Kate Bulkley, Media Analyst.

Simon Hochhauser CEO Video Networks

For Digital News June 2002.

By Kate Bulkley

Q. I know that you have not been actively marketing your Home Choice service since last year to conserve your funding, but give me a status report on where your business is now.

S.H.: At second quarter last year we hit 15,000 sub level and we decided not to expand beyond that point until such time as we were able to gain access to better rates for the carriage of our service over BT's broadband network. At the time, BT was charging an enormous amount, not just for video stream which is the method of conveying TV over their network, but also an enormous amount for their IP stream, which was their broadband Internet wholesale service. Now since then there has been major changes at BT and this is reflected not just in management but in the way management has approached broadband, but very specifically focused on fast internet access and not on carriage or provision of TV service.

Q. So the BT wholesale price cutting for IP hasnít really helped you at all?

S.H.: Not yet. The philosophy behind it should have a very, very strong knock on effect for us in terms of the way they calculate their prices and in the general attitude of what broadband is all about, (especially) in terms of focusing beyond it as (only) pure fast internet. But at the moment if you asked me about the rates as filed with Oftel, we have hardly benefited by the change within BT.

Q. So your rate of £50 a month from BT for a video stream service hasnít budged?

S.H.: We pay a falling price based on volume, unlike IP stream. IP stream is £14.75 a month, whatever amount you as a telecoms provider purchase. We (at Video Networks) would have a falling price from around £50 down to £20 but it depends on the number of lines that we purchase. And frankly even £20 for us is too high. It would mean we would have to take hundreds of thousands of lines in London to be able to benefit from the £20 price. On top of that we have a very high up front charge to pay which is still in the hundreds of pounds, about £500 pounds. Now within that (price) you have an engineer install so we will move -- like Internet-- to self-install, but even so we are (still) looking for substantial reductions in up front charges. So we really havenít seen much movement from BT since a year ago.

Q. There has been a management change at BT, when do you think this will bring any benefit to you?

S.H.: I do think there will be (benefit for us). (But the change) is good and bad. From the BT shareholder's perspective, which is frankly all he (new CEO Ben Verwaayen) really has responsibility for, he is clearly focusing on a specific range of products which both BT have, and in the wholesale sense, want to back. They have their own fast Internet service. They donít have a (broadband) TV service, (so) they do not have a strategy to defend at all. And therefore they're focusing very much on the Internet world and focus is good for any business, but the ray of light is not as yet focused on our sector. And so in that sense (the new focus) has worked a little bit to our detriment in that we have to wait for such time that they do focus on broadband entertainment because we require far more back haul bandwidth, in other words, far more fibre capacity to provide a television service than (what is needed) to provide an Internet service. Internet service is very bursty as you know and requires far less bandwidth overall for all your customers than television which is a continuous, 2 MB per second stream whilst the customer is online. Now for a large audience, 5% or 6%, so not huge, of a particular (geographic) area, the economics of scale mean that much of the cost is for the DSLAM (DSL multiplexor), whether it is for IP stream for Internet or video stream for television. But when you are growing from the start, when you are less than one percent or whatever that figure is, the dominant cost is the back haul bandwidth and there you have a lot of difference. And BT because it doesn't have its own (broadband TV) product is not particularly amenable to taking a risk on behalf of its customers.

Q: Of course the irony here is that if BT did have a broadband TV product they would compete against you, so it's hard to win here. On one hand you canít get the capacity at the right price, and on the other, if BT got into your business space, you would have a big competitor.

S.H.: Well, I think it is unlikely that BT will get directly into our space because of the expertise needed; it is so much more than just providing a connect Internet service. I think what's more likely is companies like us, not just us, in the television area will want more and more to have access to BT's network, whether in partnership with BT or otherwise. But I think that the fact they donít have a service and this is perhaps a weakness of regulation here, the fact that they donít have a service themselves, means they are not particularly amenable to concentrating on our area.

Q. Where does this all leave you and what remedies do you have?

S.H.: Well it's not too bad, but we havenít been marketing for a year and we have been controlling our costs and we have taken the opportunity to develop far more services than simply video on demand (VOD). You can imagine we've not been sitting idly by for a year. One of the main products we will launch is to offer full multi-channel cable television service alongside time-shifted VOD, so we can use ADSL and the cable distribution mechanism, not just as VOD. Also we have been working on one or two other things with BT. It is up to them to announce changes but we are doing a lot of work with BT to get to grips with this problem.

Q. And when do you see some changes happening with BT?

S.H.: Really your guess is as good as mine. I'd not like to predict when BT do things. Some things they do very quickly. I don't think any of us would have predicted the enormous fall in price to £14.95 until it happened. I knew it was going to happen but I didnít predict that it would happen so quickly after (BT CEO) Ben Verwaayen's taking up the post. So it will happen but in the meantime we are also working for the first time en masse on local loop unbundling. We haven't announced our plans, but there has been a major change in regulation which helps local loop unbundling and that took place back in December last year. It requires BT to carry a signal between its telephone exchanges on its optical fibre network at a price based on actual cost rather than on retail, which means we can actually predict what that price will be. Now that is actually another monopoly that BT has besides (owning) the local loop itself. So local loop unbundling could never have worked without this regulation. Now that regulation is being enforced, we are working very closely with government, the regulator and with BT. We expect it to produce in the early part of next year the first major local loop unbundled solution available in the U.K. and it will be carry full television as well as Internet services.

Q: So this will provide what you need, if I understand correctly, for your service, so you won't have to wait for BT to lower its own wholesale prices?

S.H. Yes. Local loop unbundling gives us access to BT's copper wires but it's all very well having access to the wires, but if we canít get our signals to those wires, to the telephone exchange, then frankly BT controls too much. The only part of the national networks that BT doesnít really have a monopoly over are the long distance links. As you know, there is over-capacity there. So the interconnect to the main cities and to connection points in cities is very competitive. There we can negotiate with any one of four or five major companies for carriage of our signal. The problem is that once you get into the main telephone exchanges in those cities how do you then connect your signals to all the other telephone exchanges in that city? Because BT pretty much owns all the ducts and fibres and it would be uneconomic, and also highly disruptive, to dig up all the roads. This (past of the network) is called the middle mile, while the copper bits or the local loop is the (so-called) last mile.

Q: And so it is middle mile where you need the lower price?

S.H.: First of all we need BT to be required to carry our signals and secondly they need to be required to carry them for a price based on underlying costs and then you have the local loop. So in the fist part of our conversation when we were talking about lower wholesale prices, that is for carriage across the whole of the network, it doesn't unbundle the network. So, for example, BT carries our signal from one of our main service centres say Staples Corner to my home. It must carry it over an optical fibre network, then on more optical fibre between telephone exchanges, it then carries into my local telephone exchange, down a DSLAM and down the copper wire into another DSL modem into my home. That is end to end. That's the wholesale price that BT charges so much for today. What we are going to be doing is using local loop unbundling to recreate that wholesale product at a much lower price by using different parts, either supplied by BT itself under regulation, or supplied by other suppliers.

Q: So this is the solution!

S.H.: Well, it will give us control of our destiny. I'm convinced that BT will lower its prices, but I think it is important for companies like us to have an independence of networks.

Q. So how long is this part of the process, the local loop unbundling part, going to take?

S.H.: Well of course it is never easy. We expect to do this by the latter part of this year so we should have the first major introductions in the first part of 2003.

Q: So you will be able to deliver broadcast cable channels by the beginning part of 2003?

S.H.: Oh, well cable channels are only just a part of it! Cable channels, VOD, games on demand, really the full monty of entertainment services.

Q: But up to now, and until then, you have not been able to raise your revenues or your ARPU (average revenue per user) on your current subscriber base?

S.H.: Well, we have been able to raise our ARPU, by increasing our service and the quality and increasing the promotion on the service. What we are not doing is increasing the numbers of customers.

Q. What is your ARPU these days?

S.H.: It is mid-20s (pounds sterling) but remember without cable TV. So we would expect to healthily beat the cable industry (ARPU) once we introduce broadcast television.

Q: I donít know how happy they'll be to hear that! Listen, to get from here to there, I understand you are going to need to raise some more money, right?

S.H.: Yes and our current shareholders (a Microsoft founder, GE Capital, etc.) continue to be very supportive of the company whilst we continue to negotiate with both strategic investors who are interested in our particular sector in the U.K. as well as financial institutions. I donít want to be specific about our funding discussions at this point but suffice it to say that our current shareholders wouldn't support it if there weren't a clear way forward.

Q; You've raised about £220 million thus farÖ

S.H.: Historically, yes. And we are still working through that.

Q: And you need about what, £150 million more?

S.H.: No. That is the number that has been bandied around. We definitely need, over the longer term, more than that in order to have national coverage for quite a broad range of services and we intend to raise that in stages. The first stage is getting us through this period of proving the network solution I've just described to you and that requires far, far less than £100 million. So we wonít need anything like £150 million (now). Once we have deployed service over the whole of London using local loop unbundling --and we would be the happiest, by the way, to use BT's network if it is properly priced and properly functioning in terms of broadcast television --then we would be raising the final tranche of cash that we need to allow us to p rovide a national service. (What we are envisioning) is really the most advanced service that you could want across the whole of Britain. I think that will give our competitors something to think about.

Q: You mentioned strategic as well as financial investors. Are some of these possible strategic investors perhaps more interested in taking a stake in your company now that we have the draft Communications Bill in place?

S.H.: There's no question. The focus on the UK now as a result of this draft Communications Bill and the relaxing of the ownership rules has really focused the attention of the international community quite strongly on the UK. I think everybody is dusting down old business plans and everybody is looking very, very seriously at the U.K. Why it helps us is that in order to get into any territory you need an integrated delivery (system), which includes traditional analogue terrestrial, right through to digital and the digital must be decidedly different from the incumbent, the incumbent being in this case, satellite distribution. The consumer must see something definably different and better rather than just another multi-channel distribution system, which is why on-demand television and interactivity is so important but it can't stand alone, it must be seen by these players as a strategy that also includes analogue terrestrial.

Q: So the draft bill is really piquing interest and you are seeing a different kind of possible investor interest in your business?

S.H.: The draft Bill has strengthened the interest with the people we have been dealing with in the UK generally.

Q: In the draft bill they donít talk about regulation for VOD. Is this a good thing?

S.H.: Interestingly they talk about not regulating VOD. They talk about carving VOD out because of the problems of regulating the Internet which are so similar (to regulating VOD). But Ministers have retained the right to impose standard broadcast regulations --which is what we have today by the way-- if they're not happy with the regulations the industry puts into place to protect children. So we are working with the DCMS (Department of Culture, Media and Sport) to put into a place by autumn a safe code of practice.

Q: The broadcast stream, the cable channels you are talking about providing, how important are they to making the business a success?

S.H.: Essential. We have to provide a one-stop shop service for our customers. They canít buy a bit of broadcast television here and a bit of PVR (personal video recorder) functions there and a bit of VOD in the third place. They need to be able to buy all this in one place. So for us VOD is a great entry into the, but unless we carry in our knapsack (of services) a full range of broadcast television that they are used to from cable and satellite operators, then we wonít stay very long in that house. It is not difficult to do and it wonít be long before we have it.

Q: But it adds cost because you need a certain amount of bandwidth, more bandwidth than VOD?

S.H.: Actually it takes less because since we are all watching the same thing, for most of the journey (on the network so) we only need one version of the signal. But what is needed is copies of the signals so we donít have a waste and that is done at the local telephone exchange where the DSLAM actually makes copies. It's technology that has been in use in Kingston Upon Hull for about two years and has been used in the USA. This technology is trivial in cost and trivial in introduction but it has not been introduced by BT. This is what is holding us up from providing broadcast television. But we will be able to do so with our local loop unbundled solution from day one.

Q: So the Kingston service has proved that this all works?

S.H.: There is no question that multiplexing is not a difficult technology. There is nothing demanding about it but the line cards have not been put into place in the telephone exchanges as yet, and it is not the top of (BT's) agenda. I donít fault BT on focusing on what is important to shareholders because you have seen the latest results and the responses, but because they are the only company in town it doesnít help companies like us that are at the forefront of these new products.

Q. How has the whole failure of ITV Digital impacting what you are up to in our business?

S.H.: Well it is helping to the degree that there is a bit of a rationalisation going on because there were far too many players with different forms of technology and distribution and it was confusing the marketplace. In the end, what it needed was a very clear statement to the consumer as to what the benefits are to them. Having a 25-channel system, albeit digital, doesnít offer the customer anything more than an analogue 25-c hannel system, except maybe a clearer picture. So if you look at it this way, digital terrestrial television as a major player in the premium television area simply will not fly. So in that sense, (ITV Digital's demise) has cleared the air a little bit in terms of a major competitive angle coming in on our form of television.

It is my view that the future of television is broadband and the future of digital television is broadband, it's not simply multi-channel, which means that all existing players over the next five to six years will go broadband. Broadband can take a number of forms: it can be hybrid fibre coaxial cable or ADSL cable. The signal doesnít care if it is travelling over one or the other as long as it is providing sufficient bandwidth. The thing about cable is that the cable industry has to go through its financial restructuring which may or may not lead to merger, after that it requires far more investment in the infrastructure to provide digital multi-channel television because there are very disparate networks at the moment. Then, a further investment is required to run fibre deep into the (cable) networks to provide true VOD in the same sense that Home Choice offers. So cable can potentially provide the sorts of services that we can provide and, indeed, we would hope to use cable as a means of distribution one day. But the fact remains that I believe we are years away from cable being a viable means in this country at least, of providing a homogeneous means, and a national means, of providing the sorts of services we believe that customers want. And so in that sense ADSL becomes very exciting.

Q: So at some point you foresee using the cable networks to carry the Home Choice services?

S.H.: I think if the cable networks were capable of carrying them, yes. We are very happy with ADSL and future generations like VDSL, which will change things for us but not for the customers. And I think compression technologies will help us. So if it was ADSL only that would be fine with us as long as we can get access to networks at proper prices. We would be interested in running our services over cable but the issue there would be regulatory rights to use the cable, although interestingly you are beginning to see this open up with ntl opening up to Freeserve and rumors that AOL will also be using their network. Clearly, even if it weren't mandated, the cable networks see there is a value in their networks and in their services and the two aren't necessarily absolutely intertwined.

Q: So eventually does BT Openworld become a big competitor to you all, isn't this really BT's first step into providing more than fast Internet connections?

S.H.: I think it is unlikely that Openworld will move into full television and VOD at least not for a long time. They have been dabbling with it for quite some years now and I just feel, and I may be wrong, that beyond fast Internet and downloads of music or whatever, that they wonít provide services (like Home Choice) for some time to come.

The Internet as a means of providing the kinds of services we provide is still three to five years away. The most successful product that BT will provide is probably a stripped down Internet access product (BT Direct). We find that within a few months of joining us our subscribers ask us to provide a home Internet product which is essentially an access product, with email facilities but they donít depend on us to do anything else because they can find that on the Internet themselves anyway.

Q: When you look at what the demise of ITV Digital in the UK against the government's professed switch-off date for analogue signals of between 2006 and 2010 is the current switch-off plan going to work? Is the demise of ITV Digital important or is it just a blip on the curve?

S.H.: It's a blip on the curve but it is predictable blip on the curve, the stumbling of ITV Digital, in the sense that we are focusing now on what digital is. Digital means nothing to people. It is the benefits of digital that mean something to people. By focusing on that and removing those products that don't focus on that helps. By focusing on the benefits to customers, whether it is VOD or interactivity, messages, games, or whatever it is, which can only be provided by digital, I think we have a much clearer pathway forward. My hunch is we will have two, possibly three, but almost certainly two suppliers of broadband entertainment into the home in the next seven years and one of them is most likely to be the existing satellite provider Sky. It is highly likely there will be more rationalisation of suppliers because it is too confusing for the customers and it is not clear what some of these products offer the customer.

Q: Well you at Video Networks have certainly been long-suffering in all thisÖ

S.H.: We have been around a long time! I never give up. Our vision is very clear and it hasnít changed since we started 10 years ago. Frankly the factors that have held us back have been artificial. It has not been the technology or the fact the government doesnít want the service. It has been an artificial problem that we know can be solved.

Q: And the new promised regulator as currently formulated Ofcom theoretically can help this to happen?

S.H.: It should. In the same way that we believe Oftel can help us. The only problem we have with Ofcom is the period of changeover where people's eyes won't be focused on the key issues. We shall try to keep them focused.


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