Cables next big competitor??? December 12, 2005 Telco David Takes on Goliaths California-Based Pioneer in Video Delivery Achieves 20% Penetration By Daisy Whitney <mailto:daisywhitney@xxxxxxxxxxx> The day before Thanksgiving, a small California telephone company conducted a trial of high-definition television services, running a feed of Discovery HD Theater on two 50-inch-plus Panasonic HDTV sets side by side. One set received the channel's signal from a satellite provider and the other received it via the phone company's own Internet protocol infrastructure. Story continues below... The result? The little guy won. The IPTV version of Discovery HD Theater delivered by Sacramento-area telephone company SureWest actually looked better than the satellite one. The picture was crisper, brighter and clearer around the edges, as judged by this reporter. The telco's engineers were pleased. After all, the delivery of video services has become a cutthroat business, with new competitors cropping up daily, threats rising from every corner of the wired world and all of the players looking to grab a slice, or even a sliver, of the potentially lucrative market for delivering entertainment services to ravenous consumers. Providers will take any edge they can get, including a slightly better HD signal. As a smaller telco, SureWest, which has offered video for three years in the fast-growing Sacramento area and plans to add about 17 HD channels in the next few weeks, doesn't command the attention that behemoths with swagger and might, such as AT&T, BellSouth and Verizon, do in the telco TV world. But SureWest, in its own way, is a major player. "SureWest is by far the leader in deploying [IPTV in the U.S.]," said Jeff Heynen, an analyst for broadband and IPTV at Infonetics Research. SureWest got started early, has been progressive with technology and has been able to capitalize on somewhat of a "feel-good" opportunity because it's the local telephone company rather than a massive regional Bell operating company, Mr. Heynen said. By year-end, SureWest will have poured about $200 million into its fiber-optic broadband system. And it's starting to pay off. SureWest offers 260 channels of video to nearly 85,000 customers via its fiber infrastructure and has almost 20 percent video penetration. Those hearty numbers are indicative of the potential for smaller phone companies to battle incumbent cable and satellite operators. That 20 percent penetration is particularly powerful given some analyst estimates of take rates for all telcos. Brahm Eiley, an analyst with Convergence Consulting in Toronto, predicts that by the end of 2009 phone companies as a whole will have taken only 5 percent of the pay TV market. Cable companies, meanwhile, will capture 20 percent of the residential phone market, he said. That makes SureWest a bit of an anomaly. But it has achieved a relatively high penetration rate for a variety of reasons, said Fred Arcuri, SureWest senior VP and chief operating officer. There's strong population growth in the region and the bundle of services is attractive, he said. Most customers opt for at least two to three services from SureWest, and the company also offers cellular, giving it a quadruple play. Customers receive a discount when they sign up for more than one service. SureWest offers voice, video and data for about $110 a month, Mr. Arcuri said, about 15 percent less than local competitors AT&T (formerly SBC) and Comcast. That lower price is a good selling point because the vast majority of consumers care most about the price of services rather than bells and whistles, Mr. Eiley said. "[Telcos] have to be highly competitive on prices," he said. "The truth of the matter [is that] for most consumers, what [they get] for the price is really the key to get into the market." So SureWest is going for the pocketbook, but at the same time it is preparing for the future, when the bells and whistles will likely become more important to consumers. Mr. Arcuri knows full well that his company can't compete right now on many advanced services. SureWest doesn't have access to CBS's 99-cent on-demand prime-time shows, which competitor Comcast will offer. Nor does it have the depth of VOD content that Comcast has with its 3,800 programs comprising 2,200 hours. SureWest's VOD library is sparse in comparison-about 400 hours, mostly consisting of movies. If telcos do want to compete for the higher-end consumer, they still have a ways to go, said Paul Rule, president of VOD research firm Marquest Research. "A bare-bones VOD offering can hardly be expected to peel away upper-end cable subs," he said. According to a recent Marquest study, 79 percent of higher-end customers-those with digital cable and broadband-said they believe the cable company would do the best job of offering a bundled triple play of services, while only 11 percent thought the phone company would do best. The other choices were spread among Internet service providers (7 percent), satellite operators (2 percent) and the electric company (1 percent). Mr. Arcuri acknowledged that SureWest isn't ready to play the high-end game yet. But the telco is shoring up its advanced services with HD this year and plans to offer an integrated DVR in the first quarter of 2006. Furthermore, he contends that SureWest's advantage lies in the triple play because Comcast has yet to offer IP voice service in the area. Comcast believes it has other advantages. It offers a dual-tuner hi-def DVR, 14 HD channels, broadband, more than 250 basic and premium channels, more than 50 channels of commercial-free music, and multicultural programming, said Erica Smith, spokeswoman for Comcast in Sacramento. SureWest has a hefty international lineup too, with 38 international channels and 24 pay-per-view international channels, as well as local Hispanic-oriented programming. SureWest started out as Roseville Telephone in 1914, operating as a small rural telephone company until the mid-1990s when it migrated into additional services such as data. The company entered the video market in 2002, when it purchased assets from bankrupt overbuilder WinFirst. WinFirst was among a crop of overbuilders that entered the scene earlier this decade with ambitious plans to build fresh cable plants from the ground up. But the company bit off more than it could chew and went belly-up. SureWest landed a foothold in video with WinFirst's 20,000 "marketable" video homes. About 4,500 of those already were video customers. In three years, SureWest basically quadrupled those numbers, rising to 85,000 marketable homes and nearly 16,000 video customers. Mr. Arcuri thinks SureWest's success is due to several factors. First, it already had the infrastructure in place in the way of trucks, technicians, a call center and billing support. It's also operating in the sweet spot. Sacramento is one of the fastest-growing areas in the country, as San Francisco and Bay Area residents escape escalating home costs and move north, where property still approaches affordability. According to U.S. Census Bureau population estimates released in June, two Sacramento-area cities were ranked among the 10 fastest-growing cities: Elk Grove was second and Roseville 10th. That influx of people means the market opportunity increases and the cost to pass homes decreases. As new homes are built it's easier for a service provider to lay fiber in the "open trenches" instead of digging up the ground around existing homes. Also, as customers move into new homes they are in a shopping and buying mode for services. A recent study by home builder Lennar Communications Ventures found that half of all new home buyers upgrade and switch communications providers. They are also heavy users. About 69 percent of new home buyers are broadband users, compared with 38 percent of the general public. In addition, 38 percent of new home buyers own HD sets, compared with 13 percent nationwide. "These people's minds are open. These customers are really in play," said David Kaiserman, president of Lennar Communications Ventures in Miami. Mr. Arcuri said SureWest has partnered with local builders to market its services. Like many smaller telcos, SureWest has chosen to rely on a combination of equipment from various technology providers. While many large telcos have said they will use Microsoft's end-to-end solution, Microsoft isn't targeting small phone companies. So smaller operators opt for a best-of-breed approach, which affords flexibility in architecture and pricing, said Bill DeMuth, chief technology officer for SureWest. That also means if a piece or part doesn't work it can easily be jettisoned or replaced. That makes all the difference for a small company, because it provides leverage the company otherwise would not have. SureWest's headend, housed inside an air-conditioned room in its headquarters, is a testament to that open philosophy, peppered with racks of equipment bearing the names of vendors such as Kasenna, Minerva, Irdeto, Big Band and Cisco. "It is a completely open architecture," Mr. DeMuth said. "We can mix and match various pieces of a network based on our needs and what we feel is most cost-effective." Nor does SureWest want to use the same equipment as its competitors. The set-top boxes it uses from Amino look nothing like the clunky boxes most cable customers have in their homes. The Amino boxes are the size of a thick sandwich. SureWest has become something of a model for other telcos. Mr. DeMuth said more than 100 telephone companies internationally, including Korean Telephone and Verizon, have visited the lab in Roseville. The lab is not glamorous. It consists mostly of plywood walls with dozens of mundane-looking pieces of equipment and boxes from various vendors. Soon that lab will be testing MPEG4 equipment. SureWest wants to start transitioning next year to MPEG4 compression, considered the next-generation TV format because it allows a service provider to deliver more channels using less bandwidth. More bandwidth also means SureWest will be able to offer more of those increasingly important bells and whistles. http://www.tvweek.com/news.cms?newsId=9024 -- ><> ><> ><> ><> ><> ><> ><> Regards, Mark A. 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