Small Telcos, Small Screens: ILECs Have Tuned Into VOD

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As their larger siblings rethink video service, a handful of smaller rural telcos are cautiously rolling forward, propelled by the prospect of greater revenues and an improved competitive stance against their cable-operator rivals.

Most of those companies have first focused on creating cable-like video services. But they're also starting to dabble in cable's latest deployment darling: video-on-demand.

These small telco deployments won't generate a mass-market buzz, but industry observers said they could serve as a strategic blueprint for larger companies that may eventually decide to enter the video realm.

For Santa Clara, Calif.-based Minerva Networks, smaller customers are indeed better right now. The company — which offers fiber-connected asynchronous digital subscriber line (ADSL) video systems — has zeroed in on smaller telcos with new optical networks.

That's because mistakes made up to this point have made most regional Bell operating companies gun shy.

"The rural market is the market moving forward," said vice president of marketing and business development Reed Majors.

Improved DSL technology and dropping equipment costs have made video more attractive for rural telcos. Industrywide, 15 rural ILEC are doing VOD, and Minerva expects that to more than double in 2002.

Majors thinks 2002 “is the year. Last year, I wouldn’t have said that."

"The rural telcos have a captive customer base, a known revenue stream, a fixed amount of money in the bank and those customers aren't going away and they want video," he added. "Americans' spending on video entertainment doesn't fluctuate very much regardless of the economy.

"So there is no financial barrier to them rolling out service, and the total capital cost of building out the solution — when you put the numbers into a business model, the numbers work out very, very well."

Though video-on-demand rollouts might not be their initial aim, ILECs would do well to keep VOD in mind as they build their video headends, said International Data Corp. digital-video market analyst Greg Ireland.

"I think one of the challenges for these DSL providers as they are getting into video is they are competing against cable operators who are slowly but surely hopping on the VOD bandwagon," he said. "And you are also getting competitive pricing from [direct-broadcast satellite providers] DirecTV [Inc.] and EchoStar [Communications Corp.]

"And I think when you launch a new service, having the extra-value services like VOD wrapping into it can just help you with your competitive message," Ireland added.

MORE BANDWIDTH

Up to now, video-over-ADSL systems have been hamstrung by bandwidth. But Minerva's fiber technology can pump 7.5 megabits per second downstream, which allows for two MPEG-2 (Moving Picture Expert Group) video channels — with room to spare for data and other services, Majors said.

Though most providers have opted to focus first on getting traditional TV service up and running, VOD is a close second on the priority list. Trials are likely to pick up in the second half of 2002, Majors projected.

"The biggest problem for our customers is they don't want to get too many things working at once, because the more you try and do out of the gate, the harder it is to keep customers satisfied," Majors said. "So video-on-demand is just going to quickly follow as soon as they are comfortable with the live television service."

Of course, the telcos face a problem that's already plagued cable operators — obtaining VOD content that's worth watching and paying for.

Minerva partners with Los Angeles-based TVN Entertainment Corp. to provide content and VOD product support. It hopes the pool of available titles will grow beyond a handful of classic movies.

"The rate of change or the rate of availability of video-on-demand content is increasing rapidly," Majors said. "You saw In Demand [LLC] ink deals, you saw Movie Fly, you saw Intertainer [Inc.] and Microsoft [Corp.], so the deal flow in terms of making video-on-demand content available has increased quite a bit."

In Majors's view, many telcos will opt for a subscription VOD model and its more predictable revenue stream.

"I think it is going to depend on what the percentage of customers is that take a given service and how much it costs to deliver that service," Majors said. "I think there is going to be a trade-off there.

"I think there is going to be a fair amount of video-on-demand, but I think it will end up being lots of SVOD packages you can purchase — whether it's kids' packages or classic movies or HBO [Home Box Office] packages. I think those are going to be the most popular."

But even though telcos may envision a cable-like video business, they also want to set themselves apart from their cable competitors.

"In fact, a couple of our customers are working very, very hard to define those features that will differentiate themselves, and pushing us equally hard to implement those," Majors said. "Because they don't know exactly what customers are going to prefer, they are coming up with a long list of features that either focuses on making it easier for the customer to make a decision or different ways to purchase — as well as adding new features."

'WE NEED TO GET IN'

One of Minerva's prospects is Midwest Telnet, a consortium of eight small, independent telcos that run 20,000 phone lines in a region 30 miles south of La Crosse, Wisc. Pooling its resources to get a better break on costs, the consortium has already rolled out a joint Internet service. It hopes to gain the same economy of scale for video services over DSL.

"We need to get into this business," said Rod Olson, general manager of Vernon Telephone Cooperative Inc., one of the consortium members. "I think we're seeing that just being a telephone company — the world is changing in that part. The access revenues are slowly decreasing with way the we have traditionally made our money."

The consortium has looked into its equipment options and expects to make a decision this month. If a choice is made, a trial phase could begin in January, followed by the rollout of 80 digital and analog channels of service in April or May.

"Video-on-demand, I guess, we look at as being just another service," Olson said.

"Since this is going to be a whole different technology than what people are looking at, we don't want to throw too much at them all at once," he added. "If you roll everything out too soon, you are just going to overwhelm them."

When the consortium does add VOD, it will likely be on a pay-per-view basis, rather than by subscription.

"I think it gives people the choice that if they don't use it, they don't have to pay for it," Olson said. "I just think it adds better value. I would rather pay for what I use than pay for something that I have the potential to use."

And as with data-over-DSL, the bigger telcos may move more slowly, but they are moving, Majors said. Minerva had talked with the Bells about rollout plans for video.

"They are hunkering down and they are focusing on where they know the revenue is coming from," he said. "But I think that's because they don't want to experiment, and so the rural telcos are going to experiment for them."

Next Level Communications Inc. is another video-technology company that has recently found traction among telcos. Its VDSL products have gained interest, in part, because competition from cable has stiffened, said senior vice president of marketing Jeff Barnell.

"We see much more opportunity now in terms of trials and interest from telcos," Barnell said. "The cable companies have really done a very good job in taking away existing revenues and subscribers, especially on the telephony and data sides, and that has made the telcos — as large as they are — much more interested in fighting back."

In some ways, DSL's video-delivery strategy will make it easier to add video-on-demand to television service. Rather than beam the entire spectrum of channels to a customer's set-top box, DSL beams channels from the controller to the customer's box one at a time. As a result, telcos won't have to struggle to add a video-on-demand channel over a twisted-copper last-mile connection, Barnell said.

Though they're interested, the telcos are still trying to gauge VOD's value. Most of Next Level's customers have also focused on rolling out pay TV service. Some quiet telco VOD trials are under way, but most companies are content to watch others and learn from their mistakes.

"Sometimes being first is not necessarily best," Barnell said. "The company that reaches the wrong answer first loses.

"The telcos have the opportunity to sit back and see what kinds of take rates occur — what kinds of revenue streams and what the cost models are for video-on-demand," he added. "No one knows what the overheads are, and that's why the trials are in place."

To prepare, Next Level has partnered with nCUBE Corp. for its control server and video-content archive system. It has developed a user interface for presenting the VOD offerings.

The company already has some VDSL-based VOD trials underway, but Barnell said he could not disclose which carriers are involved. Nonetheless, it will take more than a group of small telcos to signal the arrival of VOD, he said.

"I don't think that one could claim that the video-on-demand market is here if five [carriers] representing 50,000 subscribers implement video-on-demand," he said. "It really does take one of the major carriers to do that."

IDC's Ireland agreed. He predicted only a limited advance for any type of video service among telcos, largely because of the expense and the need to get fiber closer to the user to make a DSL-based video product work.

"I think those are limited areas in the United States," he said. "I'm not exactly bullish on this being a great opportunity here in the United States in terms of millions and millions of subscribers.

"The telcos — certainly the big guys — have shied away from doing this, and I think it is just costs and technological constraints when you are having to deal with fiber and the old copper. It just hasn't made it particularly viable to jump into it right away."

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