January 2, 2002 4:00 AM PST

WebTV founder's next act unfolding

Consumer demand for interactive TV has yet to meet industry expectations, but that isn't stopping another hopeful from gambling on the ill-defined and elusive market.

Steve Perlman, who founded WebTV, will show off the technology behind his 2-year-old company, Rearden Steel, at next week's Consumer Electronics Show in Las Vegas. According to sources, the Palo Alto, Calif.-based start-up is developing software and hardware specifications that could turn set-top cable boxes into multimedia entertainment devices capable of recording and storing digital content.

Although Perlman's experience and the company's investors make Rearden a viable contender, the problem is defining exactly what it is contending for. Although Europeans have embraced advanced TV services, most Americans still prefer to limit their interactivity to the PC. As a result, products from big names such as America Online and Microsoft--which purchased Perlman's WebTV in 1997--have been slow to catch on.

"This market is still very much in its early stages, to the degree that no one seems to have the same definition of what (interactive TV) is," said J.P. Morgan Chase analyst Jack Ripsteen.

However, Perlman's background could give Rearden Steel a boost when, or if, the market takes off. "Perlman has a certain amount of currency with the market based on what he did at WebTV," Ripsteen said.

Rearden Steel won't sell or manufacture the boxes, according to sources. Instead, it will license its technology to cable companies and others, as well as assist them in integrating the services into their networks.

A Rearden Steel representative declined to comment but did acknowledge that the company will make an announcement on Jan. 7 at CES.

Finding a successful formula for blending the television with the PC has been akin to the search for the Holy Grail. And to date, most attempts have met with meager results. A number of start-ups promoting interactive TV have crashed and burned. PC makers Gateway and Compaq Computer have also tried, and failed, with PC-TVs.

But Perlman is considered one of the more successful in this quest. He co-founded WebTV in 1995 with current Microsoft TV executives Bruce Leak and Phil Goldman. They sold the company to Microsoft in 1997 for an estimated $500 million.

After the sale, Perlman joined Microsoft to develop interactive and broadband TV services. He left the company in 1999.

Although successful in its early years, WebTV has stalled recently, with subscriptions languishing at about 1 million. WebTV is now part of MSN, Microsoft's sprawling online unit.

Following his stint at Microsoft, Perlman founded Rearden Steel, named after a character in Ayn Rand's novel "Atlas Shrugged." In April 2001 the company received $67 million for its first round of funding, led by America Online, the subsidiary of cable and Net giant AOL Time Warner; satellite company EchoStar; and networking titan Cisco Systems. Other investors include Mayfield, Vulcan Ventures, The Barksdale Group, The Washington Post Company and Macromedia Ventures.

Great expectations
With such big-name backers, expectations are high that Rearden's latest venture will be profitable and groundbreaking. Sources said the company is working on a platform, which includes software and hardware specifications, to be used on devices such as set-top boxes. Consoles using the technology will allow viewers to record and store digital audio and video, as well as pause live programs. The technology will also allow cable companies to add features, such as interactive program guides and online games, based on market demand.

Rearden Steel will announce its partners on Jan. 7, possibly including cable and satellite companies, sources say.

Interactive TV services may be the first features enabled by Rearden Steel's technology, but the company has grander plans, including using wireless networking to allow devices in the home to communicate with one other. While Rearden Steel appears to be carving out a fairly novel niche, the company's product plans will likely eventually compete against services from Microsoft, Liberate Technologies and Sonicblue, among others.

The technology's flexibility in incorporating features is likely to be a selling point to cable companies, which have been hesitant to offer new capabilities to their subscribers.

"Unlike satellite companies, who are always willing to engage early, cable companies don't have the mindset yet for interactive television," said Steven Ericsson Zenith, chief executive of Pear Avenue, a company offering a high-end home entertainment system that includes satellite TV reception. "Cable companies understand the benefits of interactive television, but no one is ready to engage in something that is going to take two to three years to mature."

Wooing partners will be key for success of the Rearden Steel platform.

"In any kind of content strategy (in the interactive TV market), it is very significant to work with cable and satellite companies, because they increasingly control the pipes into the home," said Aditya Kishore, an analyst with The Yankee Group.

The Rearden Steel platform will largely be invisible to consumers. Platform companies typically make money through licensing agreements and by getting a cut of the revenue generated from advanced services. Both methods can be highly profitable, but few interactive TV companies have managed to make any significant money with either approach in the United States.

Part of the problem is a matter of perception. The interactive TV market has taken longer than expected to develop, because providers have had a poor understanding of the market and some companies have overpromised their products. The overall economic downturn also has made cable companies more hesitant to invest in new services that many cash-strapped households might consider optional.

Earlier this year, for example, cable giant AT&T abruptly changed its interactive TV plans, saying that viewers wanted simpler features. Some industry insiders have suggested that the company grew tired of constant software delays from Microsoft's TV division and decided to go with more basic products from Liberate.

Even more ambitious than an interactive TV product is one that would serve as the center for other home entertainment features. The idea of a digital entertainment hub has floated around Silicon Valley for years. Last year, Intel, Microsoft and PC manufacturers kicked off a campaign to popularize the PC as a central port for managing, recording and playing audio and video.

Demand for a specialized hub may be justified, but price is an issue. The hard drives, compression technology and other components necessary right now to build a set-top box that can record and store audio and video might cost manufacturers $200 to $300, according to Jon Peddie, chief executive of Tiburon, Calif.-based Jon Peddie Research. That's as much as the components cost for a bargain PC. By the time such a set-top box reaches retail shelves, it could cost as much as $1,000.

"I don't think we've seen a product yet for pent-up demand. The problem is, to put all the stuff in that people want, there is a challenge with the bill of materials," he said. "For a home entertainment center, you have to do video and audio."

Like WebTV and game consoles, the hardware would likely have to be sold below cost and profits regained through services or after-market software. "There is going to have to be some sort of subsidy," Peddie said.

 

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