The Starving Actor

The Case: Since TiVo launched in 1997, it has been consistently applauded. The company name is used by consumers as a verb (to “TiVo” a show is to record it for later viewing), and customer satisfaction is off the charts. But TiVo has never generated a profit nor come close to winning the number of customers it originally expected. The company is now on the brink of profitability – but is also highly vulnerable.

The story of TiVo is a made-for-TV drama – and a good one. Few corporate histories better illustrate the fact that companies can make groundbreaking products but fail to make money. In its eight years, TiVo has struggled with a fundamental weakness: to build its customer base, it has had to cede its customer relationships to its partners. That flaw has made TiVo vulnerable to the vicissitudes of the fast-changing market for broadcast media.

That wasn’t supposed to be the way the story went. After the company formed in 1997, its then president, Mike Ramsay, claimed that TiVo “is changing the paradigm of television.” TiVo gives subscribers the ability to save television programs to digital video recorders (DVRs) for later viewing. It also does other clever things, such as recommending shows to subscribers based on their viewing behavior.

By the summer of 2000, despite slower-than-anticipated retail and Internet sales, TiVo seemed to have the cable and media relationships in place to sell millions of its DVRs. Cox Communications, NBC, Disney, and CBS had all invested in the company, and satellite broadcaster DirecTV and cable company Comcast had agreed to distribute TiVo DVRs to their customers.

Skip ahead to 2005. The company is still losing money, and the partner that is fueling most of its growth – DirecTV – will soon promote a service that will compete with TiVo. What happened?

Going It Alone
When it started in 1997, TiVo (whose officers declined to be interviewed for this story) saw an opportunity to make the experience of watching TV as controllable and personal as the experience of using a PC. This was possible largely because of the rapid improvement of storage technology: hard drives that could record hours of video were becoming affordable. Also, advances in data compression algorithms made it possible to capture video streams in real time.

TiVo’s product was a VCR-sized box that could continually capture an incoming television signal, enabling users to pause and rewind live broadcasts. The box allowed users to schedule recording in advance by selecting programs from an on-screen guide and could even record all upcoming episodes of a given show.

TiVo’s user interface for managing recorded programs set it apart from early competitor ReplayTV, which now has less than one-third of TiVo’s market share. “People who got a TiVo were extremely pleased with it,” says Josh Bernoff, an analyst with Forrester Research.

Word of mouth helped to increase TiVo subscriptions by 86 percent between 1999 and 2000, but according to Bernoff, that may have been in spite of TiVo’s marketing strategy. In 2000, when the fledgling company had revenue of $3.6 million, it spent more than $150 million on advertising and sales and ran a television ad that featured network television executives being thrown out windows. “This angered the networks with whom TiVo was trying to partner but did not help consumers understand what the TiVo did,” says Bernoff.

TiVo had a hard time convincing consumers that they should pay $9.95 per month – after purchasing the recording device – to watch content that they were already receiving anyway, adds Adi Kishore, a senior analyst with the Yankee Group. Weak sales of TiVo boxes surprised many. In 2000, Forrester Research forecast that by 2005, 53 million homes would have DVRs. According to analysis firm Magna Global, just 1.2 million DVR subscriptions were sold in the first quarter of 2005.

In 1999 and 2000, despite its small audience, TiVo signed up several network partners and advertisers – including NBC, HBO, Starz Encore, and Showtime – to offer interactive, enhanced programming and advertising through TiVo boxes. But this didn’t do much to move the needle. By the end of 2000, TiVo had fewer than 150,000 subscribers. It needed another way to get customers.

The Initial Search for Partnerships
In July 2000, Comcast agreed to a trial in which it offered TiVo boxes to its subscribers in Cherry Hill, NJ. TiVo was hoping that the trial would lead to a deal in which Comcast would integrate TiVo software into its set-top boxes. But Comcast balked. According to Kishore, the main reason for the impasse was that TiVo wanted direct access to viewers, which Comcast was unwilling to concede.

This access, TiVo knew, was of enormous value: through its DVRs, TiVo gathers data about viewing habits – such as whether viewers skip over a given ad or watch it repeatedly – and sells that information to advertisers. But without the kind of demographic details that TiVo collects from its direct customers, its data isn’t as enticing. TiVo wanted to own the subscriptions and simply give Comcast a percentage of the subscriber revenue. But Comcast wouldn’t budge, says Kishore.

In April 2001, when the initial trial with Comcast had failed to lead to a larger deal, TiVo decided to reduce the amount of cash it was burning through. The company laid off approximately 25 percent of its staff, which allowed it to avoid seeking additional funding.

TiVo’s next hope for a cable deal was dashed by a cruel twist of fate. In November 2001, ATT Broadband agreed to offer TiVo DVRs to its customers in New England, Colorado, and Silicon Valley, but within a few weeks, Comcast acquired the cable provider and its 14 million customers, killing the deal.

Without a cable partnership, TiVo felt it had to continue selling DVRs through retail channels – which it didn’t really want to do. The company prospectus filed with the SEC before TiVo went public in the fall of 1999 stated that “our current plan is to stop selling personal video recorders.” The company had hoped to make its money by selling its software to cable and satellite companies.

TiVo still sells its DVRs at stores like Best Buy, Circuit City, and Costco, and via its website. According to research firm Magna Global, between the end of 2001 and the first half of 2005, TiVo subscriptions recruited by this means increased from 235,000 to more than 1.1 million.

But while TiVo initially failed to gain a cable partner, it succeeded, in 2000, in partnering with DirecTV. In fact, the majority of TiVo’s subscriptions to date have come from this relationship. Of the satellite broadcast giant’s 14.4 million customers, more than two million use TiVo.

The deal went through for a couple of reasons. First, when TiVo began talks with DirecTV, the satellite provider already had a DVR service through its partnership with Microsoft’s UltimateTV, according to Brian Wieser, vice president of Magna Global. That gave DirecTV more leverage when it insisted on controlling TiVo’s relationship with subscribers. “I’m not sure [TiVo] would have agreed to the same deal at the same price” if it weren’t for the presence of an entrenched competitor, Wieser says.

The deal was also made simpler by a technological difference between cable and satellite. It has been easier, says Wieser, for satellite broadcasters to roll out new technologies such as the DVR because they can make software changes in a central location. Cable operators have different equipment in different areas, so they have to deploy technology gradually.

TiVo’s partnership with DirecTV has been fruitful. Since the end of 2001, subscriptions to TiVo’s service through DirecTV have increased from 230,000 to 2.1 million, and represent more than half of all DVR subscriptions through satellite services. But as we will see, DirecTV may soon cease to offer TiVo significant growth.

A New Partnership in a Newly Troubling Market
While TiVo was nurturing its relationship with DirecTV, other companies in the business of television were making life harder for TiVo. Most worryingly, cable operators began to develop their own DVRs. In 2002, the first cable boxes with DVRs arrived, produced by set-top box makers Scientific-Atlanta and Motorola.

TiVo responded in April 2003 by hiring Marty Yudkovitz as president. Yudkovitz had been an executive vice president at NBC and seemed to have the experience necessary to understand the cable industry, having helped to build the CNBC and MSNBC channels, as well as the MSNBC.com website. Yudkovitz’s tenure would be short lived, as he would leave the company in January 2005. But within weeks of his departure, the long-sought deal with Comcast was done. In March 2005, TiVo announced that it will develop software for Comcast’s DVR platform.

This time around, TiVo has relented on the issue of who owns the customer. It has agreed that Comcast will manage the relationship with consumers and will pay TiVo a monthly fee for each subscriber using one of Comcast’s DVRs. In turn, Comcast has agreed to market TiVo service to its 21 million subscribers, although fewer than half of them – 8.8 million – have digital cable, which is required to run TiVo on Comcast DVRs.

Beyond the matter of customer control, Comcast has another reason to like this deal. The company can use TiVo to entice current analog subscribers to upgrade to digital subscriptions, which cost between $10 and $15 more per month. What’s more, when Comcast converts a customer to digital, it can offer additional premium channels, as well as movies and sports programming on demand.

Being used to lure customers away from analog cable service could prove uncomfortable for TiVo, which currently markets its products to analog customers. As of July, TiVo was advising analog users – who represent 61 percent of all cable subscribers – to get the most from their existing cable packages. “You need more time, not more channels,” the company said on its website. (That admonition no longer appears on the site.)

The deal is a bit awkward for both parties, but it could help TiVo become what it has always wanted to be: a software provider. “The Comcast deal looks great on paper,” says Magna Global’s Wieser. But by waiting so long to partner, TiVo may have missed a golden opportunity. Offering its DVRs to Comcast customers in 2000 might have sparked greater demand for the devices. Instead, it was nearly two years before Time Warner Cable became the first cable company to deliver DVR service.

Still, the Comcast deal gives TiVo the chance to gain millions of new subscribers. It also improves the company’s chances of earning advertising revenues. From the beginning, TiVo expected that high-quality, long-form ads (which customers would choose to watch) would provide a substantial proportion of its revenues. While TiVo advertisers have included NBC, HBO, and Fox, as well as Coca-Cola, Chrysler, and Royal Caribbean, the company could not previously deliver the millions of viewers sought by advertisers. In an April 2005 SEC filing, TiVo stated that revenues from advertising, while increasing, were “not material.”

But if TiVo can continue to expand its audience, it will make sense as an ad platform, claims Wieser. “They are the clear leader in advertising” among DVRs, he says. TiVo is developing an ad management system that Comcast can deploy not only with TiVo’s DVRs but also with those made by Motorola and Scientific-Atlanta.

But while TiVo would love to increase revenues through ad sales, its success will ultimately hinge on its ability to differentiate itself in an increasingly crowded field. According to Magna Global, 2.3 million cable subscribers now use DVRs not developed by TiVo. The total DVR market is expected to grow by more than 260 percent between the beginning of 2004 and the end of 2005, to nearly 12 million units.

TiVo has reason to think that it can grab a good share of any new group of DVR users. No company has yet been able to match TiVo’s recording features, such as the Season Pass, which records all episodes of a program, and the WishList, which finds all programs featuring a particular actor or director. Nor has anyone designed a more user-friendly interface. TiVo also has some good old-fashioned legal defense of its market: it has received 85 domestic and foreign patents, including several related to unique aspects of its user interface. It has another 117 patents pending.

To preserve its advantage, TiVo will need to not only offer a product with better features than its competitors’ but also do so in the midst of the transition from analog to digital television. This shift could prove dangerous for TiVo. Digital-cable providers may soon begin to compete with TiVo by creating DVR services that do not require programs to be downloaded onto cable boxes. According to Wieser, Time Warner Cable has tested a network DVR service that enables viewers to rewind, pause, and fast-forward television shows by storing copies of them on its servers.

Later this year, Time Warner Cable will test a modified version of the service called Startover, which will enable viewers who tune in late to a program to watch it from the beginning. Cable companies are pursuing networked DVRs because they are more cost effective than DVR cable boxes, which typically wear out after three years, Wieser says.

But TiVo’s woes don’t end with competitor DVRs from the cable industry, or with digital cable’s pursuit of robust, networked, non-TiVo software. The company may no longer be able to rely on DirecTV for subscription growth.

In April 2003, News Corporation purchased 68 percent of Hughes Electronics, the parent company of DirecTV. The following January, DirecTV announced that its next generation of DVRs would use software from a News Corporation company, NDS Group. DirecTV receivers with NDS DVR technology are set to ship this fall.

The new DirecTV DVR service will include unique features such as the ability to jump to a specific scene in a program, as well as to pay for any downloaded pay-per-view movies only when they are viewed, says Robert Mercer, DirecTV’s director of public relations. DirecTV will continue to sell DVRs with TiVo technology, says Mercer, “but our marketing efforts will focus on the new DirecTV boxes.”

Opportunities beyond TV?
In June, TiVo installed Tom Rogers, former president of NBC Cable, as its president and CEO. Rogers has been on TiVo’s board since 1999 and oversaw NBC’s investment in the company. In a press release, he laid out two priorities for TiVo: to broaden its reach through its distribution channels, and to improve advertising revenues. Shortly after Rogers took over, TiVo launched software that allows subscribers to use their TiVo remote controls to request, while watching an ad, that information from the advertiser be sent to them.

Perhaps sensing that its partnerships may not be enough to ensure profitability, TiVo is beginning to look beyond television. This year the company signed several licensing agreements that will allow Internet content to be stored on its DVRs. In January, it announced the creation of Tahiti, a software platform that will provide tools for developers to create applications for sharing content such as music and videos between PCs and TiVo DVRs.

TiVo has also updated its DVR to enable content to be transferred to portable video players. The company has licensed this TiVoToGo software to chip maker AMD, digital-media software company Sonic Solutions, and Microsoft, to enable video playback on devices using Microsoft’s Portable Media Center, on Pocket PCs, and on smart phones.

Licensing its technology to third parties “is the best business model for TiVo,” believes the Yankee Group’s Kishore. The TiVo brand, which is so well regarded because of the user-friendly TiVo interface, could serve to differentiate consumer electronics devices that control multimedia content. Such arrangements would allow TiVo to avoid the hardware business and focus on creating innovative software.

TiVo is on the cusp of profitability. In the first quarter of 2005 it narrowed its losses to less than $1 million and upped its subscriber base by 10 percent, to 3.3 million. This represents a year-over-year doubling of its subscriber base. These are good signs. Stay tuned.