September 8, 2004 4:00 AM PDT

Five tech firms at a crossroads

Being good may not always be good enough--especially for companies in the fast-moving world of technology.

While every field faces its shakeouts--there were dozens, if not hundreds, of automakers at the dawn of the automobile age--consolidation in the tech sector can be shockingly rapid, and even companies with the best of ideas and a decent head start can be swamped by imitators.

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What's new:
Apple used to own the home computer market. Today it's in single digits. Brilliant first movers often falter as the rivals catch up.

Bottom line:
Five companies flashing all the brilliance of early Apple are reaching the point when the wolves start nipping at their heels. Can they stay ahead of the pack?

Apple Computer, for example, owned the PC market 20 or so years ago but market share for the Mac operating system is now below 5 percent. About 10 years ago, if you used a PC to write you probably used WordPerfect but today you use Microsoft's Word. And Netscape once held a similar lead in the Web browser market but has fallen by a similar degree.

In 2004, there are five innovators that appear to be at similar turning points: Netflix, PalmSource, Research In Motion, TiVo and Vonage. Each sells a product or service considered brilliant. Each has drawn raves from consumers. "The test of an elegant and innovative idea is when you hear it and it makes you want to dope-slap yourself on the side of the head and say, 'Why didn't I think of that?'" said Paul Saffo, a director of the Institute for the Future.

But that's not always enough. For example, TiVo faces rising competition from cable providers undercutting TiVo with similar services. So it was hardly surprising when reports emerged this week that the company is considering a partnership with Netflix to download movies onto TiVo set-top video recorders.

"Competition has a tendency to drive out innovation," said Roger Kay, an analyst with research firm IDC. "Others will try to commoditize an idea, while innovators need to charge a premium, so good ideas tend to have a short half-life."

So how will Netflix, PalmSource, Research In Motion, TiVo and Vonage adapt?

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Netflix
Just a few years after the company's founding, the subscriber numbers for Netflix quickly ballooned to a current total of more than 2 million. The company's growth caught the attention of investors, who in January pushed the company's stock up to a 52-week high of $39.77 per share. Worried that the growth may not be sustainable, investors have pushed the stock to about $15 (it was up 7 percent Tuesday on news of the potential TiVo hook-up.)

Investors were also spooked by big names, like Blockbuster and Wal-Mart, which have just unveiled similar services.

Others have questioned the health of the DVD rental market, claiming rentals will fall as retail prices dip, which may eat away at Netflix's audience. Growth is projected to drop in half to 13 percent in 2005, compared with 27.2 percent in 2004, according to a research note by Imran Khan, an analyst with investment bank JPMorgan.

"We believe slow growth in the overall market will create pressure on Netflix's revenue growth potential," Khan wrote.

But the company is armed with a patent and a belief that its relationship with it subscribers is what counts. The customized system ties its members to its service, said Lynn Brinton, director of corporate communications at Netflix.

"Our service is innovative and intuitive in a way that we don't expect Blockbuster to be able to replicate," Brinton said. "More than 99 percent of our 25,000 titles have been rented and we're uniquely able to connect our customers to our catalog. We can introduce people to more movies they love."

Netflix was also granted a patent covering its entire process of renting out movies, but has yet to announce licensin g terms or any lawsuits.

While remaining mum on the TiVo reports, Netflix has previously said it is looking to once again redefine movie delivery with a video-on-demand service that it will release next year. However, it has said it doesn't expect the service to be a contributor to its business for a couple years.

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Palmsource
PalmSource, formerly the operating system division of the now-split Palm, is credited with developing an operating system that helped unlock the potential of the handheld market.

"The key for the Palm OS was it got it right: a simple and elegant OS for handhelds," said Kevin Burden, analyst with research firm IDC. About 35 million devices have been sold running the Palm OS. The company is looking for even bigger numbers by tapping into the mobile phone market, where it currently holds a leading position thanks to devices such as its popular Treo 600.

PalmSource's stock has recently rallied from June's 52-week low of $15.27 per share to around $24 per share.

The problem is that the handheld market is shrinking and that Microsoft is starting to make some inroads after a slow start.

Adding to the woes, key licensee Sony Electronics, an investor in PalmSource, decided it would cut back its handheld product line, selling it only in Japan.

Analysts are also expecting PalmSource's lead in handhelds to shrivel. The Palm OS was used in 51.7 percent of handhelds shipped worldwide in 2003, while Microsoft's OS was in 38.3 percent of devices. IDC says Microsoft should take over the top spot at the end of this year with 45.9 percent of the market, compared to 45.1 percent for the Palm OS, and grab a 51 percent share by 2006.

PalmSource representatives question those statistics, but add that the company is focusing on the smart-phone market while it waits for new devices that will need an operating system to develop. It is planning to make new releases of its OS available at the end of the month, but representatives would not discuss any details.

"We want to bring the same elegance that we brought to handhelds over to smart phones," said Gabi Schindler, senior vice president of worldwide marketing at PalmSource. "Microsoft cannot make an easy solution. They have proven they can't do it."

Then again, the software giant got a slow start in the handheld market but eventually caught up.

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Research in Motion
Moving quickly is a skill that Research In Motion is familiar with.

The Canadian company has taken a fast and large lead in developing a device and service that provides always-on access to corporate e-mail and data. RIM has run up its subscriber numbers to more than 1.34 million with no other rival close to it, according to IDC.

Wall Street has been running up RIM's stock at the same time. Since the end of the year, RIM shares have climbed to about $60 from about $43 at the beginning of the year.

The company and analysts agree that to capitalize on its lead, RIM has to license its technology, but some are concerned about competitive and legal hurdles.

RIM Chief Executive Jim Balsillie says while hardware sales are doing well, RIM devices won't be a significant competitive factor to licensees.

"We're a niche hardware player, not a material threat to these cell phone guys," Balsillie said.

RIM has signed a number of deals with phone makers, including Nokia, Sony Ericsson, Motorola and Siemens, to make its service available on phones and handheld computers. However, so far no one has released a device in the United States.

That may have more to do with a patent infringement case in the United States than Balsillie wants to admit. Holding company NTP is suing RIM and was awarded an injunction preventing RIM from doing business in the United States. The injunction was stayed until an appeal decision is made, which is expected in the coming months.

"(CEO) Todd Bradley at PalmOne said he didn't want anything to do with RIM until the NTP case is settled, that's indicative of the sentiment in the industry," said Jason Tsai, an analyst with equity research firm ThinkEquity Partners.

Balsillie downplayed the concern, saying he expected several product launches from licensees in October and November. Any perceived delay in releasing devices is because development takes time.

Tsai added that the NTP case has been slightly overblown.

"On a global scale, the impact on revenue would be something like 2 percent," if NTP won the case and RIM was required to pay royalties, he said. "They aren't going to shut them down because it would be cutting off their only source (of revenue)."

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Tivo
TiVo has long been a consumer favorite, spawning episodes of television shows dedicated to it as well as a new verb, as in, "Did you TiVo it?" And if imitation is the best form of flattery, the company mascot should be red from blushing instead of black.

But that's part of the company's problem. Bigger rivals are copying and commoditizing something TiVo is trying to sell for a premium, and some partners are even getting squirrelly.

DirecTV, TiVo's largest and so far only major service partner, is teaming with another DVR Partner, British digital TV company NDS Group. The first products are promised for the first quarter of 2005.

But the biggest problem, according to futurist Saffo, is that TiVo's DVR technology is a feature and not a product.

"In the years to come, TiVo will become a button on some future product, like spell checker did for Word," Saffo said.

Consumer electronics makers that have licensed TiVo's technology would disagree, according to Susan Cashen, vice president of marketing at TiVo. And those same partners, which includes Pioneer, Toshiba, Sony and Humax, will be a significant means for TiVo to not only get into the homes of consumers but to also get them to sign up for the DVR service.

Still, TiVo has not been able to sign up a cable provider and some, such as Comcast, are preparing their own services. Cashen says the company isn't holding its breath for a cable partner.

"We're only going to do a deal that makes sense for our business," she said. "We've faced big rivals before such as Microsoft (and its UltimateTV service) on the DirecTV platform and we outlasted them."

Last month, the company slashed the cost of its entry-level machine to $99 (after a $100 rebate) to goose the number of subscribers paying $12.95 per month.

TiVo has plans for new networking and advertising features as well as a new content download service, but details and schedules are murky. The company is projecting 3 million subscribers by the end of January 2005.

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Vonage
Vonage was one of the first companies to use voice over Internet Protocol technology to offer telephone service over a broadband connection. Placing calls on the Internet allows the privately held company to charge less for telephone service than traditional phone companies.

"Their timing was excellent...it was a visionary experience," said Will Stofega, an analyst with IDC.

Investors recently agreed, adding $105 million--for a total of $208 million--to the company's coffers, which Vonage will use to expand internationally.

However, analysts fret that Vonage hasn't done enough to distinguish itself from competitors, and VoIP is a technology that any of the major service providers could offer. In fact, AT&T, Verizon Communications and Qwest are doing just that.

Another challenge is quality control issues, which may disqualify a VoIP line as a primary phone line, according to Jon Arnold, analyst with Frost &T Sullivan.

"Vonage doesn't own the facilities used with its service, so they can't control a customer's total experience...this also means it's not a replacement service, instead it's a second-line option," Arnold said.

In August, Vonage experienced its first outage, which prevented a small percentage of customers from making outbound calls for about an hour and a half in the morning, according to the company.

To its credit, Vonage has been partnering with retailer and product manufacturers, such as Linksys and Netgear, to quickly grow its subscriber numbers, Arnold said. These alliances should help Vonage lower the cost of acquiring customers, a key factor in how fast it uses up its cash.

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On the Future of TiVo....
Tivo is essentially producing a low tech video recorder which
cannot use anything else than MPEG-2, and could only interface
with a TV. For a start, that was okay. So was an Apple II. Now, at
least some of the DVR manufacturers need to move into the
21st century.

We need a DVR which can handle MPEG-2, AND H-264, .avi,
and Divx files. We need a DVR with USB2 andor FireWire
interfaces to upload and down load files from a PC. We also need
the ability to handle HDTV. The tuner choice may depend on the
TV service you have.

Until we get some technical sophistication, TiVo will be just a
toy. PC's, with upgrades, will become the real DVR's.
Posted by Earl Benser (4310 comments )
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