Amid a fragmenting interactive television market, Microsoft faces an uphill battle to regain the lead after watching a $5 billion bet on the nations largest cable operator go bad.
Instead of setting the pace for the industry, Microsoft now finds itself competing with rising star Liberate Technologies and a rival coalition that is developing a Linux-based operating system (OS) for interactive set-top boxes.
The turnabout comes as Microsoft partner AT&T Broadband scales back plans during a corporate breakup, opting to rush the most popular interactive TV (iTV) features to market as cheaply as possible.
For Microsoft, the delays may have doomed its chances to dictate standards for the next generation of set-top boxes. If the software giant had produced a viable OS on schedule for the advanced Motorola DCT5000 box, AT&T might have had a shot at sending the device to market before the tech sector downturn that led AT&T Chairman C. Michael Armstrong to split his company four ways.
Instead, AT&T is trimming its sails and planning to upgrade the 3 million boxes already in customers homes. That leaves Microsoft competing with San Carlos, Calif.-based Liberate for the OS in an intermediate box.
"I think AT&T has made a decision that its not going to spend $500 per home for a device that is arguably outmoded and might not deliver services the consumers really want," said Cynthia Brumfield, president of consulting firm Broadband Intelligence. "Thats too much."
Prospects for the Web-surfing DCT5000 — promised for nearly five years — went bad when Microsoft failed to deliver before the financial markets began shunning speculative communications ventures. "Microsoft got caught in that shift," Brumfield said.
While the partnership between AT&T and Microsoft is still technically in place, AT&T has no obligation to use Microsofts products.
"Theres no technology dictate of any kind," said Alan Yates, senior vice president of marketing and sales for Microsoft TV.
Difficulties working with vendors, as well as other problems, delayed Microsofts OS last year.
To some observers, the latest set-top setback smells of another boondoggle in the belated iTV industry. But Yates and others said the industry is still developing rapidly, despite economic handicaps.
"The interactive TV industry is not immune to the overall market, and the overall telecommunications market has been hit extraordinarily hard," Yates said. "Far from being a boondoggle, its just changed business conditions, and AT&T is making very smart business decisions in these new conditions."
AT&T is equally magnanimous in saying that Microsoft remains a valued partner. But Microsofts delays sidelined AT&T as other operators began upgrading boxes. In some of its most lucrative pay TV markets, AT&Ts competitors are already offering personal video recorders, giving viewers more power over their programs and, in some cases, video-on-demand. AT&T wants to follow suit, using software downloads to existing boxes.
The missing component will be a built-in cable modem for surfing the Web. That tool may be shelved for now, but the cable modem in a set-top box is still coming, Yates said.
Microsoft continues to push Web surfing with its own Ultimate TV product, and in trials with European partners such as Portugals TV Cabo.
But rival Liberate scored another coup last week in a deal with Germanys leading cable operator, Kabel Hessen, to provide interactive services for a potential market of 18 million customers.
Meanwhile, a coalition that includes some of Microsofts most bitter rivals is mapping plans for a set-top box using the open source Linux OS. A standard platform with Linux-based software is expected to lower development costs with fewer integration challenges for the TV Linux Alliances 24 members. They include Liberate and longtime Microsoft foe Sun Microsystems, as well as cable operators Comcast, Cox Communications — and AT&T — through their ownership of Excite@Home.
"No single company has been able to own the digital TV market," said Jerry Krasner, executive director at Electronics Market Forecasters. "The talents and technologies of these companies rallying around a single framework for a robust Linux solution should keep competition at the operating system layer thriving, while insuring that advanced interactive applications and middleware providers, along with set-top manufacturers, can get solutions to market more quickly."