Why Microsoft Is Glued To The Tube

A new, souped-up version of WebTV is what made Gates bite

It was the wee hours of the morning on Apr. 6, and the fax machine at the Treasure Island Hotel in Las Vegas was furiously cranking out an endless stream of pages. Harried hotel staffers dressed as pirates dashed back and forth to a suite on the eighth floor, where Steve Perlman and Phil Goldman--two of the three founders of WebTV Networks--were huddled with Craig Mundie, a senior vice-president at Microsoft. The faxes from Microsoft bore details of the bombshell deal they would soon announce: Microsoft would pay $425 million for WebTV, a Silicon Valley startup that was losing money, had a so-so product, and just over 50,000 customers. Do the math, and that's $8,500 per customer. Had Microsoft Chairman William H. Gates III lost his mind?

For the answer, tune in on Sept. 16, when Microsoft unveils a new, souped-up version of its WebTV system for surfing the Net via TV. That product, along with the team that built it--Perlman, Goldman, and co-founder Bruce Leak--is the real reason Gates bought the company. Gates has said that the WebTV acquisition is Microsoft's riskiest gambit to date. But if it's successful, it could be the Trojan Horse the software giant has been searching for to ride into millions of living rooms around the world.

WebTV and Net cruising devices made by a slew of rivals may well prove to be the first successful information appliances. These simplified computing devices tap into the power of the Net, are much easier to use than PCs, and cost a fraction of the price. So far, corporations have been slow to trade in their PCs for slimmed-down Net models, such as "network computers" or NetPCs. But companies from Microsoft to RCA to Sony are betting that Web appliances will catch on with consumers.

Owning a big chunk of this market is a must for Microsoft. To keep up its 30% average annual growth, the software titan must find new markets to conquer beyond its PC stronghold. And what better place than TV, now in 98% of U.S. homes, vs. just 40% for PCs? In coming years, television sets are expected to become a major portal to the Net--and a whole new set of digital programming that will be offered over it. Some 1 million Net-ready TVs will be in U.S. homes by 2000, predicts Forrester Research Inc. The software that runs on them could become as lucrative as the Windows software that runs on most PCs--one reason why the new WebTV box will run a scaled-down version of Windows. "We want to be the software supplier...the nonPC equivalent to Windows," says Mundie.

WHIZ CHIP. So what does WebTV have up its remote control? Perlman, WebTV's fiery young chief executive, isn't talking. But insiders say the company has come up with technology that helps get around the current bandwidth limitations of the Net to deliver high-quality, high-speed Web images and video. At the heart of this, say insiders, is an innovative chip that crams the capabilities of a TV tuner, cable modem, and a high-speed PC modem into one low-cost unit. That, and other tricks, help WebTV begin to blur the distinction between TV programming and Web fare. That bandwidth-busting technology has helped WebTV snag new licensees, such as Hitachi Ltd. and Mitsubishi Corp., to make the new boxes.

The boxes may be impressive, but they're just a means to a bigger end: creating a network that will deliver new kinds of digital content to homes. "We intend to define mass-market media for the next century," says the cocksure Perlman. WebTV is putting the finishing touches on a revamped Net-TV service that provides a glimpse into how media might be delivered in the future. The centerpiece: an improved program guide, called Explore, that has a dozen or so categories, such as news, sports, and shopping, and serves as a launching point to Web sites and TV programming. The idea, says Stacy Jolna, WebTV's vice-president for programming and a former CNN executive, is "to showcase the best content on the Web and TV."

BEST OF BOTH. At first, that will mostly be brand-name content from Web sites. But as content creators take advantage of the new WebTV, viewers will be able to tune into, say, the Grammy Awards and click the remote to get more info on award-winning artist Toni Braxton, listen to her latest CD, and purchase a ticket to one of her concerts. Broadcasters could soon start offering data services over the airwaves as well--stats, for example, could be zipped off the Net along with the broadcast of a sporting event. Such enhanced programming is "in everybody's business plan," says Larry Gerbrandt, an analyst at Paul Kagan Associates in Carmel, Calif.

Also in those business plans: piles of revenue from online advertising, transactions, and subscription fees. The potential is huge: Jupiter Communications Co. predicts that online revenue from these sources will swell from $1 billion in 1996 to $23.8 billion by 2000. Gates recently told a gathering of Wall Street analysts that the Net-TV market is a "completely unproven business in terms of volume and royalty." But he added: "Someone will come along and do some great software to get a revenue stream...and that someone could be us."

WebTV charges a $19.95 subscription fee for its Net service. In addition, it plans to make money from ad sales and by taking a cut of what viewers buy on its network. WebTV's Jolna says "everything from autos to travel tickets to clothing" will eventually be sold through WebTV. That could put Microsoft in the catbird seat, since it owns not only WebTV but also one of the largest collections of Web properties, including CarPoint, an online car-buyer's guide; Expedia, a Web travel agency; and Sidewalk, a local arts-and-entertainment guide.

But Gates isn't the only one with big Net-TV plans. Microsoft's WebTV buy--along with the $1 billion it invested in cable operator Comcast Corp.--jolted competitors into action. The day after Mundie's announcement in Las Vegas, NetChannel Inc., a San Francisco-based WebTV rival, said it would acquire ViewCall America, which offered a Web service called ON-TV, and combine the two companies' Net-TV services. On Sept. 15, NetChannel will formally introduce a $19.95-a-month service that delivers personalized Web content from sources including the Internet Shopping Network and Intuit's Quicken Financial Network, enhanced for TVs. The NetChannel service will be available next week from partner RCA, which makes a $300 Net-TV device.

WIDE FIELD. Microsoft's rivals in the computer world--Oracle and Sun Microsystems--won't be sitting out this round either. In August, Sun acquired Net appliance maker Diba. Samsung Group already is selling Diba-based Net TVs in Korea, and other manufacturers have licensed the Diba technology to make set-tops for sale in Taiwan, China, and Japan. "[Microsoft] hardly has a lock on the market," says Marge Breya, director of marketing for Sun Microelectronics, which includes Diba.

Oracle's Network Computer Inc. (NCI) unit, which includes Navio, the software maker it acquired in August from Netscape Communications, licenses software for Net TVs. RCA, for example, uses an NCI design for its box. In Japan, NEC Home Electronics sells an NCI-based enhanced TV that includes a hard drive. At $2,500, though, it's not cheap.

NCI is pitching its set-top design to cable execs just as hard as Microsoft is pitching WebTV's. NCI's big push is for a next-generation system it expects hardware partners to ship before Christmas. The layered design lets different companies supply various components. That's in contrast with Microsoft's proposal, which critics charge is an end-to-end system that could choke competition. Netscape CEO James L. Barksdale is a backer of NCI's proposal and has met with cable execs. "We told them: `Don't let the person who controls the set-top control the content,"' says Barksdale. Indeed, as the Net redefines media, WebTV's rivals will likely expand to include America Online and ABC as well as NCI and RCA.

This is heady stuff for Perlman, who has wanted to bring the Net to the masses since his days at Apple Computer Inc.'s research-and-development labs. Although WebTV's first product wasn't a barn-burner--about 100,000 units have been sold to date--it proved that plugging into cyberspace doesn't have to be a complicated or costly affair. The initial product, a slim black box from Sony Corp. and Philips Electronics for under $300, plugs easily into a TV or VCR. (The price of that model is expected to be slashed when the new product ships.) When hooked into a phone line, it dials into WebTV's network to let people surf from their TVs and send E-mail.

WebTV stores popular sites on servers and compresses video and images for faster performance. Its technology can also display Web content so it looks crisp on low-resolution TV screens. With his hot new technology and Microsoft's financial backing, Perlman might just fulfill his new boss's dream: Microsoft software in every living room.

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