IP: F A New Model for AOL May Influence Cable's Future

[Dave Farber <dave () farber net>]

------ Forwarded Message
From: "John F. McMullen" <observer () westnet com>
Date: Mon, 26 Aug 2002 01:43:54 -0400 (EDT)
To: johnmacsgroup () yahoogroups com
Cc: Dave Farber <farber () cis upenn edu>, Declan McCullagh <declan () well com>
Subject: A New Model for AOL May Influence Cable's Future

> From the New York Times --
http://www.nytimes.com/2002/08/26/technology/26NECO.html

A New Model for AOL May Influence Cable's Future
by Seth Schiesel

The top executives at AOL Time Warner and Comcast probably did not feel
like heavyweight boxers as they hammered out last week's deal for the
looming AT&T Comcast cable television giant to distribute the America
Online Internet service. And yet, the agreement may represent a
technological transition point in the cable TV business as important as
the "Thrilla' in Manila" heavyweight title fight in the Philippines 27
years ago.

Internet technology could now create the same kind of era-defining shift
in cable television that satellites did back then. And for the media
industry, the big question is which sorts of companies can benefit most
from this transition  the companies that operate the cable systems, or the
ones that provide the "content."

When Muhammad Ali defeated Joe Frazier on Sept. 30, 1975, in Manila, the
fledgling Home Box Office network beamed the fight to cable television
operators in the United States. It was the first time a cable network used
satellite technology to distribute live programming to affiliates around
the nation. Viewers, who up to that point had considered cable mainly a
means to better reception of local broadcast stations, soon realized that
cable operators could provide original programming available nowhere else.

Just as important, cable operators soon realized that their success hinged
on their relationship with the providers of that programming. As networks
like HBO, ESPN and CNN blossomed in the late 1970's and early 80's, they
attracted millions of households to cable for the first time.

The top executives at AOL Time Warner  which owns HBO, among other cable
channels  now hope that its America Online unit can fit into a similar
mold. After years of insisting that America Online had to "own" its
customers and trying unsuccessfully to persuade cable operators to lease
the use of their lines as "dumb pipe" for high-speed Internet access, AOL
Time Warner's executives came to a realization this summer: The only way
to persuade AT&T and Comcast to distribute the cyberspace service over
their cable lines was to package America Online as if it were a premium
movie channel.

It is a wholesale shift in America Online's business model and presumably
for its future prospects. The new approach means that viewers who use the
America Online service over the cable lines of the combined AT&T Comcast
will be billed by AT&T Comcast  not by America Online  the way the price
of HBO is included in a customer's cable bill, rather than the customer
receiving a separate invoice from HBO.

In other words, the high-speed AOL customer will be as much the cable
company's customer as they are America Online's. Customers who sign up for
the America Online service will have their cable modem installed by AT&T
Comcast. Customers who have a technical problem with the service will
first call AT&T Comcast, just as consumers who have a problem with HBO
call their cable or satellite provider.

And when a customer buys something on America Online  online transactions
are expected to play a big role in AOL's future  AT&T Comcast will receive
a cut of that revenue. This arrangement is comparable to the way cable
operators now generally receive two minutes of advertising time for their
own use for every hour of a cable network's programming they carry.

What all this means is that, a few years out, the question of whether last
week's deal was a good one for AOL Time Warner will probably depend on
whether the America Online unit can create the Internet equivalent of
must-have offerings like "The Sopranos" and "Sex and the City."

Last week, AT&T Comcast, which is to receive about $38 a month from
America Online for every high-speed AOL customer served by its cable
lines, seemed to have gotten the better part of the deal. And over the
next year or so, other cable operators may very well follow the lead of
AT&T and Comcast and strike similar arrangements with America Online.

If other cable companies follow suit, though, the risk facing the entire
cable industry over the next decade will be whether America Online
succeeds with its new strategy. The cable operators could find themselves
in a long-term position of weakness just as they have found themselves at
the mercy of programming conglomerates like Viacom (with CBS and MTV), the
Walt Disney Company (with ABC and ESPN) and yes, AOL Time Warner, with a
stable that still includes HBO and CNN.

"For a long time, we kept asking cable operators to let us import our
traditional business model into the broadband arena," said Lisa Hook, who
oversees America Online's high-speed, or broadband, business for AOL Time
Warner. "We kept saying, `Sell us wholesale access to your network and we
will have the direct relationship with the customer,' " Ms. Hook recalled
in an interview last week. "It became clear that that was really unknown
in the cable industry, and we've realized that moving more toward an HBO
model for carriage makes a lot of sense."

Brian L. Roberts, the president of Comcast, who will run the combined AT&T
Comcast if Comcast, as expected, completes its acquisition of AT&T's cable
unit later this year, also uses the HBO analogy. "We're approaching this
relationship with AOL like a premium movie channel," he said. "The HBO
model lit a fire under cable, and it really took off. Likewise, I think
the model we've worked out with AOL can really light a fire for cable
modem service. Just as we have more than one movie service, like HBO and
Showtime, we will have more than one Internet provider, and we will help
each other become more successful."

AT&T Comcast and whatever other cable operators America Online strikes
deals with will probably continue to deliver a "house brand" of cable
modem service. Moreover, that house brand will almost always be less
expensive than America Online cable modem service. Therefore, America
Online will probably have to invest tens or hundreds of millions of
dollars in the coming years to develop the Internet equivalent of ESPN's
"SportsCenter" or MTV's "TRL"  material that is available nowhere else.

The payoff for America Online could be spectacular. Consider that the
lament of cable system operators like Mr. Roberts these days is that
programmers largely have them over a barrel. A cable system that did not
include ESPN, MTV and CNN would have trouble retaining a lot of its
customers. That is why ESPN can increase its fees by 10 percent to 20
percent annually and cable operators will still pay it. (Cable operators
now pay ESPN close to $2 a month for each subscriber.)

In addition, the power of "must have" networks like ESPN allows
programmers to force cable operators to carry additional channels. Walt
Disney, which owns ESPN, is able, in essence, to say to cable operators:
"You know you need ESPN, but if you want ESPN you also have to carry
ESPN2, ESPN Classic and ESPN News. Take it or leave it."

The cable operators have little choice but to take it. And that is the
leverage that America Online hopes to exert in a decade.

Speaking on condition of anonymity, people close to AT&T and Comcast said
last week they did not think that America Online could develop sufficient
original, proprietary "must have" services to gain that sort of leverage.
They say the Internet itself, available to all comers, will be the primary
reason why people sign up for cyberspace service  whether America Online's
or the house brand.

Of course, America Online is counting on just the opposite. Stay tuned. Or
logged on.

Copyright 2002 The New York Times Company

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