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Who: Christine Heckart, General Manager, MSTV Marketing

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Who: Christine Heckart, General Manager, MSTV Marketing

  1. 1. Who: Christine Heckart, General Manager, MSTV Marketing When: September 20, 2006 Where: Microsoft - Redmond, Washington JOE BINZ (Investor Relations, Microsoft): Welcome, everyone, and thanks for joining us for today's Live Meeting on our Microsoft TV business. Before we begin, I'd like to cover the following administrative details: Today's presentation may include forward-looking statements based on our current expectations and assumptions about the business. These are subject to risks and uncertainties. Our actual results could differ materially because of risk factors we may discuss today, and those identified in our most recent 10-K and 10-Q. We don't undertake any duty to update forward-looking statements. As always, a replay of this Live Meeting will be made available at the Microsoft Investor Relations Web site. I'm pleased to be joined today by Christine Heckart, General Manager of Marketing for the Microsoft TV business. In her role, Christine is responsible for partner business development and worldwide marketing activities, including market research, strategic planning, and product management. Christine joined Microsoft just over a year ago, prior to which she was the vice president of marketing for Juniper Networks. Format-wise, Christine will provide an overview of Microsoft TV, as well as a brief update on our IPTV initiative. We'll then use the remainder of the time to field your questions. Please note that only those of you participating via Live Meeting will be able to see the presentation slides and submit questions. We ask that when you submit your questions via Live Meeting you also include your name and firm. I'll then read the questions for Christine to answer. We may not have time to answer all the questions, so if you have any further questions following the call, feel free to contact Investor Relations, and we'll be happy to follow up with you. So with that, it's my pleasure to turn the call over to Christine. CHRISTINE HECKART: Great, thanks, Joe. Hi, everybody, and thanks for tuning it today. We're going to talk about one of my favorite topics right now, which is IPTV. I thought what we would do is I'll spend 15 or 20 minutes on some prepared remarks, mostly just trying to make sure we're all on the same page for what Microsoft TV is, where we fit within the Microsoft family, and a lot about why we're excited about this market, and what we're bringing to it in terms of value. Then I'll open it up for Q&A, because I think the most value of this session is likely to come out of the second half where we can respond to your specific questions.
  2. 2. So let me start just by making sure we're all on the same page for where Microsoft TV fits. As you guys know well, if you follow the company, we've got three different business units: The platform products and services division includes the Windows client business, server and tools business, as well as the MSN business. The business division is all the software that's built on top of that. And then we have entertainment and devices. And it's in E&D that you'll find Microsoft TV. E&D breaks down into four main areas: The communications group is the Mobile & Embedded Devices group. Productivity is where we make good money on all of the peripherals that we offer as Microsoft. The gaming group is the Xbox team, which I think you're well familiar with. And then there's this new group that we launched last year under Bryan Lee, which is our entertainment group. And Microsoft TV is part of entertainment, along with Zune and eHome. And Microsoft TV has two main products that we take to two main markets, and it gets a little more complicated than that, but for right now to be simplistic we have a cable product, which we call Foundation Edition (FE), we sell it into the cable industry, and we have an IPTV product, which has the entertaining name of IPTVE for Edition, and we sell that to telcos around the world. And what we really want to spend most of the time talking about today is the IPTV market for telcos. So I thought a good place to start the discussion would just be to have a foundation of what we think of as IPTV, what's in and what's out of that, because you hear Internet TV, Apple's got this new ITV, which I'm sure will be suitably confusing for the market, we talk about IPTV. So not that there's a right or wrong, but let me just share the way we think about it. For us, IPTV is about a managed IP network over which we can deliver a managed video service. And we is not Microsoft, it's Microsoft in conjunction with the service providers who own the consumer and package up all of the content and deliver it as part of the service. IPTV is all about delivering the kind of television you know and you're used to today, broadcast TV, video on-demand, et cetera, to your TV set. It's not about Internet on the TV and it's not about TV on the PC. Internet TV is something different. I'll take you through the architecture for IPTV. Internet TV can be part of that architecture, but it's really not the foundation of the architecture. The foundation is an IP, a managed IP network. So the main components of IPTV are any kind of content that you're ingesting. That can be live broadcast, it can be videos that you're going to offer on-demand, any kind of content, radio, et cetera. A service provider will take those off satellite, airwaves, fiber network, however they're bringing that into their head-end, and then they will store that typically on servers. And there's a wide variety of servers in the Microsoft TV architecture, and, in fact, just the server infrastructure brings with it a lot of opportunity for Microsoft. We are using Microsoft’s Windows Server and SQL and MOM and SMS and lots of very traditional Microsoft products in the head-end and in the central office to deliver IPTV to these service providers.
  3. 3. And that's interesting because it really takes very traditional Microsoft server technologies into the service provider infrastructure, which is a new opportunity for the company, it's not a place where we've had a lot of business to date. So there's a lot of interesting opportunity for Microsoft just in the server infrastructure. Then we also deliver that over what would be the last mile infrastructure, all the way out to the home, and there's a software component that sits on a client, which is the set-top box, out at the subscriber's home. So those are the main elements of delivering a basic IPTV service. What you don't see in that diagram, but what is important to remember is this is basic IPTV. Once you have this infrastructure in place, you can leverage the content and the back-end server infrastructure to deliver content to mobile subscribers, if you're a service provider with a mobile offering. You can blend in what would be called over-the-top video services off of the Internet. You really take the TV and you make it part of a two-way IP network, and any other part of an IP network can also participate in this ecosystem. So that's the grounding on kind of how we see IPTV, what it is and what it isn't. We're excited because there's about 1.6 billion TVs in the world today. There's a lot more TVs still than there are PCs, and a lot of ways that you can reach consumers through those televisions. If you look at different market research, you will find that around 30 to 40 million in subscribers are predicted over the next couple of years, and the revenues in the tens to multiple tens of billions of dollars. Depending on which research you look at, and I know many of you guys do your own, you'll see anywhere from very conservative to pretty standard estimates that result in compounded annual growth rates in the hundreds to thousands of percent a year over the next couple of years. And it's a big market, it's a Microsoft size market. So we're excited because there is a very real opportunity here in a very fast growing market. So let's talk about what's better with IPTV. IPTV can and will transform a couple of industries. It will transform the service provider industry, potentially in some fundamental ways, and it will transform the entertainment industry. And somewhere along the way it has opportunities to transform advertising, which you could think of as its own industry or part of entertainment. There's a lot going on. It starts with delivering better TV. The killer application for TV is still great television, it's great content, and IPTV offers unbelievably good quality. You don't really have limitations around the number of channels you can offer and the number of channels in high definition. You really can bring almost unlimited choice to consumers in a way that you can't do with broadcast oriented services today. You can deliver this content across a wide variety of devices. You can really personalize it. And while we don't see in the short term self-publishing being an important part of the landscape, I do believe that over the next three to five years we'll see the two-way capabilities of IPTV really come to light in self-publishing of
  4. 4. content, much the way we saw happen on the Web once we had basic Internet access delivered to people's homes. There's also better control over the experience, you can personalize it. With Microsoft's IPTV solution we build DVR capabilities right into the service architecture from the ground up. And that has some really interesting side benefits like search and discovery. For any of you that have tried to find a particular piece of content, a particular movie or a particular favorite show on existing services today, you'll find that search is typically not very user friendly and not very rich. And with the Microsoft IPTV service you can search any content. We treat it all the same, whether it's live TV, favorites that you've recorded and stored, any number of video on- demand titles; you can search it all with the same search function at the same time, and it serves it up to you in a very intuitive and easy to use manner. Search is one of the things that when we do our usability study, it, along with picture-in-picture technology for browsing channels, and instant channel change are the three things that often pop to the top as what users really notice and enjoy about the service as soon as they put the remote in their hand. Then there's also opportunities for connectivity. That means sharing media in the home across a variety of devices, and integrating in other forms of communications, and over time I believe that community and commerce as well will become important parts of the IPTV experience. So there's a lot of hype about TV becoming a more connected experience. And a lot of that hype will be reality in a pretty short amount of time. Already today Alcatel can show you an application that they've built on our platform that lets you remote record from a cell phone to a television, or take a picture on a cell phone and send it directly to any TV set. We've got applications that allow you to remote record from your DVR on a PC. The truth though is that the essentials of the experience of just watching great TV are still the key drivers, they're the main requirements of the market short term. In all the research that we do in our usability labs, that's what people gravitate to, just give me a better TV experience. And people aren't terribly unhappy with their TV service today, which makes for a pretty interesting marketing challenge for service providers, but one thing that has held true over the last couple of years of the research we've done on this system is once people see it or experience it themselves, there is a noticeable difference and advantage, and they become very interested in the service. So the interest rates, the take-up rates that both AT&T, Verizon, BT and others are seeing in their early market trials show that there is a meaningful and measurable difference. One of the things that Microsoft has had to do is build a pretty substantial ecosystem to allow the end-to-end delivery of this service. So the parts of the ecosystem that we've concentrated most on to date are the encoders, the servers, and the set-top boxes, among some other things, but those are the really key components in the ecosystem right now. And this is a reasonably fair representation of that ecosystem today. I don't have Phillips on here, and there may be a couple of others, but this is the majority of vendors that you'll see delivering those parts of the ecosystem. Over time this is an open platform, the Microsoft TV platform is designed to be open both to hardware vendors, as well as to applications developers, and we want to bring the world's talent into this market and allow them to innovate on the platform
  5. 5. and to develop new applications on the platform and to extend off of the platform in new and interesting ways. So one of the things that we should expect is to see this ecosystem broaden and enrich itself over time. One of the questions that I get asked a lot, so I thought I'd just try to treat it proactively here, and we can come back to it in the Q&A if you have more questions, I get asked about competition, who does Microsoft compete with in this space. And it's a really difficult question to answer, because Microsoft right now is the only provider that brings together five or six different elements that without Microsoft you could go do or buy individually, but you'd have to bring them and systems integrate them all together, and then you'd have to synch those roadmaps over time. So what Microsoft does is we bring in, we ingest content, we use something called an A-server, an acquisition server, and that A-server not only ingests the content but it also sends out the multicast stream, which you can join when you're trying to watch an individual channel in your home. In addition to that, we do a VOD architecture, video on-demand architecture. We have something called a D-server, which does unicast of traffic, which is part of how we've been able to deliver this instant channel change experience. We have subscriber management capabilities, we do the guide, including bringing in all of the metadata, and then using that to serve up a very rich guide in the form of the client on the set-top box, so that users know what's available to them. We have our own integrated security system version of Microsoft's DRM, and then the management that goes over the top of that. So you can pick most of those individual areas, and you can find individual competitors, there's a ton of competitors in the VOD space as an example, but there isn't anybody in the market right now, besides Microsoft, that brings it all together. And in very mature markets, service providers are more comfortable in systems integrating a lot of pieces themselves. In early markets they're typically less interested in doing that, they're more interested in trying to get to market with some best in class capabilities quickly, which is I think one of the reasons why Microsoft has gained such traction with the world's largest providers so quickly. Plus TV is a very different competency for these providers, and it's something that Microsoft has been investing in for eight or ten years. So having world class talent that understands encoding and video delivery, that in and of itself is a huge benefit. The other thing that's really hard about IPTV and that doesn't show up on this slide, but is nonetheless incredibly important, is television is a deterministic application, especially live TV, and IP is a non-deterministic network. So making something like television work over IP is a nontrivial task. You have to not only really understand how you deliver TV over any infrastructure, but you also have to understand IP and IP networking. And there are some pretty substantial barriers to entry as people seek to enter this market because it is growing so quickly. So there is a lot of interest in this around the world. You guys are at least as familiar with this as I am. I've gone around the world a couple of times now and met with most of the top service providers, all of our customers, and then many prospects, to really understand what's driving their business. And there is so much interest in this for a couple of reasons. Service providers are wanting to transform their business model and entertainment is a key piece of that, and they also want to deliver triple-
  6. 6. play services, so it's not just about entertainment, it's about a bundle of services to help lock consumers in and make churn of the base more difficult. So you see the world's largest providers that are currently customers of Microsoft's IPTV service, or in the case of Verizon kind of an interesting hybrid product, and there are others around the world, I guess we have Reliance on here over in Asia, that are either in the IPTV market as well or will soon be entering. So this doesn't represent everybody out there that's doing IPTV, but it is a good representation of the Microsoft customer base right now, and is collectively representative of a very high percentage of the world's users of residential fixed access lines and of DSL services, so a very large percentage of the world's population can be reached through this pretty small number of service providers. We've announced so far about 14 in all, and that's not inclusive of the service providers that we've won jointly with Alcatel, and they've been very active in this space. One of the reasons that service providers like the Microsoft solution is it's designed to really let them customize an experience for their consumer base. And that means things as simple as re-skinning the offering, and I'm going to show you a couple of skins, all the way up to developing their own applications or having third parties develop applications on top of the platform that are interesting and unique to their market. So this is the AT&T Uverse skin, and I also have included the Club Internet skin. Club Internet is a brand of T-Online, DT's T-Online operating in France. So Club Internet is the way that they go to market in France. Club Internet has been offering a Microsoft-based IPTV service since summer of this year, and they're having a lot of success. So two very different ways to skin the product, they're the only two that I included in this case. I show Club Internet here going to market in France. You can walk into any of the main retailers in France and find the Club Internet offering there, as well as Microsoft TV. And in this case we go to market jointly, so the Microsoft ingredient brand is pretty prominent. The last thing I thought I'd hit on in terms of prepared remarks, then we can shift into Q&A, is this market itself. The pay TV market is huge, but it hasn't been growing very rapidly in some countries. In the U.S. it's a pretty mature market. Germany is still growing at a reasonable rate, but in the UK it's a pretty mature market; other parts of the developing world the market is growing rapidly. But the fact that the paid TV market itself isn't growing rapidly doesn't mean there isn't a big opportunity for telcos as they enter the market. One of their opportunities is just pure share shift, and another opportunity is in growing the pie. We just completed some research with Mercer, and I'm not including that whole study here, although I'm happy to spend more time on it either in Q&A or in calls that Joe can schedule, but a couple of things that were interesting that came out of that, this study was just U.S.-based. I don't have back yet the results from a worldwide market study that we're doing right now. I will have that in a few weeks, and hopefully we can get back together and talk about the results of that worldwide study.
  7. 7. But right now for the U.S. we're seeing that if a service provider were to enter this market with a competitive TV offering, and competitive meant you can get basically the content that you're used to today with integrated DVR service at the same price that you pay today, the service providers can pick up low double-digit share of the market, just for coming to the party. And frankly that will keep them busy for a while, because that's a reasonably healthy place to start. So while they have to start from zero and work up, there's at least 13 percent of the market that feels inclined to shift to a telco provider that doesn't have a better experience, doesn't have a lower price, doesn't have anything that differentiated, just has a competitive offering. What we wanted to find out in this study was something a little bit more interesting than that initial share shift. We wanted to find out what it would take to drive their share up, if it would take reducing the price. One of the things that we would rather not see happen is that with more competition in market, that we see ARPUs decline dramatically. We think there's a lot of innovation to be brought to this market, and we'd like to see the telcos and the cable companies both have enough profit that they can invest in ongoing innovation in this space. And one thing we found interestingly enough here is a 10 percent decrease in price could get the providers up into the 15 to 18 percent share range, if they didn't do anything else but just drop the price. However, if they kept the price the same, they didn't drop the price at all, they kept the price the same, but they added some additional features -- and we tested nine different features, I can share those with you, but they were things like caller ID and remote record and having information on your PC available to tell you about the shows that were on that evening, and a variety of other not very difficult to deliver features -- that just the added features were enough to drive a 20 percent share take for the service providers without having to lower the price of the service at all. So that's very encouraging, because it says that for a reasonable percentage of the market there are still capabilities that they're interested in and want, and those capabilities are more attractive than just having a lower price. We also found that there are a number of different ways to grow the pie. So if you just share shift, that's interesting, but what you guys I think are looking for is, is there a chance to really make the market itself bigger? And the answer to that is absolutely yes. There's a number of ways to do that. The one that I'm sharing here is the easiest and least controversial. You can talk about commerce, you can talk about new ways to do advertising, you can talk about new ways to do communications and community-based offerings; all of those are things that don't really exist today, and could dramatically grow the market. But if you want to look for something that exists today that is very tangible, and the risk isn't that high, you can look at the video spend that people today are already shucking out. Money to rent movies, to go to the theatre, to buy DVDs. And there is a lot of money that's up for grabs, and an average of $37 a month per household is being spent in this market. Now, we don't believe, and the research didn't show that we could grab all $37, that's not reasonable, but with a variety of different packages, and it almost didn't matter which package you used, we could show that service providers could take at
  8. 8. least a couple of dollars a month, so anywhere from, say, $5 a month up from there into the low teens by the ways that they packaged video offerings. So we think we can share shift not just from the pay TV market, but from the broader entertainment market into this market for the service providers, so really interesting ways for them to continue to add to the ARPUs of their subscribers. So I'll wrap it up. You can read the summary remarks here as well as I can. I'll summarize this by saying that TV itself is really in transition, what we think, what we want from TV. The service provider industry is undergoing transition, the content industry is, the advertising industry is; and one thing that you can find as a similarity across all of those industries is that software is the driver, software is the differentiator, software is what matters. And there is no company that's better positioned to take advantage of an opportunity in software than Microsoft is. And there's billions, literally billions of dollars of market opportunity here for somebody to win and possibly others to lose. Microsoft is extremely well positioned in the IPTV space, and in the adjacent markets that you can tap once you have that IPTV foundation in place. So it's a super exciting place to be right now, fraught with a lot of questions, if nothing else, and a lot of excitement. So I'll go ahead and end these prepared remarks and open up to the questions that you guys have. JOE BINZ: Okay, thanks, Christine. Our first question comes from Nikos from UBS, and he's interested in any comments we have on industry views that Microsoft IPTV software requires a server for 100 to 150 homes to implement fast channel change. In doing so, can you comment on the ability for the software to scale? CHRISTINE HECKART: Yeah, great question, thank you, Nikos. There were a lot of very legitimate concerns I think about the scalability of the platform a couple years ago, and even when I joined a year ago, it was one of the big things that I dug into before taking the position, because there had been a lot of rumors about scalability. And I don't remember the hundred, but there literally was an article written that said something like it took three servers for every one subscriber, so it wouldn't surprise me to know there was one that said a hundred. The hundred is not true, and it depends a little bit on the architecture. You can dial certain things up or down, like the amount of HD, the number of clients, set-top boxes per home, the amount of on-demand video that is likely to be served up, and it will change the scalability numbers a little bit. But right now the system is delivering usually in the, say, 500, 600, 700 per subscribers per server set, so there's a number of servers that you need in order to serve up one user, and then how many will that scale to. So scalability up today is not the problem; we're hitting all of the metrics that we initially thought to hit, and that the business cases are based on. And we know that we can improve upon those; in fact, we've just recently added both IBM and HP into the ecosystem. They both have brought some innovation into the server
  9. 9. architectures that have reduced costs further, and the cost of the hardware itself is really dropping. When I first came on, I think it was about $3,500 a server on the market, and now you can buy that same server for about $2,500. So there's lots of ways that we can improve upon it. The scalability is already solid, it's already meeting the metrics that we had set forth as objectives, and we can improve upon it. Scaling up is not the concern that I have today. If I got out and talked to service providers a year ago or a couple years ago I would have had a lot of questions, and we had a lot of questions, about scalability and also about security. You never hear about either of those now, scaling up isn't a concern and security isn't a concern. However, scaling down is a question. I don't yet know, and we haven't stress-tested how low this can go. And this year that's not such an important question, and probably next year even it's not a super important question, but as we want to drive this into more and more markets, as we want to take this into the tier 2 and tier 3 providers, then we do have to understand how low we can go, you know, can we support hundreds of subscribers per server, can we get everything that we would put today on specialized servers, which is required for scaling up, could we put all of that on a single server required for scaling down. We think the answer to that is yes, but we haven't put the kind of effort into the scaling down question that we have into the scaling up architecture, so it's hard for me to know where to draw the line. JOE BINZ: Okay, thanks. Our next question comes from Jonathan Curtis regarding the Wall Street Journal article on Verizon from the past week, and he asks, "Which elements of the IPTV solution being deployed at Verizon has Verizon had to develop on its own, and do you know why they felt this was necessary?" CHRISTINE HECKART: Okay, so first of all, Verizon is not deploying an IPTV architecture. So there were a number of inaccuracies, I lost count at about 12, in the Wall Street Journal article. And we've called them and we've gone over what we believe were just kind of blatant inaccuracies. Verizon is deployed on a unique hybrid architecture that's built on our FE product. So remember at the very beginning of this we talked about Microsoft TV having two products, one for cable, one for telcos. Cable is the FE product, and then the telcos are generally using IPTV. Verizon has neither of those. Verizon has a special product that we built for them that is based on the FE product, but it has an IP back channel so that you can get some parts of a two-way experience and two-way communication using IP, but still using a com-based delivery system, which is their current architecture. So they have a very unique offering. That product, similar to our FE product and our IPTV product, is designed for service providers to be able to write their own applications on top of that, and that was part of Verizon's strategy from the beginning. At least for the year that I've been here, that's always been an explicit and open part of the dialogue we've had with them, and it's been an explicit part of their strategy. So they will continue, I believe, to innovate on top of that platform. Right now they
  10. 10. are enjoying pretty amazing success in the market with Fios, I think certainly more than they predicted. We're very happy to see it. I do surveys on their customer base in terms of how satisfied the users are with the Microsoft experience that we're delivering with our parts of the software, which include the user's guide, and the satisfaction levels are very high with that service. So there continue to be innovations that we want to deliver to Verizon that they can take to market. In fact, one of those recently just came out, which is Whole Home DVR, and Verizon is now the only provider in the market with Whole Home DVR capabilities, and that was one of the innovations that Microsoft delivered to them. So I would see that we continue to have an ongoing partnership with them. I absolutely anticipate that they continue to innovate and develop on top of the platform. I hope all providers do, but I know it's an important part of the Verizon strategy. I think every provider is going to have to decide how much they're going to insource and how much they're going to outsource, and outsourcing can be other third parties besides Microsoft for developing applications, and typically will be on the applications front, as well as how much of their own systems integration and underlying components that they do. Most service providers don't have that competency, they don't believe they can attract the world's best, and they want to take something that one company can develop and then share the cost because the cost to develop this is pretty expensive. Microsoft invests a lot of money in bringing world class software to this market, and, of course, we can share that over a wide number of providers. So I would anticipate they're all going to do some level, and Verizon will be no different. JOE BINZ: Our next question comes from Rick Sherlund, and he would like to know, "Are the cable companies able to offer this, or just telcos, given that cable does not have an IP network? Will cable deliver IPTV as well over time?" CHRISTINE HECKART: Yeah, and that's a great question. You can answer that yes and no. Cable companies can do many of the things that you can do with IPTV over a combination of a broadcast cable network with a back channel IP network. And most of the big cable companies have been investing in IP networks for a long time, so they have that infrastructure. You can't do everything. With IPTV you're really turning the TV into a two-way receiver. The TV has not been part of the digital age, and it really was left behind. And with IPTV you are bringing it full into the digital revolution, you're making it part of a two-way network, and you can do things as a result that you really can't do any other way. So over time I think you'll see that cable companies will look at IPTV and when it makes sense for their network and their shareholders you may see them start to dip their toe in that water, but right now they've got huge investments in their cable infrastructure, they can bring many of the same advantages using a back system based on IP, and I think you'll see the two industries continue to be different in those underlying infrastructures for a while.
  11. 11. JOE BINZ: Our next question comes from John Hodulik of UBS, and he asks, "A recent article suggests that Verizon developed their own EPG instead of going with Microsoft’s product. What did Verizon not like about the Microsoft product?" CHRISTINE HECKART: That would be I think the Wall Street Journal article, the same one that was mentioned earlier. That article had a number of inaccuracies. The Verizon product is based on the Microsoft EPG, the Electronic Program Guide, as well as a number of other aspects of a special hybrid product that we developed and delivered to them. I think Verizon does like the EPG. I think their customers love it, and that's borne out both in the rate of subscriber ramps that they're having on the service, as well as the feedback from the subscribers that use the service. So I don't believe that Verizon is unhappy, but I'd let them speak for themselves on it. JOE BINZ: Okay. Sid from McAdams Wright Ragen asks, "Can you talk about the IPTV revenue model, and various related revenue streams for Microsoft associated with IPTV?" CHRISTINE HECKART: Yep, good question, Sid. So this is a subscriber license model much like other software. So we charge a license fee, a client and a server license fee for each subscriber. And what we've done is we've been able to package together into one license fee a number of different underlying Microsoft technologies like the WinCE, Windows Server, SQL, MOM, and our own Microsoft IPTV software, so all that gets packaged into a subscriber license. And the way that, if you're looking for kind of how do you tell whether or not Microsoft is doing well financially, since we don't disclose revenue down to a per business unit level, what you would look for is the rate of subscriber ramp. So the more subscribers there are on the services around the world, the more revenue that we'll make over time. It's not exactly linear, but it's near enough that it will give you a good flavor for the health of the business. JOE BINZ: Our next question comes from Andy, and he asks, "Does this platform assume delivery over the open Internet or dedicated IP networks?" CHRISTINE HECKART: So if you remember one of the very first slides that I showed you was that end-to-end architecture, IPTV the way Microsoft talks about it, and it's not that it's right or wrong but just the way we view it, IPTV is really about delivering live TV and video on-demand and other services over a managed IP network, not over the open Internet. Now, that's the basic architecture, and that lets you deliver a very high quality service, pay TV service to subscribers. It doesn't prevent you from also offering what could be called over-the-top. Over-the-top is a variety of different things kind of lumped into there, which means delivering Internet like services and Internet like quality and video downloads and anything else you want to think of to over an Internet-like service to your television. It does allow the TV to participate in the larger Internet community if the service providers want to open up their offerings in
  12. 12. that way. And most of them are looking at how they will blend together the managed IPTV service, great television to your TV set, with Internet like offerings, including over-the-top video services, as well as mobile, as well as some other interesting things. So over time I think you'll see all of them coming together into an architecture, but if you were talking just about IPTV, it's about managed IP services. JOE BINZ: Our next question comes from Scott Coleman of Morgan Stanley. "What, if any, are the middleware related technical hurdles to delivering high def, DVR, and fast channel change? And of the carriers you're currently engaged with, how many offer one or all of these services?" CHRISTINE HECKART: So good questions, Scott, a lot is lumped in there. And all of them offer all of those that you named. Each of those is part of the Microsoft TV experience, the user experience that we deliver. And you asked about what are the difficulties in the middleware. I don't think of it in terms of just a middleware component, so I guess it depends maybe on how broadly you're using that term. But the difficult parts are some of the things that you mentioned, how do you just do something as deterministic as TV over a non- deterministic network like IP, and that's pretty hard. HD itself proved to be pretty difficult. If we were to go back, rewind to say this time last year, HD was hard. And one of the reasons that we transitioned the ecosystem from a basic Intel-based chipset to a system on a chip, a custom piece of silicon called a SOC that we have a reference architecture for, and Sigma and some others are delivering as part of the set-top box, was in part to get the kinds of very rich video experiences like HD delivered via software onto a television set, and to be able to do that, do something like sports, very fast moving in high definition. So it is in part the software, but it's the entire ecosystem from the encoders, you know, it takes new encoders to do HD, all the way down to the silicon, and just about everything in between. And if you look at what this industry has done, in three years basically it has duplicated almost 60 years worth of television innovation, if you go back to the early '40s and the first RCA television, and all of the innovation that has taken place in the TV market over that period. So it has not only brought all of that onto an IP network, but it has improved upon it. There is now instant channel change, tuner- less TV really, so tuner-less picture-in-picture, unlimited channels that you have access to, and the ability to have this HD content, and pretty much unlimited HD content, as well as the ability to move into this very two-way not just content- centric, but over time communications, commerce and community-centric experience. JOE BINZ: The next question is from Dylan Moore of Robert Baird, and he wants to drill a little bit on the SOC issue. "Sigma Designs and STMicro have been selected as partners for the Microsoft IPTV Edition software platform. Are these chips far along or are there things that still need to be worked out for each, like additional functionality?"
  13. 13. CHRISTINE HECKART: Yeah, in the case of those two chip vendors, they're developed. They're all ready, the software is ported to them, they're working inside set-top boxes, the set-top boxes are being delivered to service providers, the service providers are delivering them to market. However, we do want to bring more silicon vendors into the ecosystem. So we have not yet opened up the ecosystem beyond those two SOCs that you mentioned. Those are working well. I don't want to say no issues, because we'll continue to innovate with them, but for the software that we have today delivered on the SOC through the existing ecosystem, no show-stopper issues there, everything seems to be working well. Again, if you go back a year ago, there were a lot, it was hard to get the reference design up and running on the software, make HD work, just a ton of man hours went into that, but no issues right now. JOE BINZ: We have a follow-up from Nikos. He asks, "Do you view the regulatory issues in Europe right now regarding unbundling new broadband networks as pushing back the timing of IPTV deployments? Can you provide any insight into this?" CHRISTINE HECKART: Yeah, that's a great question, and I don't -- Nikos, I don't think that they will push back. I think you'll see, you know, DT has said late last year, early this year that they were planning to launch in several markets the second half of this year; they're on track to do that. So I don't think you're going to see it turn back the clock or slow down the progression of getting the services to market. However, I don't think it's a very favorable regulatory climate right now. I do think it will cause DT to really look at their investment model, what they can afford to invest in, how much they're going to have to open up, what kinds of innovations that they can uniquely bring. So it's a very challenging environment for them right now, but it's also a market that's evolving in real time. I'm over there at least a couple times a quarter, and every time I'm there there's something pretty material that's changing. So I think that we'll continue to see a pretty fast pace of evolution. I'd like to see it move beyond where it is today. I don't think it's in the best environment for us or DT. But where it is right now I don't think hampers them from being successful, I just think it makes it a little bit more difficult. JOE BINZ: And a follow-up question from Rick Sherlund: "Can we get a sense for how rapidly this gets deployed, and what are the constraints to broad adoption in the market?" CHRISTINE HECKART: Yeah, Rick, that is the question. That's the issue that we're all dealing with. We can deliver the best possible TV experience, and then once you have that, and I believe we do have that today, how do you get that to market? And there's a couple of things that I think are going to be key. One is just the physical networks; you know, we're going to march behind physical infrastructure deployment that AT&T, BT, DT and others are investing in, upgrading their networks so that they have the capacity to deliver live TV and video on-demand and other interesting services to subscribers.
  14. 14. So just pure physical infrastructure will be a gating factor over the next couple of years. They are going fast, they're really upgrading on existing DSL infrastructure, so they've got a pretty good paved highway to work from, and I think they have good competencies in how to do this quickly. But you can't get the service where you physically can't reach the consumers with the network, so that's one thing that we have to look at. The second is once you can reach the consumer, what causes the consumer to want to shift. And that's the question that I spend, and my team spends a lot of time researching. And I don't think we have a magic bullet yet. One of the things that we're doing is a worldwide market segmentation study, because certain segments are going to move faster than others, and they're going to be interested in different things. We have to understand that first and better than anybody, and we're in the process of really digging into that right now. One thing that we have found that's really encouraging is if you just get the experience in front of people, if you give them the remote control and give them five minutes, they walk away loving it. And we've had service providers in this country and other countries do demos in their retail presence, their areas of retail presence, and they get people that are walking off the street and they might be coming in to buy a cell phone or coming in to buy some other service from the provider, and the service provider has their TV offering their. Once you get that -- and they're not even a customer at that point, they're somebody walking in off the street -- once you get them with the remote in their hand playing with it, the interest level, the people who say, "Yes, I'm interested in learning more about this service and whether or not it's available to me" is very high, well over 50 percent. That's amazingly encouraging. I've been involved, I've spent 20 years in this industry; almost every one of those years has been on the forefront of a brand new market. I've never seen interest this early in the market be that high. People love the experience once they have it. So I think the marketing challenge is getting people to experience it, and AT&T has been doing that with Tupperware parties and parties in people's homes and in their neighborhoods and showing it off in public places. BT and DT are doing similar, slightly different but very similar things. And that's going to be the hard part, just making people aware. In the research that we've done there's a high percentage of consumers in the high teens that aren't even aware that they have a choice today, cable or satellite. They’re just not paying attention to what's available even now. So how do we make the user experience, how do we make better television something that people want? And that's going to be the hard marketing challenge, and that's something that Microsoft is interested in helping with and raising the awareness on, service providers are interested in doing that, and I think cable companies ultimately will be over time as well, because once people become more engaged in the experience, we really can make the overall pie bigger, it won't just be about share shift, it will be about market size gains. JOE BINZ: Our next question comes from Tim Daubenspeck and he asks, "How are you prioritizing the communication equipment vendor relationships between Alcatel, Cisco and/or Juniper? Do each of these vendors have the same access to Microsoft code and feature roadmap?" CHRISTINE HECKART: Good question. The simple answer is, no, they don't. We have a preferred relationship with Alcatel, they are a preferred go-to-market partner.
  15. 15. They bring kind of the whole package of all the different underlying parts of the network, plus our software, plus the system integration around that, and they have applications that can ride on top of it. So they bring a very comprehensive package, and we have a pretty unique relationship with them in the market. Cisco also is an important partner of ours, particularly today in the set-top box area. So Cisco bought Scientific Atlanta, and they bought KISS. Both of those are important set-top box ecosystem partners. They're being deployed in various parts of the world right now. And Cisco also provides some of the underlying, they don't provide the same components that Alcatel does, in some cases they overlap and in other cases they don't, but Cisco routers are very well entrenched in the market. Juniper is in the backbone. And in almost all of our deployments it's a very heterogeneous environment. You might have Juniper doing the security system, Cisco doing parts of the underlying IP network, Alcatel doing the entire end-to-end IPTV piece, and the access piece. So we won't see any one service provider that has the same architecture, it will be similar but different. We'll see very heterogeneous environments. We will need to know how to interoperate with and work on all of them, and Alcatel will remain the preferred go-to-market partner, and system integration partner. JOE BINZ: Okay, we're going to take two more questions. The first question comes from John, and he asks, "What is the minimum broadband bandwidth requirement needed to support high dev TV on IPTV?" CHRISTINE HECKART: Oh, good question. So because you said high def that's going to change the nature of the answer. The kind of minimum needed just to support TV is about 3 meg, and we've got service providers in various parts of the world that are delivering a TV-based service on a 3 megabit network. Now, they'll go up from there, but that's their minimum. Once you get into high def you need at least 8 just for the TV service. And if you say you want to be able to do some VoIP and some data service, you're going to need 9 or 10. If you look at the average U.S. household that has, say, three televisions, and almost all of the installed televisions are not HD right now, although the share is growing very rapidly, if you take kind of a standard configuration that we think about, which is one HD television set and a couple standard definitions, plus some high speed Internet service and phone, in that case you're looking at 3 meg plus 3 meg plus 8 plus a little bit more, so you're probably up in the, say, 25 range to really be able to deliver all of those services and have some underlying DVR capabilities and not have contention on the line. So minimum of 8 would be the base answer to your question. JOE BINZ: And the last question comes from Dave Sundquist and he asks, "It seems like Microsoft is trying to create traditional broadcast TV using an IP-based architecture, but the market has shifted to an on-demand world where 90 percent of the content people watch is on-demand versus broadcast. Shouldn't all content be available all the time versus switching through numerical TV channels?"
  16. 16. CHRISTINE HECKART: Yes. So I'd answer your question yes, yes, and yes. Microsoft is delivering broadcast television, and it's an essential element of the service, and we want to do it, and we believe we do it better than anybody else. And we have built DVR capabilities into the architecture from the ground up. We absolutely believe what you just said, the world is going to move to an all on- demand. Today, most people watch what somebody else decides to serve up to them at different points in time, and they orient their lives around somebody else's TV schedule. And tomorrow that will not be the case, and any DVR user today will tell you that once you get into a mode of you record everything and you watch what you want when you want to watch it, your entire world moves to a on-demand world. And that's built in from our system from the ground up, and it's a key element. The interesting problem that you have to solve in that all on-demand world is one of introducing people to what content is out there. And this is a problem that DVR users talk about today. They record their favorites, but they don't know about what's new, because they're not being exposed. So our system has some very interesting ways that you can search and discover new content, and you can have recommendations delivered to you by friends, by experts and so forth. And that's something that you'll see roll out over time, some capabilities are available immediately, others you'll see roll out over time in the form of new features and new applications, all built on top of this idea that as you do move to an everything on-demand world there are new problems that you encounter, and therefore new opportunities to make things available to people. JOE BINZ: There's a follow-up to that question: "Where will DVR content be stored? Will it be in the network or will it be on consumers' homes?" CHRISTINE HECKART: Probably a combination of the two. So the easiest way to do it right now, and again it varies a little based on the service provider you're talking about, but you store it on the device. And as you move into whole-home environments and as you move into network-based PVR environments, then the answer to that question changes. And even in some markets today there is the concept of a certain amount of TV, and it changes by market. It can be 24 hours, it can be seven days of broadcast television that gets stored on the network and delivered up to anybody. They don't have to store it as a favorite on their own device. So you'll see a combination of that. We want to drive that, we are well equipped for it. In fact, we are better equipped than anybody in the market, because we've built it in as part of the system from the ground up. So you can be watching any show in any part of the guide live or flipping through the guide or whatever, and with literally one click of one button, you can record it. It does not get any more intuitive and any easier. And again with basically one click you can find it, which is itself kind of interesting, and with the whole-home feature you'll be able to find it anywhere in the house from any device. JOE BINZ: Okay, thanks, Christine, and thanks to everyone for your participation in today's Live Meeting. We hope that it provided you with a better understanding of our Microsoft TV business. And as I mentioned earlier, this Live Meeting will be made available for replay at our Investor Relations Web site.
  17. 17. With that, I'd like to turn the call back over to Aaron, our Live Meeting producer. END

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