Sony to develop state-of-the-art videotape machines--the heart of its $100 million digital-broadcast center.

JANUARY, 1993 The Disney Channel and Paramount Pictures finally agree to provide programming.

Eventually, two dozen studios and cable networks sign up.

OCTOBER, 1994 As the national rollout of 175-channel service begins, the NFL agrees to provide $139 "season tickets" broadcasting 12 games each Sunday.

FEBRUARY, 1995 RCA-Thomson ships 700,000 units. Nearly a half-million households sign up.

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