Murdoch's digital assault rattles rivals

News Analysis: BSkyB is basking in City approval as its offer of free set-top boxes shakes competitors

RUPERT MURDOCH rarely does things by half and yesterday's dramatic attempt to seize the high ground in the digital television battle was no exception. The announcement by BSkyB that it is to give free set-top boxes, Internet connection and cut-price telephony to subscribers to its new satellite television service sent shockwaves through the market.

Shares in Carlton Communications, one of the two media companies behind the rival ONdigital service, fell by 8 per cent to 544.5p. The effect on the cable operators was even more pronounced. Shares in Cable & Wireless Communications, Britain's biggest cable operator with 1.2 million subscribers, fell 11 per cent, while Telewest shares retreated by 6 per cent.

BSkyB, however, was basking in the warm approval of the City. Even though the company will take a pounds 315m hit to its profitability this year to fund the cost of the free set top boxes, and dividend payments have been suspended indefinitely, shares in BSkyB soared by 12 per cent to a 12-month high of 607p. After a rocky period for the business, not made any smoother by the blocking of its bid for Manchester United, BSkyB shares areclimbing back towards their all-time high of 696p.

When Mr Murdoch launched the original Sky service a decade ago, he was, quite literally, betting the ranch. Had Sky fallen from the heavens then it could have brought the entire Murdoch empire crashing down with it.

This time the gamble is far more calculated and the risk much better contained, hence yesterday's stock market reaction. On the face of it, the BSkyB offer is generous - the price of set top box is about pounds 200, a hefty saving. But that will not be the cost to BSkyB. For one thing, customers who subscribe to the new digital service will have to pay a pounds 40 installation charge while their monthly subscription charges will rise by up to pounds 2. By way of compensation for the 550,000 subscribers who have so far signed up for the digital service and paid their pounds 200, monthly charges will be frozen until September 2001.

The cost of manufacturing the set top boxes and installing them is also coming down. The net result is that the cost of signing up a digital customer will only rise by pounds 20 for new subscribers and by pounds 70 for existing ones to a figure of pounds 155.

In addition, BSkyB will benefit from lower transmission and infrastructure costs once all its analogue subscribers have migrated to digital, saving the company an estimated pounds 50m a year.

Based on experience in other countries, there should also be a reduction in churn rates - the percentage of customers who decide not to renew their subscription from a current level of 13 per cent down to 6-9 per cent.

As an industry, television is prone to hyperbole and, yesterday, Mark Booth, BSkyB's departing chief executive, did not disappoint. "We have unlocked the formula to transform the company," he declared.

As the analysts left BSkyB's presentation, the mood was bullish: "BSkyB's target of one million digital subscribers by this October will be smashed easily," said Hitesh Thakrar, media analyst with Robert Fleming.

The assumption that BSkyB's aggressive move is aimed primarily at snuffing out ONdigital, as BSkyB successfully did with British Satellite Broadcasting, may be misplaced. "This has frozen out the competition from the cable companies before they even launch, said Mr Thakrar. "Their advantage of offering a free set top box has gone ... This move has put [BSkyB] further out in front."

Not surprisingly, the cable companies see things rather differently. Greg Clarke, chief executive of CWC, which launches its digital television service in July, also with free set top boxes, detects a defensive strategy behind Mr Murdoch's gambit.

BSkyB's own subscriber figures tend to support the argument. In the past nine months, it has lost just over 100,000 dish subscribers. All the growth in subscription numbers has come from households taking BSkyB's programming on cable. "Secondly, this market is not going to be fought out on the strength of free set top boxes but on the products and services people want to buy," adds Mr Clarke.

CWC will launch in Manchester and the North-west, and then extend the digital service to London in October. By the end of the year, half the homes served in its franchise area - some two million - will be able to subscribe to digital cable television. CWC will offer the same number of channels - 200 - as BSkyB and promises to be as competitive in the range of pay-per-view feature films and top sporting events on offer.

Also, CWC claims that its interactive television service will be better than BSkyB's. Apart from the usual e-mail and home shopping, CWC willoffer features such as quiz shows where viewers can participate at home using a control pad.

According to research by Flemings, 46 per cent of all British households with a television will be digital by 2003. It also predicts that by then BSkyB's share of the market will be 45 per cent against 38 per cent for the cable companies and just under 17 per cent for ONdigital.

Mr Thakrar believes that, unlike 1989, this is unlikely to be a fight to the death between BSkyB and its rivals. There will still be room in the market for ONdigital, albeit it with a niche share that may fall to 10 per cent.

Mathew Horsman, media analyst with Investec Henderson Crosthwaite, adds that the stakes are not quite so high this time. Whereas it cost almost pounds 2bn to launch British Satellite Broadcasting a decade ago, CWC is only putting pounds 300m into developing its digital service, together with an additional pounds 60m this year to support marketing and customer service.

He adds that in the event of ONdigital failing altogether, Carlton would probably not have to write-off much more than pounds 80m. In the interests of sustaining healthy competition as the digital television market expands, viewers must hope that it does not come to that.