The Ad Zappers

By Daren Fonda

John Harper watches plenty of TV. But he no longer does it the old-fashioned way: plunking down in front of the tube when his favorite shows air. Instead, he has his TiVo device hunt the listings for his weekly lineup, from Boston Public to Trading Spaces, and record the shows onto a hard drive. He watches what he wants when he wants. He loves being able to fast-forward through ads. And he's a fan of TiVo's pause feature, which can stop a broadcast, freeing him to take a phone call. Says Harper, 34, a sales administrator in Los Angeles: "I can't imagine not having TiVo."

Many users of TiVo and its competitors, like SONICblue's ReplayTV, tell similar tales. Call them a satisfied minority. So far, fewer than 1% of U.S. households are using so-called personal video recorders; blame poor marketing, high prices for equipment, subscription fees and a tricky installation process. But while those drawbacks confounded expectations that the PVR technology would become a killer app, it is now heading for prime time--and not just inside a TiVo or Replay box.

The market-research firm IDC forecasts that 29.9 million U.S. households will have PVR technology by 2006. Stand-alone units like TiVo and Replay are expected to capture 20% of the market. And the technology is rapidly spreading through other platforms, including cable- and satellite-TV set-top boxes, and PC-like "home-entertainment gateways" made by companies such as Motorola that offer TiVo-like features, broadband Internet access, a videophone and a home-networking port.

As the price of PVRs continues to fall, and as the cable and satellite folks take over more of the installation process, analysts say, millions more couch potatoes will start watching TV as the TiVo pioneers do: viewing The Shield on Sunday morning, recording Spy Game to watch Monday night, skipping ads and pausing and rewinding live broadcasts at whim. All of that, in turn, is expected to spark a radical rethinking of the cable and TV networks' business models.

For the satellite providers, PVR technology isn't just an option anymore; it's crucial to their strategy for winning over cable subscribers and bolstering revenues. The big satellite firms EchoStar and DirecTV, awaiting federal approval to merge, lack the network architecture to support "true" video on demand (allowing for a movie to be paused and rewound, which requires a two-way connection). So the satellite companies are banking on combo PVR-tuners, aiming to put TiVo-like "servers" in subscribers' homes and have shows and movies stored there. DirecTV has partnered with TiVo to offer the boxes, while EchoStar is marketing a proprietary PVR-tuner. The two have already pushed the technology into more than 800,000 homes, and both are planning marketing campaigns to sell more powerful boxes this year.

Satellite operators are finding that subscribers with PVR boxes are more likely to sign up for premium channels like hbo, because they can watch recorded movies when they want. And PVR owners cancel satellite service half as frequently as subscribers without the gear. The satellite providers are betting that as long as their subscribers are happily TiVoing, the cable companies' promise of vast movie libraries won't steal them away.

So far, the cable companies have been playing catch-up with EchoStar and DirecTV in the PVR set-top-box race. Of more immediate concern for them has been building the infrastructure for digital cable, including video on demand--at a staggering cost of $60 billion--and hanging on to customers tempted to switch to satellite by the new PVR-tuners and lower subscription fees. But with about 9 million cable customers expected to have video on demand by year's end, the cable operators plan to roll out PVR-equipped boxes too. Stacy Forbes, an analyst with the investment bank Janco Partners, says cable companies, like the satellite providers, "see the boxes as a new way of generating revenue" by encouraging viewers to subscribe to more premium channels and buy more pay-per-view movies.

By this fall, Time Warner Cable is expected to start trials of new boxes from Scientific-Atlanta. Motorola, licensing technology from SONICblue, has received orders for PVR boxes from Comcast, Charter Communications and Adelphia. Charter, with 6.2 million subscribers, says it will also start offering the much lauded Moxi--a "home-media entertainment center" made by Motorola with technology from Digeo, a company started by Microsoft co-founder Paul Allen (who is also Charter's chairman).

The PVR cable boxes may store up to 120 hours of content--twice as much as TiVo's latest model. But cable operators are loath to promote ad zapping, fearing that will erode ad revenues and spark lawsuits. The media giants are already suing SONICblue over its Replay device, saying it contributes to copyright infringement through its ad-zapping powers and its feature that enables users to send recorded content over the Internet. AOL Time Warner, a party to the suit, has said its new boxes won't contain either feature. But things are never simple with that troubled company. Time Warner Cable was an early investor in Replay's technology, as AOL was with TiVo. (AOLTW is the parent of TIME magazine.)

Hollywood and the cable operators also fear Napster-like consequences if millions of subscribers start recording movies and TV shows and have free rein to reproduce them. "Motorola and Scientific-Atlanta have been ready to ship PVR boxes for a year," says Richard Doherty of the research firm the Envisioneering Group. "But getting a green light from Hollywood is slowing them down." The media giants want Congress to pass legislation that would require new PVR set-top boxes to contain strong copy-protection technology.

Such a law isn't expected anytime soon, but to avoid further delays some suppliers of PVR cable boxes plan to restrict how subscribers can use them. Say you decide to order Spider-Man through your cable operator's video-on-demand service. The movie may have been "pre-cached" onto the hard drive of your cable set-top box during the night, and you would pay a one-time fee for watching it. It would then disappear from your PVR. An encryption scheme would prevent you from ripping it to a DVD, unless perhaps you paid extra. And the encryption technology would make it fruitless to send it over the Internet to a friend (unless your friend had an illegal decoder, or you sent a hacked copy). Countless shows and movies could expire on your hard drive this way. There's also talk of restricting the PVR's ability to "time shift" regular shows. "nbc might say you can only watch ER for 24 hours after it airs," says Doherty.

Viewers, though, might rebel against too many restrictions on the cable-box PVRs and opt for stand-alone units. TiVo's new $400 Series2 units will be sold at retail through Best Buy, and Sony will produce the devices too. Competition from SONICblue's ReplayTV--which has less than 3% of the market--is also heating up. New Replay units hitting stores later this year will be priced "equal to or better than TiVo, with higher functionality," says SONICblue ceo Ken Potashner.

More problematic for TiVo is that its partnership with DirecTV--its main distribution channel so far--seems shaky. If EchoStar wins approval to buy DirecTV's parent company, Hughes Electronics, TiVo may be squeezed out, because EchoStar stands to make more money off its proprietary box. EchoStar can also offer customers a price advantage: its subscribers don't have to pay additional subscription fees to use its PVRs.

Whichever box wins, advertisers are hatching ways to fight rampant ad zapping. One solution: make spots more entertaining, as research shows that even PVR users are likely to watch a commercial they find amusing. Advertisers aim to exploit data about which shows and spots viewers are skipping and which they're watching (since the technology can track one's TV habits), and they plan to use that knowledge to send ads, infomercials and special deals targeted to a household's income and interests. TiVo has sent its subscribers promos from Lexus and Best Buy, and this month they will get a trailer for the movie Mr. Deeds. Sound Big Brotherish? It doesn't seem to bother TiVo fans like John Harper. "If the commercial is entertaining enough," he says, "I'll watch it."