By Bertold Heil

In the autumn of 2002, our analysis came to the conclusion that the German pay-TV market’s potential can only be harvested by an investor with deep pockets and a business model that emphasises individual choice rather than adding more TV channels. Both parts of our conclusion hinted at a new entrant to the German market and included some scepticism regarding the prospects for Premiere’s multi-channel, non-interactive approach.

In the spring of 2003, nothing looks more unlikely than an investor going head-to-head with a seemingly rejuvenated Premiere in its core pay-TV market or challenging their service offering with interactive.

Looking at some statements from industry insiders in the press, the outlook for pay-TV in Germany seems to have never been brighter. As always, reality currently is a mixture – the justified scepticism of our view six months ago and the optimism of our colleagues today.

The state of the German market can be assessed by looking at Premiere, which has been able to gain more than 360,000 new subscribers since August 2002. Despite 170,000 subscribers dropping service last year, Premier was able to reach 2.6 million in total by the end of the year. Considering Premiere had 2.4 million subscribers at the beginning of 2001 and its 2002 growth was driven by a strongly discounted price plan, the increased subscribership last year cannot be considered spectacular. On the other hand, considering the poor state of the German pay-TV market last year, Premiere CEO Georg Kofler seems to have been successful in creating a sound business foundation to meet the expectations of the German TV audience later.

To rescue the firm financially, Kofler forced Premiere into a cost-cutting program, which has put in sight the goal of returning to profitability by the end of 2003. Besides cutting organisational costs, Premiere renegotiated all programming deals in a way that cut costs while ensuring access to the output of all the major studies in Hollywood. His deal to sell stakes in Premier to the Permira investment group, which paid just 143 million euros ($150.6 million) for 65 per cent – Rupert Murdoch had earlier paid 1.5 billion euros ($1.58 billion) for 20 per cent – increased his financial flexibility without constraining his ability to define and execute strategy. If Premiere can reach 2.9 million subscribers by the end of this year, profitability in 2004 is a realistic goal. If so, taking the company public would be a realistic goal for 2005.

Doubt still lingers over the long term prospects for Premiere. It is surprising to most industry experts, including people inside Europe’s leading pay-TV broadcaster BSkyB, that Premiere is able to “upsell” its 5 euro ($5.32) per month subscriptions to premium services at a rate of 35 per cent. However, a Detecon report to be published in May argues that Premiere still lacks premium features that would enable a more customised consumption of its programs and access to a subscriber potential larger than 4 million. Despite the re-branded channels, such as Cinema, its competitive advantage or its actual benefit compared to advertising or fee-financed TV is difficult to assess. According to company sources, this will not change this year, since the switch to a new encryption system this fall will take the company’s resources, so innovations will have to wait until 2004. At the same time, if Premiere can reach the break-even point, there is no real threat to its position in the German market place, even supposed it would remain in its current niche.

The German cable industry, once expected to rule the pay-TV market after Deutsche Telekom sold its network, is far from offering a pay-TV bouquet to rival Premiere. The investors of the large distribution networks are tied up in severe financial problems that have slowed down even their plain vanilla infrastructure plans (upgrading the networks to support a triple play strategy) and the atomistic structure of the market that serves the last mile to the consumer. Other cable network operators that try to compete are too small and too regionally limited to pose a credible threat to Premiere.

Looking at broadband Internet service providers (ISPs), the situation is different. T-Online has just recently demonstrated a broadband service. Based on a DVD-player/PVR- equipped set top box that computes TV signals from both cable and satellite and IP-data delivered via ADSL, the leading German ISP is negotiating video on demand rights and deals with TV broadcasters to tailor services to its system. If the once technology-focused and content-blind T-Online is able to aggregate a compelling bouquet of TV content, video-on- demand and other interactive services, then such offerings could force Premiere to truly compete in the interactive market. To do so, T-Online needs to solve the usual chicken/egg problem. It needs to get its pricey set top box to the market and remove two potential show stoppers: (1) getting the ADSL signal to the living room in a plug-and-play way (the phone outlet is typically located in the hall or the study in Germany) and (2) transforming the T-Online brand, which is not considered as TV or entertainment related, into a household name for interactive TV.

All facts considered, we expect no dramatic changes to the German pay-TV markets until the end of this year. Anyway, the upcoming month will show if Premiere’s strategy will drive subscriptions and profitability up or if the company will remain in a market niche forever.

Dr. Bertold Heil is head of broadcast, online and entertainment segment at German consultancy detecon. He can be reached at tel. 49-(0)-89-546365-60 or email [email protected].