BT threatens to cross the lines: Plans for dial-up home videos signal all-out war with cable firms. Russell Hotten reports

AFTER months of skirmishing, BT is at last squaring up for open warfare with Britain's cable industry. Both sides have been sniping at each other over speculation that Britain's biggest company wants to provide an entertainment service down its telephone lines.

Iain Vallance, BT's chief executive, is expected this month to announce plans to press ahead with the development of a video-on-demand (VOD) service, which would enable customers to dial up videos from their living-room sofa without paying expensive cable subscriptions. Such a service would threaten the billions of pounds that cable companies are investing in the UK and could trigger one of the most bitter and expensive commercial scraps for years.

Yet there is uncertainty over BT's real intentions. Is it serious about proposals to transmit film and television programmes to the 23 million homes linked to its telephone network? Or is it - as some franchise operators argue - just a devious plan to unsettle the confidence of investors in Britain's cable industry?

Either way, cable companies are outraged that BT is encroaching on their patch and are threatening a legal battle that will have expensive corporate lawyers salivating with delight. Last week, they asked the Government to stand by its bar on BT entering the business.

Restrictions have been put on BT, and Mercury, from sending entertainment services over their networks to allow the fledgling cable franchises to get off the ground. BT is barred until at least 1998 from going into conventional cable entertainment, but the sector is becoming so important that the company urgently wants a slice of the action.

American telecommunications companies, such as Bell Atlantic, have invested billions of pounds in US cable and VOD. At the moment, VOD as a stand-alone product is not a commercial proposition. Philips, the Dutch electronics company, has developed VOD decoders for televisions, but they cost an estimated dollars 1,000 ( pounds 650) each. However, as a mass market develops, the cost of VOD would fall, and the potential for VOD add-on services such as interactive games and video mail is enormous.

Even though cable operators say BT's move into entertainment would be illegal, the company is now toying with a system by which a subscriber can dial up a movie or TV programme and have it sent down the telephone wire to a decoder sitting on the television in less than 10 seconds. The phone could be used simultaneously. BT would, in effect, be doing what cable franchises are doing: running a combined phone and television service.

Eugene Connell, chief executive of Nynex, Britain's largest cable operator with about 20 per cent of the market, claims BT has a hidden agenda. 'They are using VOD as a marketing ploy to thwart the success of cable and confuse the marketplace. They are concerned about the phone penetration that all of us in cable are making.'

This conspiracy theory is not as far-fetched as it may sound. UK cable companies, largely backed by American telecommunications giants, are currently signing up phone customers at the rate of 20,000 a month.

The total number of UK cable subscribers in September was about 225,000, up from 106,989 in January. And 62 of the 127 proposed franchises are in operation. More than pounds 1bn was invested by cable last year alone, and a further pounds 4.5bn will be spent completing the network.

Combining revenue from telephones and TV has become a highly attractive investment. Videotron, a Canadian company that operates several London franchises, has even applied for a telecom licence outside its areas - in Westminster, home to BT's only cable TV franchise. Other applications by operators outside their franchises are likely to follow.

BT, then, has cause for concern, and some believe its decision to start selling BSkyB satellite dishes in its high- street shops is another attempt to slow the onward march of cable. The more satellite dishes sold, the less reason for customers to subscribe to cable.

James Dodd, telecommunications analyst at Kleinwort Benson, said: 'We believe the major motivation for BT raising the profile of a possible video-on-demand service at the current time is to unsettle cable operators and particularly their backers.

'Any headlines which can raise the apparent risk of the cable industry will raise the effective cost of capital and so make life that much more difficult for BT's competitors.

'Our research shows that as the construction rate of cable accelerates rapidly from now on, this loss of revenue will have an increasingly adverse effect on BT's results. Our projections show that with planned build rates, BT's profit growth could be flattened from 1995 onwards.'

Yet there are strong signs that BT is doing more than throwing a spoiling stunt. Indeed, it appears to be very serious about VOD. It has done extensive tests and has talked to Pearson, Kingfisher, London Weekend Television and Hollywood studios about supplying entertainment packages. A joint venture might avoid legal obstacles, and such companies would not take kindly to being used as part of a mere diversionary tactic. Furthermore, BT attempted to run a pilot VOD service in East Anglia, which was blocked when the Cable Television Association protested that it broke broadcasting regulations.

The CTA may not be so lucky next time, because the issue of BT moving into VOD was thrown into legal confusion last month. The Independent Television Commission, after talks with Oftel (the telecommunications watchdog) and the Department of Trade and Industry, did not think BT would need the local delivery licence required by cable broadcasters. This is not the same as saying that BT can run an entertainment operation, but it certainly removes an important regulatory hurdle. BT would still need a broadcasting licence, also provided by the ITC.

The ITC statement was attacked by the CTA. Richard Woollam, director-general of the CTA, said: 'The association will be seeking clarification from the Government about their current policies with regard to the development of a competitive telecommunications market in the UK.

'To ensure that this massive project continues, it is vital that the investors are clear on the legal, regulatory, and policy environment they work within. The ITC video-on-demand statement throws this into some confusion.'

If the ITC is ambivalent about BT's position, the 1991 Duopoly Review by Oftel and the DTI is not. It says: 'The Government intends . . . not to allow the national PTOs (Public Telecommunications Operators) to provide entertainment services nationally in their own right. This policy will not be reviewed for at least 10 years.' Kleinwort's Mr Dodd added: 'Thus it would seem clear that to allow BT to proceed with video-on-demand would involve a reversal of policy, which the Government has clearly ruled out for 10 years.'

One way round the regulations - according to BT, at least - might be to argue that VOD is not entertainment broadcasting in the conventional sense. Most broadcasting is a one-to-many medium. Dialling up a video is a one-to- one service. VOD could be more of a competition for video shops than for cable companies. Any legal action would turn on the interpretation of what exactly is broadcasting. But it is clear that technology is moving faster than legislation.

If the law does not defeat BT, technology might. BT says its VOD trials have achieved video quality pictures, though the company accepts that the picture quality degenerates the further the subscriber is from the telephone exchange. Advances in digital compression technology mean that BT has the spare capacity to squeeze more signals down its network. The average British phone is in operation only four minutes per 24 hours, so the network is underused. But BT's telephone network is ageing, and is positively ancient compared with the sophisticated system being laid by cable franchises.

Mr Woollam said: 'You can do quite a lot in a cable laboratory, but that quality deteriorates when you go 'real'. You cannot provide a good quality TV picture by squeezing the service down 40-year- old copper wire.'

Upgrading the network could cost hundreds of millions of pounds, although such capital expenditure is unlikely to be a problem for BT.

A simpler alternative for BT might be to follow the route of its telecommunications counterparts in America, which have used their enormous cash flows to buy out the US cable interests. But it would not be before the end of the decade that it could do this.

What is ironic is that BT already had the chance to operate sophisticated cable operations. In the late 1980s, it sold 20 cable franchises, retaining just the Westminster one, which it uses largely as a test- bed. BT said it sold them because it is a nationwide telecommunications company and did not like operating separate subsidiaries.

BT is about to decide whether a return to the fray is worth it. If the answer is yes, the ensuing battle is likely to be as entertaining as any of its VOD programmes.

(Photographs omitted)