Winners and losers in the digital TV race

But there are some notable exceptions, among them Pace Micro Technology. In the eye of the economic downturn, Europe's biggest set-top box supplier is sitting pretty as the appetite for interactive TV services, which promise to reduce dependency on advertising revenues, grows worldwide. And there is no sign of the 20.1% margin that Pace made in the year to June abating when it reports first-half earnings early in January.

The British company has just started shipping set-top boxes to AOL Time Warner in the US. Together with its contract with Comcast, the third biggest cable network there, the deal marks its breakthrough into the US, a market which has been sewn up by the tightly controlled duopoly of Motorola and Scientific-Atlanta for the past 30 years. Then there is Comcast's pending bid for AT&T Broadband which, if successful, could open more doors in this crucial territory.

If there's a part of the technology sector that appears immune to recession so far, it's digital TV equipment manufacturing. This is largely because network operators are financing the cost of getting set-top boxes and related equipment into homes as they make a mad dash to raise average revenue per user. Governments are also pushing the transition to digital so they can sell analogue frequencies.

Add to all that the fact that Pace is the biggest set-top box supplier to News Corp which has, for the moment, lost in its bid to buy DirecTV, and things are looking busy. Even if EchoStar manages to get its proposed acquisition of DirecTV past US regulators, that will put pressure on US cable operators to increase investment. It's what you might call a win-win position for Pace.

But it would be a mistake to think that all set-top box equipment-makers are in the money. The story at Philips, Pace's biggest competitor in Europe, is a very different one. Its Digital Networks division has had to rethink its digital set-top box strategy as a result of the economic slowdown and having misread the US market for interactive TV.

The company has lost about £200m in the past two years as unit shipments have fallen and prices have dropped. Despite having made some inroads into the US market with a contract for a million set-tops with AT&T, it turns out that the company backed the wrong horse: AT&T has scaled back plans to install the kind of advanced interactive set-tops that Philips sells, leaving the company feeling squeezed as the smallest player there.

Pace appears to have played the game well so far. But it knows that to sustain margin growth at current levels, it must move higher up the value chain with products that do more than convert digital broadcasts to analogue signals for conventional TV sets. Otherwise, it would face the same price crunch and slowdown in sales growth that PC makers have experienced.

Philips' experience serves as a stark reminder that digital television is a new frontier. In Europe the rollout of next-generation set-tops has already been delayed by a year, and hardware and software vendors are rapidly realizing that this market is not about quick profits. Instead, it will be a protracted, risky business that will inevitably lead
to consolidation further down the line.