Living room new Internet battlefield: Apple vs. Microsoft

Peter Nowak, Financial Post
Published: Thursday, December 28, 2006

There's a battle going on to connect your living room to the Internet, and it is about to intensify as two tech titans -- Microsoft Corp. and Apple Computer Inc. -- gear up for the next round of their decades- long rivalry.

But it's not just the next chapter in this classic feud. The fight for the connected living room -- in which television, movies, games, music and the Internet will all be downloaded to your TV screen -- looks to forever change the way people consume entertainment at home.

"It's really going to be a Goliath battle," says John Ruffolo, national leader for Deloitte & Touche's technology, media and telecommunications practice. "Whoever wins, it's going to be the great big business opportunity for the next number of years."

The main driver of the Internet's move from the den to the living room is video, in the form of paid television and movie downloads. It's a trend that started in 2006 and is expected to blast off in 2007, with retailers including Amazon.com and Wal-Mart Stores Inc. also getting in on the trend.

A report last week by U.S. market research firm NPD Group expects paid video downloads to double or triple in the next year. Strategy Analytics sees the market growing to US$1.4-billion in 2007 from US$298-million in 2006, and rising to nearly US$6-billion by 2010.

"2007 will be remembered as the year in which online sales of pre-recorded video finally became a real business," says Martin Olausson, senior analyst at Strategy Analytics' broadband media and communications service. "Just like with music, online delivery of video content is now emerging as a viable and increasingly important distribution channel for content owners."

While such video services are typically available only in the United States so far, they are expected to migrate north once the business models prove themselves over the next year.

Redmond, Wash.-based Microsoft is in the driver's seat with its Xbox 360 video-game console and associated online subscription service, Xbox Live. The console, launched a year ago, is aimed primarily at gamers, but Microsoft is increasingly talking it up as a full, Internet-connected multimedia machine. It is capable of wirelessly connecting with a person's PC and streaming the media on it to the television.

Xbox Live, meanwhile, has been offering online gaming for some time, but this year added television downloads in the United States for between US$2 and US$3 an episode, along with other video content, including free music videos and movie trailers. Two weeks ago, Microsoft took the long-expected step of adding movie rental downloads in standard and high-definition formats, ranging from US$3 to US$4 each, to Xbox Live's U.S. offerings.

The company says Xbox Live has four million subscribers worldwide (it does not break down numbers by country) and is projecting six million by the end of June. Microsoft expects to have sold 10 million Xbox 360 consoles by the end of this year, with about two-thirds of those connected to Xbox Live. So far, more than 70 million pieces of content have been downloaded since the 360 launched, a number Microsoft expects will grow significantly in 2007.

Cupertino, Calif.-based Apple Computer also got in on the action in 2006, and plans to accelerate its move into the living room in the coming year. In May, the iPod maker introduced television episodes for US$1.99 each to its online iTunes store and in September added full movies for US$12.99.

Chief executive Steve Jobs also in September announced a device tentatively called "iTV," to be released in the first quarter of 2007. The device will wirelessly connect the television in the living room with the computer in the den and is expected to allow users to access iTunes from their TVs.

Apple says it has sold more than 1.5 billion music tracks and tens of millions television episodes and movies through iTunes. Analysts estimate it has about 90% of the paid video download market and is therefore well-positioned for the coming boom.

Yet, dozens of telecommunications and technology companies have for years tried and failed to connect the living room to the Internet, so why is it taking off now?

NPD says increased levels of broadband access, powerful and fast computers with DVD writers, portable video devices and file-sharing services are combining to make Internet video consumption easier. Better wireless broadband connectivity is also saving consumers from having to run wires between their den and living room.

Microsoft is one of those firms guilty of trying and failing with its Windows Media PC, which came out before the technology was ready, Mr. Ruffolo says.

"They were coming out with this concept, but the basic infrastructure wasn't really there. Everything is now ready from a technological perspective, whereas five years ago Microsoft was premature."

The original Xbox, the predecessor to the 360, was the software company's first real attempt at cracking the living room. When the Xbox was released five years ago, it was obvious it was about more than just video games. It differed from its peers by virtue of having a hard drive and broadband port, meaning it was designed to connect to the Internet, download content and store it. The Xbox was instantly dubbed a "PC in disguise."

Its successor, the 360, has a wireless broadband connection and high-definition graphic ability, which means it's tailor-made for downloadable video content, Microsoft says.

"People are on their couches looking to be entertained. Gaming is a big part of that, but it can be so much more," says Jason Anderson, marketing manager of Xbox Canada. "It's time to broaden."

Despite Microsoft's head start, however, it's Apple that is being seen as the force that will drive the explosive growth of the Internet in the living room. While the Xbox 360 requires some technical know-how to connect wirelessly, Apple has built its reputation on making easy to-use, aesthetically pleasing products, a fact that is particularly obvious in its dominance of the music-player market with the hugely successful iPod. If Apple's iTV is as easy to use as the iPod, consumers could flock to downloading television episodes and movies from iTunes.

Apple is a secretive company that rarely comments about its future products, and declined to talk about its iTV device for this article.

It's not all Microsoft and Apple, however, as Sony Corp. also wants a piece of the pie. Its recently launched Play- Station 3 video game console has all the same features of the 360 -- hard drive storage, broadband connectivity and high-definition graphics -- and in addition lets users surf the Web and check their e-mail. Sony also says it has two advantages over Microsoft and Apple: the Japanese company has its own extensive movie and music content, and it can offer interactivity with its Play Station Portable handheld device.

"The ace we have up our sleeve at this point is that they can't replicate our 10- year heritage of making great games," says Matt Levitan, marketing manager of Sony Computer Entertainment Canada. "So although [Apple]may be able to provide something that can download or view movies or songs, we also have the game-play element on [the PSP], which is something they can't really address."

Sony's online presence is in its infancy, but the company plans to integrate its various offerings. For example, consumers will be able to download movies or music from Sony's online store to their PS3, then access the stored media with their PSP from any wireless Internet hotspot in the world.

Analysts tend to discount Sony as a serious player, despite the fact it is still the market leader in video games, and peg it as a company in disarray. Its content ownership and diversity as a company

could also actually prove to be a disadvantage.

"I don't think it's provided any sort of cost or business advantage to Sony," Mr. Ruffolo says. "Frankly, the evidence is there that it might actually be a liability. It's not in their core competency. If you speak to the folks at Sony in Japan, do they really know how to run a movie business? Can they run a music studio?"

Another serious player could be San Jose, Calif.-based networking company Cisco Systems Inc., which currently makes digital television receivers through its Scientific Atlanta subsidiary for cable firms. The company is planning to release a cable bypass box that will allow consumers to download television and movies. Cisco's advantage is that it actually builds and understands the broadband connections necessary for the delivery of all the content, analysts say.

"Cisco actually might be the scariest of the three. They are a scary company because they get the critical aspect of this -- it's the pipe," says California based technology analyst Rob Enderle of The Enderle Group. "Cisco is heavily versed in that back-end infrastructure and they know how to tune that."

Mr. Enderle says Cisco is not likely to go it alone, however, and will more probably market its service as an enhanced broadband offering in partnership with telephone companies.

Ironically, the Internet-connected living room is a competitive threat to cable and telephone companies alike. Both types of providers are increasingly getting into offering on-demand, digital, high-definition video over their high-speed Internet networks. Phone and cable providers are finding it disingenuous that companies such as Microsoft and Apple are using their own networks to compete against them, so they are taking steps to slow them.

BCE Inc., for example, recently announced its broadband subscribers will be billed according to how much they download, a move analysts say is clearly designed to slow Internet video consumption.

In the end, the battle for the Internet connected living room will come down to whoever has the best business model, Mr. Enderle says.

Pay-per-view services generally have not done well, and some sort of all-you can-eat download subscription services are sure to emerge over the next year. Microsoft may have the early advantage, he says, but "it's not an extreme advantage."

Mr. Ruffolo, meanwhile, says it's a bad idea to give too much credit to Apple based on its success with the iPod.

"People have been dismissing Microsoft in the last year or two, but I never count those guys out."

pnowak@nationalpost.com