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A friend recently installed a cable modem from @Home.com. Instead of looking at pages at 56K, he can now cruise the Web at T1 speeds. What was the first thing he did? He went to every video Website he could find. He listened to music videos, movie trailers, and network broadcasts. "It's like television on demand," my friend said. I think he's not an exception. As bandwidth increases, more and more people will be looking at video on the Web.

One company at the forefront of this industry is RealNetworks. Basically, the company sells two types of products: players, which bring audio and video to your browser, and servers, which let companies send audio and video to people's browsers. The way to win the battle to dominate the Net multimedia market is to get as many people as possible to use the product. As for RealNetworks, it used a strategy that made Netscape so successful: Let users download the software for free. There have been more than 18 million copies of the RealPlayer software downloaded from the RealNetworks site. Although, RealNetworks has pursued another clever strategy -- that is, there's a premium version of the RealPlayer, called RealPlayer Plus. More than 200,000 copies have been sold.

With so many RealPlayers on the market, it's no surprise that about 100,000 hours of audio and video content is been broadcasted over the Web using the RealNetworks' technology. What's more, more than 150,000 Web pages use the RealNetworks' software. And the RealPlayer technology is getting better and better. The recent beta version (version 5.0) has much improved audio and video quality, as well as full-screen video. The new server technology allows for animation; in-stream advertising; and password-protected access to content, so as to allow for a "pay-per-view" model.

I had an opportunity to use the RealVideo technology. Two friends, Craig Gold and Grant Moncur, who run a consultancy called eStreem, helped me create a RealVideo presentation for my new Website. You can see it at the Taulli Report.

Here's what it entailed. In terms of hardware, we used a Windows NT machine and a dual Pentium Pro 200 (both chips run at 200 MHZ). We used an Osprey 100 video capture card, which is one of the few cards that allows for lower resolutions (such as 120-by-160, which is typical for Real Video). The system has a SCSI hard drive system with AV capabilities. If not, you won't be able to use richer video quality, since you'll lose lots of frames. Installing the server software is fairly straightforward. Once you have a real media segment recorded and encoded, you upload it to the server's real media directory and create a metafile with that segment's Internet address in it. You load the metafile onto your Web server and put a link to the metafile in your document.

OK, enough with the technical stuff. Now let's see how the business is doing.

As with most Internet companies, RealNetworks has huge losses. The accumulated deficit is $14.8 million. However, the company is spending its capital wisely. Let's take a look at its income statement:

Revenues: The company has three main sources of revenues-software license fees, services, and advertising.

1. Software License Fees: For the past nine months, the revenues were $17.5 million, compared with the same period last year of $7.2 million. Of this amount, Player sales accounted for $7.1 million; servers, $10.4 million. About $6 million of the sales derived from electronic delivery from the RealNetworks Website. 2. Service Revenues: Services include consulting, content hosting, technical support, and upgrade contracts. For the past nine months, service revenues were $3.3 million, compared with $635,000 for the same period last year. 3. Advertising Revenues: For the first nine months of this year, advertising revenues were $1.5 million, compared with $426,000 for the same period last year. Interestingly enough, of the total sales, about 24 percent was from international markets, compared with 18 percent for last year. RealNetworks established three foreign subsidiaries -- France, Japan, and the United Kingdom.

Cost of Software License Fees: This includes the cost of duplication of CDs, manuals, packaging, product media, payments to third-party vendors (such as for product fulfillment), and content providers. Like any good software company, this cost item was relatively small: $2 million for the past nine months, compared with $470,000 for the same period last year. Cost of Advertising Revenues: This includes the costs for personnel to create catchy advertisements, as well as the expenses for providing bandwidth to serve the heavy traffic. This cost item was $572,000 for the first nine months of this year, compared with $187,000 for the same period last year. Cost of Service Revenues: This includes the costs for the payroll of highly trained personnel. This cost item was $1.9 million in the first nine months of 1997, compared with $312,000 in the same period for last year. Included in the cost of service revenues was the expense for the RealMedia conference, which meant RealNetworks had to shell out a cool $1 million. Research and Development: This is a critical factor for RealNetworks. The company has wisely spent lots of money on this category. In the first nine months of this year, the R&D expenditures were $9.1 million, compared with $3 million for the same period last year. With the money from the IPO, these expenses are likely to soar. Selling and Marketing: Again, this is another key area. So far, RealNetworks has been fairly successful in creating a tremendous brand. The selling and marketing expenses were $14 million for the first nine months of 1997. They were $4.3 million in the same period last year. General and Administrative: These expenses are primarily for the salaries and fees for professional services (HR, accounting, etc.) These expenses were $4.4 million for the first nine months of this year, compared with $2.3 million for the same period last year.

The biggest challenge is the former employer of RealNetworks' CEO, Rob Glaser: Microsoft. In June, RealNetworks signed a $30 million deal with the world's largest software company. According to the terms, Microsoft received 12.5 percent of RealNetworks. More important, Microsoft was granted a nonexclusive license to "substantial elements of the source code" of the Real Technology. But, of course, Microsoft has its own audio/video technology called NetShow. And Bill Gates has an aversion to competition. Several months later, Gates purchased Vxtreme -- which also has an audio/visual player -- so as to integrate this technology into NetShow. It's no secret that Microsoft wants to turn computers into television sets. After all, Gates bought $1 billion in stock of Cox Cable and acquired WebTV. Oh, and he also owns a chunk of VDOnet, another audio/visual player company.

See a trend?

Well, the Justice Department does. It launched an investigation of Microsoft's position in this fast-growth industry. But if the Justice Department's response is anything like what it did in response to the bundling of Explorer with Windows (a fine that amounts to mere pocket change for Gates), then Gates will likely dominate audio/video on the Web. It's inevitable that Microsoft will bundle its NetShow technology in its Explorer browser and server software. And RealNetworks is already feeling the pressure. The company has made its Basic Server a free product (it once sold between $295 to $995). True, this will help increase its market share. But the result will be much damage to revenues.

RealNetworks is a very smart company. For three years, it's been the driving force in bringing multimedia to the Web. The Real products are tremendous. The management is awesome (one of the board members is Mitch Kapor, founder of Lotus). But Microsoft has too much ambition and money. The Redmond, Wash., giant wants to dominate audio/video on the Web. The best chance for RealNetworks is not to sell 12.5 percent of the company, but 100 percent of it.

For comments/questions, contact Tom Taulli at ttaulli@bpia.com.