Big Bang!

Digital convergence is finally happening -- and that means new opportunities for upstarts and challenges for tech icons

What's this, A digital role-playing game? There's Dell Inc. (DELL ) selling flat-screen TVs. Microsoft Corp. (MSFT ) execs are unveiling a system to compete with the iPod that plays movies as well as music. And Cisco Systems Inc. (CSCO ) is hawking a Wi-Fi boombox you can carry out by the pool. Nearly everyone, it seems, is venturing far from their specialties. And it's not just tech companies. TV manufacturers in Japan and cell-phone makers in Korea are jerry-rigging their products with microprocessors and software, racing to turn them into a new generation of digit-gobbling, network-ready contraptions.

For nearly two decades, industry sages have heralded the coming age of converging digital technology. But it remained an empty slogan. Now, thanks to faster chips, broader bandwidth, and a common Internet standard, technologies are quickly merging. The market for personal digital assistants, so hot in the late '90s, is vanishing as customers get the same functions in a cell phone -- often with a camera to boot. The latest televisions from Royal Philips Electronics (PHG ) and Sony Corp. (SNE ) have enough computing firepower to grab streaming video off the Net. "Convergence is finally really happening," says Gottfried Dutiné, an executive vice-president at Philips. "Digitalization is creating products that can't be categorized as tech or consumer electronics. The walls are coming down."

That sets up a collision of three massive industries. In one corner stands the $1.1 trillion computer and software biz, with its American leaders. In another is the $225 billion consumer-electronics sector, with its strong Asian roots and a host of aggressive new Chinese players. The third camp is the $2.2 trillion communications industry, a behemoth that extends from wireless powerhouses in Asia and Europe to the networking stars of Silicon Valley. All three groups will have a hand in building the digital wonders that are headed our way. But none of these industries, much less a single company, can put all the pieces together. They all need help. For this they venture into adjoining territories, where they forge new partnerships and take on new rivals.

The result is a Big Bang of convergence, and it's likely to produce the biggest explosion of innovation since the dawn of the Internet. Flip through BusinessWeek's Information Technology 100. From global powerhouses such as Samsung Group, IBM (IBM ), Microsoft, and Hewlett-Packard (HPQ ) to lesser-known players such as Taiwanese laptop king Quanta Computer and Hong Kong display maker TPV Technology, all are busy crafting strategies for convergence. Over the coming years, they'll turn today's scribblings on laboratory white boards into thousands of new computerized products and network services. Most will flop. But a few breakthroughs are sure to take off, giving birth to new tech champions and changing the way we live and work. Hossein Eslambolchi, president of AT&T Laboratories (T ), thinks the changes ahead will be as significant as the advent of commercial aviation in connecting people and communities. "This is going to be the most disruptive period in the past 50 years," he says.

Driving this long-awaited trend are two powerful factors: the relentless evolution of technology and the tech industry's hunger for growth. For decades, the mere idea of a computer company making Brazilian TVs or French phones would have been laughable. Those markets were cloistered behind varying standards and a maze of diverse technologies. But with the spread of digital technology and the rise of Internet standards, those differences are fast melting away. The chips and software and network connections that have defined the computer industry are spreading quickly into other domains. For tech companies grappling with a maturing computer industry, these new markets brim with potential growth. "As technology converges, our opportunities expand," says Intel Corp. (INTC ) Chief Executive Craig R. Barrett. "This is where we're putting all of our resources."

Rush to Innovate

The ecosystem for the new networked machines is starting to take shape. One-third of U.S. households now have broadband access to the Internet. The connections are still far too poky for TV, but they're always on -- and that's a start. In the past three years, 14 million U.S. families have linked their computers with wireless home networks. These set-ups are quirky and weak, but they provide a base to grow from. The third leg is the mobile phone and all the goodies it can deliver. Some 55% of Americans now carry cell phones, and the first data services -- radio, photos, and short video clips -- are starting to take off.

As these technologies evolve over the next decade, a new digital world will emerge. Analysts predict that these nascent networks will speed up by an average of 50% a year, the historic norm. That will help the U.S. catch up over the next few years to where the Japanese and Koreans are today -- with far faster broadband and mobile systems that are robust enough for commuters to check for traffic jams and watch soap operas on their cell phones. As networks grow and chips continue to strengthen, companies will work madly to come up with winning products and services. Within the next five years, industry analysts say, practically every machine in the wide realm of communications -- every gadget that sings, talks, beams images, or messages -- will sport a powerful computer and a network connection. And every bit of digital information, whether it's a phone call, a song, a Web page, or a movie, will flow among these machines in the very same river of data.

By the end of this 10-year cycle, the change could be extreme. Web pages will snap to life. Hundreds of thousands of political bloggers, fly fishermen, chefs, and Oprah wannabes will be uploading gobs of video programming -- creating their own channels. This plethora of Web shows will joust for attention with television fare, Internet radio, video e-mails, and games. All of it will play on televisions, computers, and cell phones, which will be different flavors of the same machine. "The concept of a network or a channel will go away," says Jakob Nielsen, a partner at technology consultant Nielsen Norman Group in Fremont, Calif. "They're artifacts of old technology."

The dramatic shifts ahead are likely to shake up age-old concepts at the foundation of our economy. In the coming markets of moving bits, who owns what? Will people buy their programming and machines? Or will they rent and subscribe? Innovative companies will sort out these questions, leading the way in building new business models for the coming age. Those who figure out how to reach through the networks to deliver customized information and services will be the architects and kings of the converged economy. Michael Moe, co-founder of ThinkEquity Partners LLC, a San Francisco investment bank, predicts that these people and companies will rise quickly. "Five years from now, it will be over," he says. "The winners will be determined."

The clock is ticking -- pushing companies to hurry into bruising and unformed markets far from their roots and their expertise. The process, as Nokia Corp. (NOK ) can attest, is often humbling. A year ago, the Finnish company created N-Gage, a handheld phone/game-console designed to beat the consumer-electronics champs into a new hybrid market. But its awkward design drew scorn from gamers, and today even Nokia admits the first version was a disappointment. Then there's Intel, AT&T (T ), and IBM, which together backed a Wi-Fi joint venture in 2002 called Cometa Networks Inc. The goal was to link all the Wi-Fi hot spots into one seamless network. But last month, Cometa said it would shut down, the victim of fierce competition and an embryonic business plan. Says Sky Dayton, founder of Boingo Wireless Inc., a Cometa rival: "It's hard to translate success from one industry into success in another."

As the giants struggle to adjust, they'll face swarms of upstarts that enjoy powerful advantages. The newcomers carry no baggage from the old days, and they have the chance to sprint ahead on the strength of one breakthrough idea. History, too, is on their side. Precious few companies have made the leap from one generation of technology to the next. Who figured out the PC? Not minicomputer makers, but Apple Computer Inc. (AAPL ). Who mastered the Web? Upstarts such as eBay Inc. (EBAY ) and Yahoo! Inc. (YHOO ). "Big companies cannot really see beyond their current customer base," says Nicholas Negroponte, chairman of Massachusetts Institute of Technology's MediaLab. "This is why most new ideas come from small companies that have nothing to lose."


Which industry is best positioned for the clashes ahead? Each of them eyes soaring opportunities while confronting stark vulnerabilities. Hardware manufacturers tiptoe at the edge of commodity markets. DVD players, for example, have fallen in price from $400 to $49.99 in the past six years. Software makers face the specter of free open-source programs, such as Linux. Hollywood confronts pirates.

It's too early to choose winners from losers, but a few trends are clear. Chipmakers such as Intel, Texas Instruments, (TXN ) and ST Microelectronics start out on top. Their microprocessors will be scooped up to power a widening galaxy of products. And as their chips grow stronger, they can etch new services, such as networking, into the silicon. Korea's Samsung also seems to be sitting pretty. It has chips of its own, flat screens, and it drives innovation at the high end of the hardware markets, above the commodity fray. At the other end of the spectrum, entertainment studios and sports franchises produce the much-needed programming that will splash across high-definition screens and bring hundreds of new devices to life. It is in the vast center of this meta-industry that the dogfight of convergence is likely to rage. "What you find are commoditized low-end or a smaller high-end business," says analyst Stephen Baker of NPD Group Inc. "There are lots of problems in the middle." There, myriad distributors and hardware makers -- from Sony and BellSouth (BLS ) to TiVo (TIVO ) and Blackberry maker Research In Motion (RIMM ) -- will be scratching and clawing for each customer.

To see how this drama will play out over the next few years, begin with the key arena of China. That's where the assembly lines for digital convergence already are starting to hum. This vast workshop should drive down prices for important appliances, especially flat-screen TVs. They now cost from $2,000 to $6,000, about 10 times the price of a standard color TV. The hope is that new production will slice the price by half, or more, by 2006. Analysts predict that hot monitors will help spur spending on a host of networked consumer goods. Think of flat screens in the kitchen, in cars, in stores, or in schools -- all of them carrying programming customized for that particular spot. Oliver D. Curme, a general partner at Battery Ventures, thinks spending on consumer electronics, which grew from 1% of disposable income in 1980 to 1.5% in 2000, could rise to 2% within the next two to three years. "That's a really big wave," he says.

The Chinese-driven market for hardware promises to drive down prices mercilessly -- and spawn a host of fleet-footed startups. Using the computer industry's off-the-shelf components, newcomers can piece together dream machines in a hurry. Tiger Telematics Inc., a Jacksonville (Fla.) maker of global positioning systems, is one example. In the past year, the company has fashioned a potpourri of components from Microsoft, Samsung, and others into a new handheld. The result? A $400 game machine, the Gizmondo, that includes GPS, full-motion video, a music player, and text and photo messaging. Says CEO Michael W. Carrender: "Suddenly we can compete with the Sonys of the world with a best-of-class product."

To escape what promises to be a brutal hardware market, companies are likely to embrace entirely new business models. The first step, already under way, is to sell or rent hardware with subscriptions. One example is Walt Disney Co.'s (DIS ) Movie Beam, a video-on-demand service. The box rents for $7.99 a month. Its network connection keeps its hard drive stocked with about 100 new movies from a range of studios. Increasingly, industry analysts expect hardware makers to sell home-entertainment systems bundled with similar subscription packages. Juha Christensen, a former Microsoft executive and president of Macromedia Inc.'s (MACR ) Mobile & Devices Div., expects companies from Sony to Best Buy (BBY ) to promote new subscription services by practically giving away the hardware. "We're within 24 months of a subsidized TV," says Christensen.

While new hybrid machines will hog much of the limelight, the services wrapped around them will create far more impact. Consider a couple of the pioneers. With the iPod music player, Apple Computer added a tiny hard drive to a music-playing computer and -- voilá! -- vast music collections suddenly fit into a pocket. But it was the accompanying service -- the 99 cents downloads through iTunes -- that ultimately caused bigger waves. Suddenly the music industry was facing an entirely new and destabilizing model for selling its product. Around the same time, the founders of TiVo jerry-rigged a computer with vast storage. Still, it was TiVo's service, complete with an easy-to-grok remote, that helped viewers design their own viewing schedule. This has not only shaken the advertising industry but provoked a rush toward on-demand programming. "It's changing the way people experience TV," says Dave Watson, vice-president for sales at Comcast Corp. (CMCSK ), which is rolling out its own video-on-demand service.

Key Fixes Needed

As innovative services take root, the very concept of ownership is likely to fade in much of the tech industry -- as it already has in cars, with widespread leasing. Paul Saffo, director of Institute for the Future in Menlo Park, Calif., sees a wide array of tech products turning into what he calls "congealed services." Instead of buying a device, he says, consumers will rent or borrow it and subscribe to just about everything they want: music, movies, software, burglary protection. Service providers will handle installation and maintenance -- a mammoth business in a networked world. And since the machines will be defined increasingly by their software, they'll be able to add features and functions with upgrades sent through the network into subscribers' homes.

The home is shaping up as a key battleground in convergence. That's where the computer industry, quarantined in the den, is attempting to bust its way into the consumer-electronics stronghold, the living room. Both sides embrace the sparkling vision of the networked home -- a place where music and movies and Web pages all zip from one device to the next at the touch of a remote. Parks Associates, a market-research firm that follows home technologies, predicts that shipments of media-hub computers will grow in the U.S. from 13 million this year to more than 40 million in 2008.

Which side will provide the software for these networks? Microsoft, naturally, lays claim to this market. Its Media Center software puts the controls for all home appliances, including the TV, right into the PC. But Samsung, Sony, and others offer the same service through a set-top box. Says Kazuo Hirai, president of Sony Computer Entertainment America Inc.: "Innovation takes two forms -- one driven by us, the other driven by the software-development community."

But unless these merging industries get a few key things right, the digital home will remain the rarified realm of millionaires and geeks. The first is simplicity. If appliances can find and accommodate one another on the home network with the touch of a button on a single remote, the technology could sweep into the consumer mainstream around the world. But that's asking a lot. These are the industries, after all, that among them have brought us four or five separate remotes in a single living room, not to mention crashes, pop-ups, and viruses. "You don't want to reboot your whole computer just to watch a half-hour of Friends," says Sean Debow, Asia Pacific technology strategist at UBS (UBS ). So what will lead to simplicity? Perhaps the all-too-present fear that if one company doesn't get it right, it'll be swept away by others that do.

Just as vital as simplicity are across-the-board standards. A maze of stand-alone technologies threatens to balkanize the networked home and sap its potential. Apple and Microsoft, for example, are each trying make its own music software the industry norm, while Toshiba (TOSBF ) and Sony lock horns over next-gen DVD technologies. Perhaps the most important standard is a strong and unified system for protecting digital-rights management. Without such a guarantee, studios and publishers will withhold their jewels from the new networks for fear of piracy. The challenge is to come up with a norm that permits users to shuttle programming from one TV to the other, out to the cell phone and into the car -- without letting it escape, Napster-style, to hundreds of millions of other customers on the network.

Who's in Charge?

The future of entire industries could hinge on this jousting over digital rights. Microsoft and others are busy building their own standards. If one emerges, customers could buy their music and programming directly from the studios or even the artists, bypassing the cable and network powers that dominate distribution today. Brad Brooks, Microsoft's director for Windows XP consumer marketing, notes that consumers already are creating their own program and music mixes through services such as TiVo and music downloads. He thinks similar trends will thunder through the cable industry within 3 to 10 years. Others maintain that Microsoft's threat will spur the entertainment industry into developing its own technology. Says Philips' Dutiné, a Microsoft rival: "One thing that's waking them up now is the role of Microsoft. People are saying: 'If they control [digital rights], we're in deep s--t!"'

As industries converge, the pressure to offer every conceivable service is relentless. Stay out of a market and -- who knows? -- someone might step into it and steal your customers. Apple Chief Executive Steven P. Jobs says a key to succeeding in the converged economy is resisting the temptations to enter certain markets and to know when to say no. "I'm as proud of what we don't do as what we do do," he says. Jobs, for example, nixed calls to enter the cell-phone industry, which has 1.3 billion subscribers today and could reach an estimated 2 billion by 2007, according to In-Stat/MDR. Jobs says the economies of scale are too big for niche players such as Apple.

But for lots of companies, the mobile market is just too enormous, and too rich, to pass up. Hewlett-Packard Co. (HPQ ) is coming out with a telephone pocket PC later this year, targeting business users. And Huawei Technologies Co., China's networking leader, is preparing its own line of high-speed smart phones. Why? To be able to sell phone companies a package of networking, data services, and handsets, says William Xu, Huawei's executive vice-president.

Putting together the machines is the easy part. After the N-Gage misstep, execs at Nokia are releasing the second generation of the phone-and-game-player combo and studying the lessons of the first. Number one, they say, is that while it's relatively easy to package a potpourri of digital technologies, it's an ordeal to build a business around new suppliers and sales channels and to master different marketing techniques. Most important, says Ilkka Raiskinen, Nokia's senior vice-president for games, "is to convince people you're in it for the long haul."

The fact is, it's hard to know. The industry teems with upstarts, and any one of them is capable of rocking industries with just one new idea. Newcomers have defined each stage of the Information Era. And the age of convergence offers perhaps the richest yet. Why? The networks now taking shape will link together more than 1 billion people, not just with words or voices, but with music, video, games, and commerce. A vast chunk of the world economy is going digital -- and for the next few years it's up for grabs. This revolution won't quiet down anytime soon.

By Stephen Baker and Heather GreenWith Bruce Einhorn in Hong Kong, Moon Ihlwan in Seoul, Andy Reinhardt in Paris, Jay Greene in Seattle, and Cliff Edwards in San Mateo, Calif.

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