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From...

500 channels and nothing's on

L.J. Davis's account of TCI's John Malone tells of false promises of interactive TV

December 4, 1998
Web posted at: 2:15 PM EST

by Bill Rosenblatt

(IDG) -- Does your cable TV service stink? Mine, in New York City, sure does. Thanks to Time Warner Cable, I have to put up with poor customer service, steadily rising rates (even amid attempts by the U.S. Congress to lower them), and worst of all, no Nickelodeon TV Land until the year 2000. Forget about the cable modem Internet access enjoyed by friends of mine in the suburbs. L. J. Davis's The Billionaire Shell Game: How Cable Baron John Malone and Assorted Corporate Titans Invented a Future Nobody Wanted provides some explanation of why cable service in this country is the way it is. It centers on the rise of Malone, the CEO of Tele-Communications Inc. (TCI) and the so-called Darth Vader of the cable business. Davis, a contributing editor of Harper's (my favorite magazine), has written a cynical, amusing, and clever (if cliché-ridden) account of corporate greed and purposeless technology that is fun to read and bound to appeal to those of us who are fed up with our cable service providers.

The book makes two basic points. The first is that interactive television is a joke, was a joke, and will continue to be a joke for the forseeable future. Second, by way of explaining why most cable services leave much to be desired, is that the U.S. cable infrastructure was built because tax laws made it a nice way of making lots of money, not because anyone actually cared about television.

While there's no doubt we are heading toward the definition of some sort of universal interactive information and entertainment medium, the exact nature of that medium is in question. This book will convince you it won't be television.

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Which came first, the PC or the interactive TV?

Interactive TV is an idea that has been floating around since the early 1970s, long before the days of the personal computer, let alone the Internet. Its first incarnation, in Columbus, OH, in 1977, was as the brainchild of the late Warner Brothers CEO Steve Ross. The system, called Qube, was simple but effective. Each of 31,000 subscribers used option menus on their TV screens to choose programming, vote on issues, participate in game shows, do home banking, and so on, by hitting the appropriate keys on a keypad. This was a prototypical "thin client" system: a central computer was dedicated to scanning all of the subscribers' keypads every few seconds and acting according to their input.

Qube was moderately successful. During its seven years of existence, it expanded into Dallas, St. Louis, Houston, Cincinnati, and Pittsburgh and signed up a total of 350,000 subscribers. But eventually, the gee-whiz factor wore off and people just weren't interested in, for example, paying $5 to look at the daily newspaper on a TV screen.

One wonders why we never hear about Qube these days (I certainly haven't). As this book puts it, every one of the many interactive TV experiments since Qube has done nothing but lose money for the cable company that tried it. No one has been able to come up with the killer app that makes interactive television worth its subscriber fees. Technology has gotten incrementally better and significantly cheaper, but somehow the various systems haven't been able to deliver enough additional features to consumers to induce mass subscription.

The best-known recent American attempt at interactive television -- once again from Time Warner -- is the Full Service Network in Orlando, FL, which was launched in 1994 and died last year. With technology supplied by Scientific-Atlanta (set-top boxes), Silicon Graphics (digital video servers), and Andersen Consulting (integration services), among others, FSN delivered personalized news, games, movies on demand, home shopping, and other services.

How well did it do? A friend of mine who is a broadcasting consultant put it this way: "In the media business, the word Orlando has a resonance equivalent to that of Chernobyl."

Davis's attitude toward the several interactive TV trials he describes is one of naked contempt. He cites the "14 inches vs. 14 feet" dichotomy to explain why interactive TV will never work: people typically sit 14 inches from their computer screens, but they sit 14 feet from their TVs. He claims there is no persuasive evidence that people even want to interact with their TVs. Furthermore, he says that a world of 500 channels will never work, because none of these channels will attract a large enough audience to command sufficient advertising revenue.

The great cable scheme

John Malone, for a long time, was not at all interested in interactive TV. He is perhaps the most successful of the second generation cable operators; his empire was, for a long time, the largest in the U.S. First-generation cable operators flourished in rural valleys during the early days of broadcast television, when there were only a few broadcast stations in big cities. These small-time entrepreneurs erected antennas on hilltops, ran cables down the hill and into homes, and charged a monthly fee for access. Broadcast TV networks tolerated this because it increased the viewing audience for their advertisers.

The second generation began to wire entire cities. They found they could take advantage of certain accounting rules and enjoy great revenue streams while paying almost no taxes. Here, basically, is how the scheme worked: You took out a loan to build the infrastructure, which was a capital expense, which meant you could write it off over a period of several years. So, instead of paying taxes, you paid interest on your loan, which was considerably cheaper. Meanwhile, you recouped most of your capital cost up front through installation fees. After that, the subscription revenue would just roll in. Operating costs were low: all you had to do was keep the system running and deal with occasional problems; programming came free in the early days.

Cable operators could keep this tax-free gravy train running indefinitely, as long as they kept expanding their empires and thus had enough capital expenditures to write off. That, claims Davis, is why people like John Malone and his partner, Bob Magness, built out the national cable infrastructure during the 1960s and 1970s.

TCI gained a reputation as the shrewdest and most tight-fisted cable operation of them all. It strong-armed city governments into handing over permits to build its systems and stuck to suburbs and small cities, avoiding the large metropolises because they were disproportionately expensive to build out. (In Manhattan, for example, it was necessary to dig up streets to run cables underneath, whereas in more rural areas it was easy enough to just string cables up on telephone poles.)

How content became king

As cable systems were built nationwide, demand for programming started to grow; broadcast network programming couldn't fill several dozen channels. Although a small part of the void was filled by community access television (CATV) programming -- always a great source of amusement here in NYC -- the demand led to the creation of several cable channels, including HBO and ESPN.

HBO started as a cheap and easy way to fill time on unused cable channels: just show old movies, pay for the rights, and make money from subscriptions. At first, HBO physically sent videotapes to cable operators that carried its programming. Then, its parent company, Sterling Manhattan Cable, was acquired by the publishing giant Time Inc., which put one of its corporate lawyers, Gerald Levin, in charge. In the mid-1970s, Levin came up with the idea of transmitting HBO's programming over satellite to cable operators, and the concept of the national cable channel was born. Levin, of course, rode this wave of success to his present position as chairman and CEO of Time Warner.

Many other channels followed in HBO's footsteps to national distribution via satellite. Whereas HBO was (and is) a premium service that charges subscribers an extra fee on top of their basic cable subscriptions, ESPN, the sports network, offered free programming and made its money from advertising. But it became famous in the industry, after ABC bought it in the early 1980s, when it attempted to charge cable operators like TCI for its programming. TCI's position in the industry was so strong that it got ABC to back down (most of the way) by threatening not to carry ESPN at all.

By the end of the '80s the national cable infrastructure had expanded to the point of saturation, and other means of video program distribution -- such as digital television and satellite services like DirectTV -- began looming on the horizon. As a result, TCI was no longer in a position to dictate terms to programming providers. For example, ESPN was able to turn the tables on Malone, threatening to pull its programming from TCI unless TCI agreed to pay higher fees.

Malone's escape hatch

Because most of the nation had been wired for cable, the industry's profit model of tax-free revenue through continuous capital expansion no longer applied. TCI was no longer a darling of Wall Street, and John Malone began disappearing from the public eye; some claimed he was ill and just needed a rest. But according to this book, he spent the late '80s and early '90s looking for a way out. His plan was to keep the parts of TCI that still generated a nice profit, while getting rid of those whose prognosis was dimming. He did this in two major steps.

The first was to lure a buyer for the undesirable parts of the company -- the basic cable infrastructure. To do this, he all of a sudden "discovered" interactive TV. This was a man who had run a bone-lean operation through cost control, low salaries, and minimal customer service, and by avoiding costly ventures such as interactive TV trials. But now, he started making grandiose claims about the 500-channel, digital, interactive future.

Davis asserts that Malone's sole purpose in doing this was to lure some large company -- a telephone company or diversified media concern -- into buying him out. He created the illusion of building digital interactive capabilities by installing a few small new systems at the periphery of his operation, while leaving most of TCI's core infrastructure in its existing, obsolete, dilapidated state.

The second step in Malone's plan was to create an escape pod containing the lucrative programming entities that he had been steadily acquiring. Cable programming providers had become more powerful because they had established national brand identities (CNN, HBO, MTV, ESPN, etc.), so cable operators felt it necessary to try to control them. By the late '80s, TCI had acquired significant stakes in many cable channels, including Discovery Channel, the QVC shopping channel, and American Movie Classics. Malone created a company called Liberty Media, under which he combined his programming assets and spun them off from TCI.

In 1992, Malone almost succeeded in getting a buyer for his cable operations: Bell Atlantic. The regional phone company was looking for additional ways to make money, beyond its basic local phone service in the mid-Atlantic states (and other ventures, such as buying national phone systems in countries such as Indonesia). Ray Smith, Bell Atlantic's unconventional, audacious CEO, had also discovered digital interactive TV. Smith understood that he needed a cable infrastructure like TCI's to supply the necessary bandwidth to deliver digital signals and interactive services.

TCI and Bell Atlantic came to agreement and announced their intent to merge, in what would have been the largest deal in American history. But after the purchase price was decided, Bell Atlantic was finally allowed its "due diligence" to look into TCI's operations. The company didn't like what it saw -- crumbling old cable systems and unfavorable balance sheets -- and it ended up backing out of the deal. Malone eventually ended up selling TCI's cable operations to AT&T, for an even higher price than that named in the Bell Atlantic deal, and emerged as a billionaire while still holding onto his programming interests in Liberty.

The shell game

From the late 1980s through the failed deal with Bell Atlantic and up to the present, The Billionaire Shell Game, attempts to describe the outrageously complex financial dealings and corporate ownership relationships that resulted from attempts by the cable, telephone, computer, and media industries to position themselves for dominance in the coming era of "convergence." The cast of characters includes media giants such as Steve Ross and Jerry Levin of Time Warner, Ted Turner, Rupert Murdoch, and Barry Diller, other cable moguls like Brian Roberts of Comcast, and major technology figures such as Bill Gates and Nicholas Negroponte.

It also includes lesser-known technologists like Woo Paik, the scientist who invented digital television, and Jim Chiddix, the chief engineer of Time Warner Cable who invented hybrid fiber coax (HFC). HFC is the technical development that paved the way for digital interactive services: it consists of fiber-optic cable that conveys digital video signals from a cable operator's head end to points of presence in neighborhoods, plus traditional coaxial cable that runs conventional analog from those points of presence into each household. HFC has the ability to carry signals back from the user to the head end, which is where interactivity comes in.

Davis presents the personalities in all their glory, but it becomes nearly impossible to figure out all of the corporate interrelationships as shares of companies are bought, sold, and traded. Eventually, things get so tangled that, as Davis puts it, "Malone [ran] into himself coming around a corner. He would be competing with himself."

After years of expansion, consolidation, and utopian hype about interactive video services, the industry became vastly more complex, and the players changed from many cable operators to a few cable operators, assorted phone, wireless, and media concerns, and various other players. But the true nature of the business stayed exactly the same: an industry controlled by people whose primary skills and interests seemed to be in financial engineering rather than customer service or programming.

That's the cynical view propounded by Davis in this book. He is negative about virtually everyone and everything, although his attitude is offset by his pithy, often amusing writing style.

He has the fewest kind words for Nicholas Negroponte, the celebrated director of the MIT Media Lab, and his role in the development of interactive TV technologies. In fact, Davis is at his absolute best when describing Negroponte -- he is wicked, hilarious, and cuts straight to the heart of the matter. He trashes Negroponte as a crackpot and an idealist with little consideration for pragmatic issues, supposedly an outgrowth of his privileged childhood as the son of a rich Greek shipping magnate.

For example, he describes Negroponte's beginnings as an architect investigating the idea of smart homes: "The house would perform [additions and expansions] while the owners took a much needed vacation. It did not seem to occur to Negroponte that the house's first task would be to bribe the city building inspector. ... If the owner approached the house from the outside, laden with grocery bags, the house would automatically open the door. It did not seem to occur to Negroponte that in places like Brooklyn, this might not be such a hot idea."

Davis tries to be clever in this way throughout the book. Sometimes he succeeds ("Technological breakthroughs that ... performed superbly in the lab had a way of not working very well, or at all, in a workday environment where people spilled beer on things ..."); but just as often, he drowns in a pile of lugubriousness ("There was one thing about the future that everyone seemed to forget. Unlike the past, it hadn't happened yet.") The worst thing about Davis's writing is his annoying overuse of cliches. For example, if I had a dollar for every time he used the phrase "rich beyond the dreams of avarice," I'd be ... well, you figure it out.

Enter the Internet

As The Billionaire Shell Game closes, Davis begins to mention the Internet. During the last couple of years, cable companies have shifted their energies from interactive TV trials composed of closed, proprietary systems (such as Qube and the Orlando Full Service Network) to building cable-modem Internet services like Time Warner's Road Runner and TCI's @Home. I believe Davis's book offers two important lessons about the Internet, even though he doesn't mention either of them.

The first is that interactive video services are not, despite what Davis says, a bad idea that will never catch on. The problem with all previous interactive TV experiments wasn't that they didn't offer enough services or that the technology wasn't good enough. Rather, it was that these systems were built with seemingly little or no input from actual customers, and that the technology wasn't flexible enough to adapt to users' desires. Think about it: If you look at each of these trials as a "focus group," rather than an attempt at a profitable operation, you get what turns out to be a horrendously expensive and inefficient way of testing various possibilities for interactive services -- one that, at the rate it has gone, would take decades and zillions of dollars to develop into a successful system.

The second problem for interactive TV was its adoption of proprietary, monolithic systems, as opposed to open standards that allow flexibility. It seems obvious that the Internet is the key to the success of interactive video services in the marketplace. The Internet is based on open standards, which allows many vendors to build applicable tools and services for it. Cable operators' adoption of Java technologies and Windows CE for set-top boxes will certainly foster such an environment, although those operating system-level components exist at too low a level to be of much direct help to content developers.

It's also big enough that users can and will choose which services they want -- and, more importantly, will pay for. The winning formula for digital video services will be one based on already-successful Internet services. Video is simply one data format; it's not a service in and of itself. Good services can exist without video, although of course video can enhance online services. The use of video will simply grow together with bandwidth, production tools, and understanding of what makes good interactive video content.

The second lesson we can draw from this book has to do with the place of content as a force and source of revenue on the Internet. Look at how the cable industry grew: In the very beginning, it was about giving people in rural areas access to some TV, as opposed to none at all. Similarly, during cable's nationwide expansion, it was about getting connected -- getting access. The carriers, not the programmers, had the upper hand. Only after cable access became commonplace and cable channels developed brand identities did content achieve primacy in the eyes of consumers. TCI's history with ESPN is a very concrete illustration of this point. By the late 1980s, people took their cable hookups for granted, but they wanted their MTV.

If we impose the same analogy on the Internet, we can argue that we're still in the period where it's all about building access. Once everyone has reliable access to the Web at speeds that are at least tolerable, the emphasis will be more on content.

Of course, it remains to be seen whether the successful content brands are extensions of existing brands from other media, Web brands like C|Net and Yahoo, or something entirely new. When that day comes, content companies will be able to charge for content. Some (following the HBO model) will charge customers directly for subscriptions, some will charge customers per piece of content (the pay-per-view model), and others (a la ESPN) will charge Internet service providers.

There are already certain examples of the first and last of these happening today, such as Wall Street Journal Interactive charging customers for subscriptions, and Time magazine charging AOL for its content. (Technology that supports the pay-per-view model is coming soon.)

Despite its lack of Internet perspective, L. J. Davis's view of the cable business is fascinating and entertaining. Many in the computer and media industries think of cable TV as the great source of bandwidth that we're all just waiting to exploit. The Billionaire Shell Game blows that myth apart. Read it for new insights into this mysterious phenomenon called convergence. It might also help you better understand why you have this fancy gizmo on top of your TV set, yet still have to rely on your newspaper's printed TV listings to see what's on tonight.

Title: The Billionaire Shell Game: How Cable Baron John Malone and Assorted Corporate Titans Invented a Future Nobody Wanted
Author: L.J. Davis
Publisher: Doubleday & Co, Inc.
ISBN: 0385479271
Pub. Date: September 1998

Bill Rosenblatt is market development manager for media and publishing industries at Sun Microsystems Inc. Reach Bill at bill.rosenblatt@sunworld.com.

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