Many channels, monthly fees

With RealOne, Larry Jacobson has built an Internet service that looks a lot like cable

Most racing fans want to hear the roar of the engines as the cars zip around the track. Not Dave Watson. Despite a devotion to NASCAR, when he sits down to watch a Winston Cup race, the first thing he does is turn the sound to his television lower. But then he
cranks up the volume on his computer, tuning into a feed from that lets him in on the real-time radio chatter between drivers and their pit crews. That's something that's simply not available on television.

Watson's highlight so far was this month's Samsung 500 in Fort Worth, Texas, where he got to listen to his favorite driver burrow through the pack from 31st place to second before losing out to Matt Kenseth.

'I just jump around the nine drivers,' says Watson, of Brandywine, Md.

There are two surprises. One is that, so far, Watson has only heard one driver swear. The other is that the Internet stream isn't free. He's actually paying for it. In an online world where the mantra is 'gimme, gimme,' Watson has coughed up $29.95 to streaming-media provider RealOne for the racing season.

RealOne won't give Watson live video; that would conflict with the networks' TV rights. But he can get 'condensed' video of races later and highlights packages.

Watson's heard a lot of complaining from other race fans about paying for the coverage, some of which used to give away for free. But Watson isn't squawking. 'People spend more money on lottery tickets in a month or a good meal, and I get every single race.'

Watson isn't alone. RealNetworks' RealOne service has coaxed 600,000 subscribers into paying for various packages of video and audio services on the Internet. They include live radio broadcasts of every Major League Baseball game, full-length replays of ABC's Nightline
and World News Tonight, gossipcasts from E! Entertainment Television and outtakes of athlete interviews on Fox Sports.

CNN has moved virtually all of its online video behind RealOne's subscription wall. RealOne is still working to create 20-minute condensed replays of baseball games and is helping Sony's Soap City create its own stand-alone online video channel.

The dismissive way of looking at RealOne is calculating that all its subscribers watching one channel simultaneously wouldn't add up to even a single Nielsen ratings point.

A more intriguing way is looking at RealOne as a cable or DBS operator, which also aggregates content from different programmers and retails it to home users. Seen that way, RealOne falls just shy of the Top 10 multichannel video providers and is on a growth track to hit eight or nine by the end of the year.

And RealOne isn't even offering porn.

It's up to Larry Jacobson to keep RealOne on the growth path. Jacobson, president and COO of RealNetworks and an ex-president of Fox Network, sees RealNetworks 'in the middle of a 15-year march. . I can tell you that we and most of our content partners expect us to grow over time to multiple millions of subscribers.

'The business, because of the fixed nature of the costs, gets really interesting once you get over the million mark, and once you get past the 1.5 million-2 million mark,' Jacobson continues. 'I can't tell you how long it's going to take to get there.'

Media analyst Tom Wolzien said he was startled to learn how large RealOne's sub base has become. It's far from a challenge to conventional television, but, he says, 'it's a big number for subscription video.'

The comparison to cable only goes so far. First, of course, the dotcom carnage makes it hard for investors and media executives to get too excited about online streaming.

But worse, RealOne's growth is not accelerating. RealNetworks relaunched its old Goldpass subscription service as RealOne in December and added about 100,000 paying subscribers during the first quarter. But that's no more than the company added during the fourth quarter when promotion wasn't so heavy.

Also, inquiries for more detailed numbers send Jacobson and RealNetworks Chairman Rob Glaser into silence. Like the churn rate of customers unhappy with the content. Is RealOne signing up 110,000 subs a quarter and losing just 10,000 old ones, fairly low churn? Or adding 200,000 new customer and losing 100,000 old ones, which would be a terrible, possibly fatal, churn? And what's the average revenue per subscriber that sticks around? No clue. The executives say they don't want to give potential competitors any useful information.

'There's no doubt this service is growing quickly; the question is how fast can this really grow, and how big is it,' said John Corcoran, Internet analyst for CIBC worldwide, who is skeptical about RealOne as a stand-alone business.

But it's tantalizing to programmers. Despite the ongoing dotcom financial trauma, TV networks remain eager to exploit the Web. Dotcom stocks have sunk; usage has not. Networks have given video clips away online for a few years, but advertising has dried up. Using Web sites only to promote their core TV properties isn't enough. They need a business model.

'I am convinced subscription video content on the Internet is a business,' said Bernie Gershon, vice president and general manager of 'Real has a good model.'

RealOne has different kinds of content providers and different kinds of deals with them. RealNetworks guaranteed Major League Baseball $20 million over three years to retail radio broadcasts of games and highlight reels. Brand names like Fox Sports or ABC that might draw subscribers get a per-subscriber license fee. Unknowns-like a Food Channel clone called allfoods and a similarly imitative AnimalChannel-get a fee based on how much of their content is actually downloaded.

For programmers that want to go it alone, like Sony's Soap City soap opera channel, RealOne will simply provide technology and distribution services and forget packaging. Soap City plans to start selling old episodes of Days of Our Lives
and The Young and the Restless
for up to $8 a month.

Robertson Stephens analyst Aleksandar Sasa Zorovic predicts that RealOne will generate about $66 million in sales this year and $118 million in 2003. He estimates that average revenue per subscriber runs $7.60 per month, with customers loading up on $5 monthly sports product rather than the RealOne basic package.

Neither Jacobson nor programmers would disclose the fees being paid to programmers, but the numbers don't appear to be outrageously high. License fees appear to consume 25-30% of RealOne's revenues. That's about the same as what cable operators pay.

It also means that programmers will collect $20 million or so in license fees this year.

Glaser says that even with the bandwidth, server and other distribution costs, RealOne is already profitable.

For most of the content suppliers, RealOne is a way of squeezing extra cash out their networks. 'Once you've created content, there's a powerful motive to find other outlets for it,' analyst Corcoran said. 'It's a sunk cost.'

But RealOne executives and some providers hope to create new mini-networks. Joseph Langhan, an executive in the early days of Food Network, is trying to clone the popular cable network online with Partnered with the producer of cooking shows on BBC, is offering some well-known chefs, short recipe clips and cooking classes. (Its first book, Minute Meals, is due out this week from John Wiley & Sons.)

Langhan compares streaming and RealOne to the early days of cable. 'ESPN was a joke when it first started,' Langhan said. 'If ESPN was doing today what it was doing back then, cable TV would not be successful.'

The rush hour is 4-6 p.m weekdays. 'Housewives trying to figure out what to serve for dinner,' Langhan said.

CNN is big whenever there's a hot story. ABC News gets a surprising traffic spurt on the weekends from people downloading 20/20
stories. (managed by AOL Time Warner's Turner Broadcasting System) did huge Monday traffic when a Sunday Winston Cup race was delayed by rain.

RealOne is critical to RealNetworks because the other parts of its business, primarily technology, are under pressure. Since starting up in 1995, Glaser has given consumers basic RealPlayers or sold them more elaborate versions. The main money is selling servers and distribution services to companies that want to stream audio and video over the Web, whether music, earnings announcements, or product demos.

RealNetworks now generates $188 million a year in revenue and around $20 million in negative operating cash flow. It has no debt and $337 million in cash on the books, raised during those days when the stock was trading at more than $200 per share (it now trades at $7).

With the dotcom bust, software licensing revenue has stalled. Also, rival Microsoft simply gives away servers for small users seeking to stream in its Windows Media format. So Corcoran expects software license revenue to fall from $108 million last year to $99 million this year.

Some analysts see the RealOne push as a move of desperation, more of a showcase than a going concern. Glaser and Jacobson have to convince big players that streaming video can be a business.

'Real is not trying to create the next NBC. They're trying to show people in the media business that the next NBC can be built. And if they do, Rob Glaser sells a lot more servers,' said Steve Vondehar, principal of research firm Interactive Media Strategies.

Jacobson denies that. While the company is happy to work with content providers that don't want RealOne's packaging, establishing a retail media business 'is completely central to our future.' If RealOne wanted to merely juice server sales, it would be pushing companies to keep giving their video away, he says. 'With subscriptions, by definition there are fewer users.'

RealOne's future is tied to the spread of high-speed data connections in homes. Jacobson's major goal is to cut bulk deals with cable operators to incorporate RealOne into their high-speed service, at a rate far less than $9.95 a month. Such bulk wholesale deals would make RealOne's life a lot easier and cheaper than chasing subscribers one at a time.

'We are open and flexible about taking advantage of that,' Jacobson says. 'If they want to private-label a package, we can do that.'

Cable operators, however, say they're not focusing on offering much in the way of special content to online customers.

There are two problems. One is that some of its highest-profile content partners-including ABC and CNN, industry executives say-specifically withheld rights to bulk cable sales.

More important is the broader worry that streaming-video packagers could be a Trojan horse that could hurt cable's core video business down the road. That was the central fear in operators' regulatory fight against being forced to 'open access' to their high-speed data networks. Bits are bits. Once Earthlink gets the right to sell a Web surfing stream down a cable system, it's a small digital leap to sell Internet video.

It's not a big deal if a packager is selling, but what if someone like RealOne starts selling ESPN or HBO? Cable networks would, of course, resist infuriating cable operators. But they initially resisted DBS operators, who then successfully lobbied Congress to secure access to programming.

'The video quality's not there, but you presume it will be,' said one senior cable executive. 'It's a question of what you're opening a door to.'

Glaser and Jacobson insist they do not have designs to make RealOne into any kind of competitive packager.

'I don't think the Internet is anytime soon going to be providing what I get on cable,' Jacobson says. 'They're different things.'