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Stop Acting Like the Entertainment Industry!

by Matthew Gast, author of 802.11 Wireless Networks: The Definitive Guide
01/17/2003

Late last year, SONICblue and TiVo announced that they were ending their internecine patent feud to concentrate on "expanding the market for digital video recorders (DVRs)" because "the overall success of the DVR category is what is most important to the companies at this time."

It's about time. Let's hope that SONICblue and TiVo start acting to make the DVR a successful product. DVRs combine the recording capability of a VCR, the power of random access to any spot in a computerized data stream, and the user-friendliness of satellite TV's channel guide into a package that has been described as "a new way to watch TV."

The DVR is a new way to watch TV, but not necessarily in the friendly viewer-empowering way painted by the advertisements. It turns TV into a service, complete with a plethora of legal restrictions and one-sided contracts reminiscent of the Hollywood "military-entertainment complex" that is working so hard to choke innovation. When you purchase a DVR, the transaction is really making a down payment for a service that rests on shaky financial ground and depends on a restrictive user agreement. The restrictive nature of the service, not the minimal monthly fee, is what keeps me sticking to my VCR. DVRs offer increased functionality, but at what cost?

TV as Indentured Service

Both TiVo and SONICblue make legalistic statements that their devices have no functionality without the "required" service subscription. Taking these statements at face value means that buyers should really look at TiVo and ReplayTV as services that allow you to record TV programs, not products that record TV programs.

Why is it important to make the distinction between a product and a service? The question of whether something is a product or a service affects how users perceive value. Products have value because they do things, even without their manufacturer. Old computers work if you plug them into the wall, even though the manufacturer may not be in business anymore. Historic buildings have value because they still keep out the weather. If the manufacturer of a product goes bankrupt, the product still has some residual value. (If you have any doubt, look at the number of old electronic devices that are no longer supported but nonetheless are for sale on eBay.) In the event of bankruptcy, buyers may demand a larger discount from the original selling price, but there is no question that a working product that has been orphaned by its manufacturer still has value. What is a service without its provider? Without the phone company's dialtone, telephone service is a useless box with buttons. The phone without service is a product without a purpose. Simply put, products can outlive their manufacturers. Services do not outlive their providers. Users may be more willing to take a risk on a product than on a service because at the end of the day, they own the product, but only rent the service.

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Services also usually have a much more complicated legal framework. When you buy a product, you have the right to expect it will not start shooting flames and burning your house down, and you may expect some level of ongoing support, especially for a technology product. Services have user agreements and terms that can change. The only recourse when a service provider changes the terms is to cancel service, which usually means that you are out any setup costs, and that any equipment enabling the service becomes much less useful. In many cases, canceling service may even make the equipment worth almost nothing.

Conceptually, TiVo and ReplayTV are similar to the initial attempt at providing DSL service in the United States. The subscriber pays an activation and setup fee (about $200), receives the hardware required to access the service included as part of that fee (the DVR or DSL modem), and uses a service that makes the hardware useful on an ongoing basis. It is common for some services to be billed monthly (telephones, electricity, Internet access), though it is common to have up-front payments for longer periods of time (auto insurance, magazine subscriptions). TiVo and SONICblue both offer "lifetime" subscriptions for a fixed fee. Although the monthly cost is zero, it is still properly interpreted as a service because the device is not functional without the magic elixir of the company, and you are still subject to the service agreement.

Financial Viability and the Service Model

Both TiVo and SONICblue make legalistic statements that their devices have no functionality without service. The economic shake-out of the past two years has made many consumers more cautious about who they buy products and services from. For obvious reasons, consumers are reluctant to begin paying for a new service if it may cease operation, especially if it requires a high initial payment. As a result, I often do a bit of financial analysis before buying products or services from smaller companies.

While I am not categorically opposed to spending several hundred dollars on a relatively new product category, spending hundreds of dollars to start up a new service is much harder to justify. Products can outlive their manufacturers. Services fade away without their providers. When product vendors go bankrupt, the product will still function, though obtaining warranty service may be impossible. If a service provider fails, the service they are selling will almost certainly fade away in short order.

ReplayTV and TiVo are both services, so the financial viability of SONICblue and TiVo are of great interest. If either company fails, its orphaned devices lose almost all of their value to the end user because of possible service interruption. There are several financial metrics that you can use to judge a company or a stock, but in this case, I'm biased toward the quick and dirty. I'm not trying to reap large gains from the future appreciation of the company's stock. I just want to know how the company's survival prospects look. As a yardstick, I've used Downside's "Deathwatch" calculation. It's easy to do because it's a simple "burn rate" calculation. Pull the company's most recent financial reports and look for two things. Money is the equivalent of oxygen for a company. Go to the balance sheet and add up the liquid assets, usually broken out as "cash and cash equivalents" or "short term investments." A company will face a day of reckoning when that money runs out. Look at the income statement and find the line labeled "net income," which tells how much money the company is losing. Divide the liquid assets by the losses, and you can predict how soon the money runs out.

Is this a fair way to look at the financial position of a company? Of course not. The prediction is static, and assumes that present trends will continue until the company runs out of cash. Management is likely to notice a dwindling cash supply and cut expenses to preserve cash. New products could come out and become big hits that dramatically increase revenue and make expenses sustainable. The company could offer additional stock to the market to raise capital, as TiVo did in October. While I admit the metric is limited, I also don't feel that I should have to become a sophisticated stock analyst to determine whether or not to purchase consumer electronics.

So, let's take a look at what the calculation says for SONICblue (Nasdaq: SBLU), ReplayTV's corporate parent, and TiVo (Nasdaq: TIVO). Financial reports are available from the Securities and Exchange Commission's EDGAR service, but many Web sites will summarize the data in the SEC reports. For example, Yahoo! Finance will summarize recent filings in a consolidated form; see the pages for SONICblue and TiVo.

Table 1: Financial Information for SONICblue and TiVo

  SONICblue TiVo
10-Q date September 30, 2002 July 31, 2002
Cash & equivalents 12,818,000   26,753,000  
Short-term securities 64,679,000   0  
Liquid Assets   77,497,000   26,753,000
Income (loss), most recent four quarters (32,362,000)
(23,457,000)
(16,567,000)
(52,648,000)
  (3,038,000)
(33,509,000)
(41,154,000)
(33,838,000)
 
Death Date   May 3, 2003
(2.4 quarters)
  November 30, 2004
(8.8 quarters)

Unfortunately, the obvious conclusion from this table is that neither company is in a particularly strong financial position. In fact, a TiVo regulatory filing on October 10 noted that "[w]e have recognized very limited revenue, have incurred significant net losses, and may never achieve profitability."

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