Sony Re-dreams Its Future Its wizards are hatching lovable, Internet-connected gadgets that know you and tend to your needs.
By Peter Lewis

(FORTUNE Magazine) – Kunitake Ando is all smiles, as you would expect him to be, given that he presides over what is arguably the world's greatest and (next to Santa's workshop) most legendary toy factory. As president of Sony Corp., Ando gets to play with every new gadget in Sony's tightly guarded development labs, and to preview all the new movies, television shows, and videogames. He's not shy about letting people know he's having fun. At a recent gathering in Yokohama of Sony's top international dealers, Ando joined a skit on stage that allowed him to wear his favorite toy, a prototype Sony wristwatch videophone. Later in the program he appeared in a promotional video in which he swung through the air like Spider-Man, the hero of Sony's $403 million hit movie.

And when Ando talks about his Sony Airboard, he becomes positively effervescent. The Airboard is a wireless portable video and Internet display that belongs to a new generation of Sony products designed for the coming era of ubiquitous broadband networks. You can't buy one in the U.S. yet, but they sell in Japan for about $1,000, and Ando is addicted to his. His aides giggle at the memory of him using it to sneak peeks at World Cup soccer broadcasts during meetings. "I'm always carrying it to meetings and watching games," Ando laughs. "I even take it to the bathroom with me. I've asked the engineers to make it waterproof, because it's dangerous in the bathtub."

But when asked how the Airboard is selling, Ando's smile fades. "That's where we have some difficulty," he sighs. "People don't know what it is, whether it's a PC or a TV or something else. We try to explain the concept, but people find it difficult. And dealers don't know how to sell it.

"In the meantime," Ando continues, showing a hint of frustration, "Sharp's Aquos, a simple LCD TV, sells so well. But Airboard is so much more than Aquos!"

The Airboard is just one example of the immense challenge Sony faces these days: reinventing one of the world's best-known companies for the day when gadgets evolve into delivery vehicles for streams of digital bits. If Ando and his managers are successful, tomorrow's Sony will no more resemble today's consumer-electronics powerhouse than today's Sony does the struggling maker of electric rice-cookers that rose from the rubble of Tokyo after World War II. But if they guess wrong--if their new generation of products is too far ahead of its time, or if they misjudge the public's appetite for music, videos, and games delivered digitally on everything from television sets to mobile phones--the company risks being stymied by competitors ranging from Nokia to Samsung to Microsoft. It's the biggest gamble Sony has undertaken since co-founder Akio Morita pushed the company into Hollywood more than a decade ago.

For the past two years, Ando and Sony's chairman and CEO, Nobuyuki Idei, have been trying to fast-forward the company into a broadband entertainment future, one in which nearly every Sony consumer product--mobile phones, digital cameras, televisions, multimedia computers, game consoles, portable stereos, video recorders, set-top boxes, handheld PDAs, even robots--will be connected to the Internet or an Internet gateway device.

Once all these products are so joined, Sony will be able to deliver its music, movies, television, games, and data services to customers wherever they may be, in the office, at home, in the car, or wandering down the street. The customers will be able to instantly share their own digital pictures, videoclips, and text and voice messages--put another way, their ideas and emotions--at the touch of a button. Sony executives say, with a sincerity that disarms even cynical observers, that a core design criterion for all Sony products is to touch the heart.

But this new vision has wrenching implications for the $57-billion-a-year company. Before Sony can touch the hearts of customers (and reach into their wallets), it has to win their minds. That means selling the broadband vision to consumers who have been slow to embrace high-speed networks. It also means selling the vision to dealers, who may actually have to reconceive and reconfigure their stores to accommodate the new Sony products.

The network vision also has to be sold internally. Historically, Sony's many business and product units have pursued their goals largely independently. Hardware and content managers, for example, are literally oceans or continents apart, with the gadget wizards in Japan, the moviemakers in California, and the music makers in New York. Earlier this year Idei promoted Masayuki Nozoe, one of the company's few senior managers with experience in both consumer electronics and the music and movie groups, to head an initiative called the Network Application and Content Service Sector, or NACSS. Never mind the mysterious name: Nozoe's mission is to do organizationally within Sony what Sony is striving to do in the market with its products--make everything work together seamlessly, bridging the businesses of hardware and content.

That hasn't been easy. "Yeah, I guess it takes some time," Ando says of the internal changes, which have involved a series of major reorganizations. The mental shift is even more difficult than the technical challenges of redesigning all new products, he adds. "It took almost two years for everyone to grasp the network concept and go in the same direction. Now we're all going the same way. The horizontal and vertical are more balanced." Engineers no longer start work on a new device without considering how it will play on the network. Those far-flung hardware and content managers now gather regularly for meetings and stay in touch via e-mail and videoconferences.

Chasing the network vision puts Sony into conflict with scary new adversaries: Nokia and Samsung in telecommunications, Hewlett-Packard and Dell in computers, and Microsoft in the fast-growing game-console business. Add to those the rivals Sony faces in its mainstream businesses. In entertainment, it is up against AOL Time Warner (parent of FORTUNE's publisher) and other giant providers of content, services, and online distribution. In consumer electronics, which still accounts for nearly two-thirds of Sony's revenue, the competition with Matsushita, Philips, and others remains fierce; last year the sector lost money as profit margins vanished. And did we mention that Microsoft, Intel, Apple, and Samsung are all pushing broadband visions of their own?

From the standpoint of Sony's marketers, those challenges could not have come at a tougher time. Consumer confidence is at a nine-year low in the U.S., which accounts for one-third of the company's sales. In Japan, its No. 2 market, the economy has been in pause mode for nearly a decade with no relief in sight.

Yet Ando has reasons besides his natural ebullience to be cheerful. Last year Sony's desktop and laptop VAIO multimedia computers gained global market share faster than any other major PC brand. Its Playstation 2 game console widened a commanding lead over Microsoft's Xbox and Nintendo's Game Cube--Playstation accounted for more than half of Sony's $1 billion in profit in fiscal 2001, which ended March 31. Thanks to Spider-Man, the Vin Diesel action film XXX, and Men in Black II, Sony's movie business has raked in more money so far this year than any other studio.

And after a dismal 2001 in which revenues grew 3% while profits fell 40%, profits are growing again. Driving the rebound: cost cutting and brisk growth in products like digital cameras and camcorders, big-screen TVs, computers, and components, which more than offset losses in music and mobile phones. Sony is aiming for higher profits on flat sales for the fiscal year. But that all depends on the critical holiday quarter. Already threatened by the weak economy and a West Coast dock strike, holiday sales are so uncertain that Sony recently had to lower its financial targets for the rest of the year. "For the first six months of our year we had done so well," Ando says, "but we are not so sure about the second half."

At presstime Sony's stock price was hovering in the mid-40s, well below its bubble high of $157--but whose stock isn't? Compared with many of its rivals', Sony's shares have held up pretty well--rising nearly 16% in the past year, vs. a 16% decline for the S&P 500.

No matter how Christmas turns out, Sony's fate is riding on consumer acceptance of those network-enabled electronics products, which are just beginning to show up in Japan. Eventually they'll roll out in the U.S., and Europe, and China, which Sony expects will surpass Japan as a consumer market well before the end of the decade. Anticipating the day when these broadband-connected devices are in the hands of millions of consumers, Sony already has a portfolio of 1,000 digitized films, 33,000 hours of TV programming, and more than 500,000 songs ready to pump out to them.

A nifty example of the new design philosophy is Sony's Bluetooth Handicam camcorder. Working wirelessly with a Sony-Ericsson Bluetooth phone, the camcorder lets the user send videoclips and still images to friends immediately via e-mail without passing through a PC. It also sends images wirelessly to a Sony photo printer or to an Airboard. The camcorder can even browse the web and receive short e-mail messages, on its built-in LCD screen.

Sony recently added miniature digital cameras to its Clie PDA and its VAIO palmtop computers. When equipped with wireless adapters that eventually will become standard, such video-enabled devices will allow someone attending a wedding, say, to send live eyewitness-news-style video of the ceremony to friends watching on their computer screens, TV monitors, Airboards, or mobile handsets. Get the picture?

Nowhere is the marriage of electronic hardware and broadband connectivity more apparent and yet so challenging for Sony to explain than in a new product line called Cocoon. Cocoon is a "smart" gateway to the Internet, one that Sony hopes will change the way people consume video, music, and other products and services that the company is developing for broadband distribution. Sony describes it as "the future of television"--indeed, if Cocoon catches on, it could eventually become as integral a part of the TV as the tuner is today.

The first Cocoon product, a "channel server" that went on sale this month in Japan for $1,100, is on one level a personal video recorder (PVR), sort of like a TiVo or ReplayTV box. It comes with two tuners and a 160-gigabyte hard drive capable of storing 15 hours of high-definition video (HDTV) or 100 hours of regular TV. There's room for a second 160GB drive, doubling the recording capacity. Like other real-time, hard-drive recorders, it lets viewers pause live programming, rewind, skip commercials, and perform other video tricks.

Cocoon has a flamboyant side as well. It is built to communicate over a home network with a VAIO or other brand of PC, and through an always-on broadband connection to the Internet. Hook up the machine that way, and you can program a recording session remotely from an office PC or from a web-browsing mobile phone. Cocoon also "learns" what sorts of shows the owner likes to watch, based on an onscreen questionnaire and an analysis of what the user records onto the hard disk. It then autonomously scans the network and records similar shows--creating, in effect, a personal TV channel. Because of its network connection, the Cocoon can be upgraded to offer new products and services as they emerge. One can imagine future Sony stereo systems in the Cocoon series that will scan Internet-based music services for new tunes according to user preferences; Sony Music might even send such machines samples from its artists to entice online music sales.

Cocoon-enabled TVs are one of four categories of "gateway" products upon which Sony is basing its strategy. (The others are the VAIO computer, the PlayStation 2 game console, and mobile devices.) Notably, while Cocoon does hook users to the Internet, it's not a PC--it doesn't use Intel microprocessors or a Microsoft operating system. Instead, it's based on a MIPS RISC chip and the Linux open-source operating system. While Intel and Microsoft have a vested interest in making the PC the main hub between the home and the Internet, Sony sees non-PC devices like Cocoon as the key to greatly expanding the Internet's consumer appeal. Because they avoid Intel and Microsoft licensing fees, non-PC network devices can, in theory, be made and sold more cheaply.

The idea of gadgets that tailor themselves to their owner is fundamental to Sony's strategy, and has shaped the company's plans for future PCs. At the Dream World show in Yokohama in September, Ando revealed a puck-sized prototype of a next-generation VAIO computer. Little more than a conceptual model at this point, the hexagonal prototype is intended primarily as a sensing tool. Like the Cocoon video recorder, it memorizes the user's preferences and personal information, and acts as a wireless interface between the user and any intelligent device--including, perhaps, robots. "The next-generation VAIO has little eyes--little cameras--and all these sensing devices," Ando says. "It will learn from your experience and become your personal agent. I'm always saying, Put this into AIBO [Sony's robot dog] and it becomes another you. Of course, the other you will look like a dog. But we're working on two-legged robots." At a cocktail party, a more discreet version of the future VAIO could "see" an approaching person's face, wirelessly scour a database, and match the face to a name fast enough to help its owner avoid embarrassment.

Toshitada Doi, president of Sony's Digital Creatures Laboratory, is in fact working on two-legged robots, and he thinks that in the next generation (of humans, that is, not gadgets) robots will eclipse PCs in product growth worldwide. "PCs will continue to grow, but robots will grow faster," he says. "When this will happen, I don't know--maybe 30 years. But maybe ten years to 15 years."

Doi oversaw the development of AIBO, the robo-dog that has won a cult following in Japan since its introduction in 1999, despite prices ranging from $600 to $2,500 and more. Tens of thousands of these petlike automatons have been sold. AIBOs, waving their paws, now greet visitors to many of the offices in Sony's headquarters buildings. The most advanced AIBO robots can recognize spoken commands and can pick out their owners' faces in a crowd. Forget fetching the newspaper: In the networked world, AIBO can fetch and recite its master's e-mail.

Doi, however, dismisses such parlor tricks as irrelevant. He developed AIBO, he says, purely as an entertainment. His next robot, code-named the SDR-4X, is also an entertainer but has the skills to act more as a companion than as a pet.

The SDR-4X Small Biped Entertainment Robot is expected to reach the market in a year or two. It can best be described as the physical embodiment of Astro-Boy, a popular cartoon character of postwar Japan that combined a young boy's brain in the body of a humanoid robot. In demonstrations, the two-foot-tall SDR-4X walks on two legs to a microphone, gestures gracefully, and begins speaking and singing in a sweet, high-pitched voice. It has two "eyes," which give it depth perception and the ability to calculate distances, and it can get back on its feet if it falls. It doesn't take much imagination to envision the day when Son of Astro-Boy, connected to a home network, reminds elderly owners that it's time to take their medication, "sings" music as it streams from a home gateway, and acts as a roving security guard whose eyes broadcast video over a remote network connection.

Ando vows that despite emphasis on network-based content and services, Sony will not lose its focus on hardware. In its R&D labs are such future wonders as a TV display not much thicker than a few sheets of paper, "grating light valve" high-definition video projectors that turn entire walls into film screens, and "digital chopsticks"--a digital pointer that allows a user to pluck a file or image directly from a computer or wallboard display and deposit it on another screen, say, on the TV at home, just as one would use chopsticks to move a morsel of food from one plate to another. And, of course, there's Ando's favorite Dick Tracy wristwatch. "We can't use the name 'Dick Tracy' in public," Ando whispers. "It's copyrighted."

Ando argues that Sony is better positioned than any other company, including HP, Microsoft, and Philips, to make the transition to the broadband world. It has seasoned executives--like Mitsuru Inaba, senior general manager of Sony's Creative Center--who know how to design consumer products that are both sexy and functional. It has a proven global distribution system and is in constant contact with consumers. It has a deep understanding of networking technology, led by co-chief technology officer Mario Tokoro, a computer scientist who once taught at Carnegie-Mellon. Kenji Kimura, president of Sony's Mobile Network Company, has a string of hits including the Clie handheld device, VAIO notebook computers, and Sony-Ericsson mobile phones. Finally, it has found synergy between the hardware and content sides of the business, an area in which other "convergence" conglomerates are struggling. When Sony's game developers cook up a new product, it's tailored not just for the Playstation 2 but also for Sony Clies and Sony-Ericsson phones. The venerable Walkman was retooled to integrate with VAIO PCs and Sony Music's Pressplay joint-venture online music service.

What's missing in the broadband network strategy is the network, at least in the United States. There's a reason Cocoon and other broadband products are released first in Japan: More than half of all households there are expected to have broadband Internet access by the end of 2005, compared with only about 30% in the U.S. "This is the first time in Sony's history that they are producing products that are ahead of the infrastructure's ability to use them," says Richard Doherty, research director for the Envisioneering Group, a technology assessment and market research firm in Seaford, N.Y. "When they came out with the first transistor radios and Trinitron TVs, the broadcasters were already there. When they came out with the Walkman, everyone was already using cassettes. There's a huge question mark about broadband networks."

Indeed, the rollout of broadband service in the U.S. has been stymied by ineptitude on the parts of cable and telephone companies, high infrastructure costs, lack of availability in some areas, and perhaps most of all by the high cost of monthly service to consumers. Prices for broadband access in the U.S. average around $50 a month, vs. as little as $20 per month in Japan. Especially in this economy, price matters.

Given Sony's goal of driving a big chunk of its future growth through the digital distribution of its music, video, games, and other services, "they can't do much without broadband," says Mike Paxton, senior analyst at the research firm Instat/MDR in Scottsdale. And yet the majority of Americans still get their Internet access through slower dial-up phone lines that are inhospitable to video and music. Paxton says that while broadband penetration in the U.S. certainly lags behind Japan, Korea, and other countries, its growth in the past few years has nonetheless been impressive. "If you look at where we were at the end of 1999, with about 2.5 million households, we've had pretty impressive growth, to about 19.5 million households by the end of this year," he says. "By the end of 2006, we expect that number to be 38 million."

"There's no question that broadband will eventually become mainstream in the United States," says Tim Bajarin, president of Creative Strategies International in San Jose. But even if acceptance takes longer than expected, Bajarin says, Sony can't afford to wait. "Even though it's a chicken-and-egg situation, you have to have the vision and drive toward it. A small or even medium-sized company can't afford to make that bet. Sony has some insulation from risk. The company has revenues from so many other spaces and products that it can fill in the profit gaps even in the short term."

That assumes, of course, that Sony can come up with broadband-ready products that consumers find compelling. As the Airboard is proving, it's not a given. Sony's first attempt at an Internet appliance, the stylish but buggy eVilla, failed when it hit the market in 2001. Its network-connected Walkman, a big hit in Japan, hasn't taken off in the U.S. And in an ominous sign that consumers may not be all that interested in watching music videos on their mobile devices, sales of the new third-generation (3G) phones in Japan have been disappointing.

What's more, selling the vision at retail stores may prove even more difficult than devising hit products. In most electronics stores, camcorders are in one section, PCs are in another, and TVs are against the back wall. Digital cameras and mobile devices are in the front, DVD players and video recorders on the side--it's an impossible environment in which to educate consumers on the benefits of networked devices like Cocoon or Airboard. Sony has begun offering consumer seminars in Japan, but to succeed in the U.S. and Europe it either has to persuade retailers like Best Buy and Circuit City to reconfigure their stores--which is highly unlikely--or develop a new retail selling environment, perhaps along the lines of the showcase stores run by Apple or Gateway.

Ando acknowledges the risks but says, "If Sony is going to be different from all the others, it has to really step ahead. It's the difference between originality and a copy machine. We are not like a Dell. We are trying always to come up with something new, to create innovative products." He pauses. "That's basically Sony's DNA," he says. "The path is not always smooth. But if you lose your mission, your DNA, you lose your reason for being. Sony's reason for being has always been to create something new, to create more dreams, to make things fun." Sony built its reputation by inventing great products. If it can reinvent itself as a global media and technology power, that will be its greatest creation yet.

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