(First in a three-part series)

SHANGHAI, China--How successful is IPTV in this city of 18 million people?

Successful enough for DaZhong Zhang, vice president of Shanghai Media Group and CEO of its IPTV joint venture, BesTV, to feel in the position to offer advice to what he sees as a laggard IPTV market – the U.S.

“Operators don’t have enough confidence in IPTV in the states,” Zhang told a group of U.S. analysts and media last month. “Technology is one thing, business is another. Investors on Wall Street would like to see relatively short period of return – they don’t have confidence in a long-term investment.”

By contrast, he said, the Chinese are seeing IPTV as something that requires “a huge amount of investment and a long-time to get a return,” with benefits in the meantime that weren’t necessarily the anticipated ones.

Certainly, the Chinese are getting to large scale deployments much faster than the U.S. Since BesTV launched its service in Shanghai last September, it has signed more than 150,000 customers in its partnership with China Telecom, the government-owned telephone company. To the North, in Harbin, service has been available since August of 2005 and currently there are 112,200 users on a system built to support 129,500.

“Our aim is to make Shanghai the biggest IPTV network in the world,” Zhang said. “Now, it is PCCW.”

Ying Wu, a Bell Labs veteran who co-founded UT Starcom and is now its executive vice president and chairman/CEO of its China unit, said he believes the Chinese will hit 1 million IPTV users on the mainland by the end of 2007. Wu is in position to know – UT Starcom provides the end-to-end system for Harbin and has 54% of the set-top box market for Shanghai, as well as most of the infrastructure.

He believes the Chinese market is poised to explode because the country has overcome regulatory challenges and doesn’t face organized competition from a cable industry that is comprised of 2200 smaller players, many owned by municipalities. The Chinese government – which owns Shanghai Media Group and both telcos – is also backing IPTV, according to Zhang and Wu.

Zhang also credits UT Starcom with delivering IPTV on an infrastructure that can scale.

“Microsoft is a very good partner of SMG, UT Starcom is also a good partner of SMG,” he said. “The difference is that UT Starcom is delivering on tangible products and progressing every day.”

In Shanghai, BesTV features an electronic programming guide, with trailers that promote upcoming features, a vertical list of programming by types including a news magazine and a children’s channel, plus buttons for Look Back – a service which retrieves any programming from the previous 48-hours – video on demand, and information channels.

This month, BesTV will add 39 channels to its current 77 channel lineup, far surpassing what the local cable channel can offer, said Minnie Huang, CTO of BesTV. The network-based Digital Video Recorder capabilities make it easy for subscribers to pause live action and replay.

“We provide 48-hours Look Back now but we could go back as much as two weeks, that is only limited by the amount of storage,” she said. “Soon we will go back seven days, and that change is based on customer feedback.”

In addition, BesTV will launch High Definition service May 17, albeit with limited channels – there are only two in China – and limited reach, since customers need to have a 12 Megabit per second service to get HD, a step up from the 3 Mb/s service over which IPTV is being delivered.

Unlike the U.S., China has no licensing or legal challenges to the network-based DVR system, a fact which has allowed BesTV to deploy IPTV with low-cost, low-function set-top boxes, and use UT Starcom’s MediaStation Streaming and Storage servers to deliver content on demand. In Shanghai, customers get a free set-top with a two-year contract. In Harbin, China Netcom is also waiving set-top box fees, said MingXia Xu, executive assistant of the president of China Netcom Harbin.

One major drawback for SMG is that the Chinese government maintains tight controls over foreign content, which cannot be broadcast live.

“Good content is the number one thing that consumers are asking for,” Huang said. “They want us to diversify. Right now, it is mostly Chinese content. Customers want Korean soap operas, they want Hollywood content.”

According to SMG’s research, 50% of its subscribers are using VoD and time-shifting, Huang said.

BesTV can offer foreign content via video-on-demand and does so, but again, there are limits. By contrast, Chinese venues which serve mostly foreigners, such as hotels, are allowed to show live foreign programming through direct negotiations.

Those limits on content pose the biggest challenge to IPTV in China, said Andrew Chetham, Hong Kong-based research vice president in Consumer Communications Services for Gartner Group.

“They are pushing time-shifting which is a nice concept, but it is time-shifting the same old content, and is that alone enough to drive it?” he queries. While China Telecom and China Netcom may be able to easily outpace their cable competitors and don’t face any satellite competition, they do face significant competition for the entertainment dollar in a market where pirated videos of Western content are easily available for less than a dollar, Chetham pointed out.

He’s also not convinced that the telecom operators are as sold on IPTV as they seem to be. By law, China Telecom, which serves the southern 21 provinces of China, and China Netcom, which serves the northern 10 provinces, are not allowed to own IPTV licenses, but can partner with the license holders – now up to four, led by SMG which was first – to offer the service over their broadband infrastructure.

Peter Li, CFO of BesTV, characterized the relationship between SMG and the telecom operators as “harmonious,” serving the media company’s desire for a national franchise and the telecom operators’ need for growth, now that the broadband growth engine is slowing.

“IPTV is an offensive, not a defensive move for them,” Li said. “It’s not like AT&T or Verizon. The cable operators are not posing any meaningful threat to them. They want growth and that is their reason for doing this. The partnership model gives us benefits – part of the equation is the telcos, they need to have the desire to make IP happen. They are eager, they need growth.”

“This is the first time a telecom company and a media company work together,” said Zhang. “Our model of cooperation provides a new model for the government. We created a brand new business model and our aim is to make Shanghai the biggest IPTV network in the world.”

Chetham believes, however, that the Chinese telcos are more eager for the next generation of wireless technology and will likely get distracted from IPTV expansion, especially if more Chinese TV offerings don’t excite an audience looking for other content.

In China, however, IPTV is not as much about TV content as it is about other services, maintains Brian Caskey, vice president of worldwide marketing for UT Starcom.

“It’s more about interactivity – using the system for more things other than TV,” he said. “In China, where fewer people own PCs, the TV becomes a way to surf the Internet – a home tool. We think that television will drive broadband growth and subsequently the Internet access.”

So far, BesTV is looking at TV polling for reality shows, stock tracking and trading for the booming Chinese stock market, and even the ability to make doctors’ appointments in a country where the health care system is stretched. A joint venture known as Shanghai People’s Health Information Technology Co. Ltd. will offer a private Internet-based network to link doctors and patients and enable both consultations and information exchange as well as a national interactive health channel on BesTV. The joint venture, which includes an Australian company, eHealth, is also tied into 180 hospitals including 90% of the Tier 1 hospitals in Shanghai. The service went live in March following two earlier trials.

“China is probably one of the few countries if not the only country in the world where TV is not the killer app,” said Danny Briere, CEO of the TeleChoice consultancy. “Censorship, the paucity of Hollywood content that is allowed – the content is more staid. So there is much greater emphasis on the next-gen applications like videophone, videoconferencing, checking your stocks. These applications are probably in advance of the rest of the world.”

For example, he said, SMG is getting 10% of its revenues from TV shopping.

The other X factor in the Chinese IPTV experiment is the government, which is believed to back this next-generation service. Such approval would go a long way to enable expansion even in the face of relatively low Average Revenue per User in the $4 to $8 range.

“What we believe is that you get into the major cities with the $4 to $8 ARPU, which is affordable but not revenue-enhancing, and then it’s the services you add, targeting what is a growing middle class in China,” Caskey said.

Under the partnership agreement, the telecom providers stand to benefit most from advanced services, Li agreed, while SMG is more focused on entertainment and advertising revenues.

COMING NEXT: What the world can learn from China’s IPTV experience

The IPTV service itself is relatively inexpensive – in Shanghai, the service packages range from $5 a month to $10 a month, with pay-per-view charges for some content while in Harbin, the top tier is about $7.50 a month, with a new lower tier offered at half that price.