What the hell is going on with TV?

January 3, 2011: 5:00 AM ET

Google TV. Xbox. Apple TV. Roku. All these gadgets promise to make television more like the web. There's just one hitch: None of them are ready for primetime.

By Jessi Hempel, senior writer

Image of TVs, tablets and devices all wired together haphazardly and showing Dwight from the Office

You don't have to wait for Thursday nights to watch The Office these days. Thanks to the Net, the show's available nearly anywhere at any time -- but you have to know how to find it. That's not always easy.

I had great expectations for Google TV. When the brick-size plastic box that powered it arrived at my home, I was able to hook it up in less than 10 minutes -- I didn't even need directions. I scrolled through specially built apps for YouTube and CNBC, pulled up the Chrome web browser to check my e-mail, and logged on to Twitter (@jessiwrites: tweeting from my TV). Then, the novelty of the Net having worn off, I decided to check out the ABC sitcom Modern Family.

It was no easy feat. I scrolled through my cable guide, but couldn't watch old episodes. I toggled back to the apps, but ABC didn't have one. I found my show on Amazon (AMZN), but I'd have to pay $1.99 an episode on top of the $99 per month I'm paying for cable. I pulled up the browser again to search for Hulu, but the site was blocked. And so I spent my first night with Google (GOOG) TV cross-legged on my couch watching Modern Family ... on my laptop.

After more than a decade of false starts, web TV is here -- sort of. I'm talking about more than just streaming a sitcom on my laptop. We know the web has the power to make any media distribution system cheaper and more efficient. This is different. Thanks to streaming video services like Hulu and Netflix (NFLX) and new portable devices such as the iPad, we've begun to expect that TV should be more like the web itself: social, mobile, searchable, and instantly available. When we can't figure out what to watch, web-based recommendation software ("If you liked Inception, you'll love Heroes!") might do a better job of finding us programs we like than the professionals who program ABC -- or we might just want to check an onscreen guide of our friends' status updates to see which shows they've enjoyed recently. And once we've reached a decision, we want to click and watch on any screen that happens to be nearby.

But for the moment, all that promise translates into a proliferation of new boxes and services that are impossible to compare. Do I want an Internet-connected TV from Samsung or Sony (SNE), or should I just buy a separate box that hooks up to the Net, like that brick-size Logitech (LOGI) gadget that enables Google TV? What about the supercheap Roku box? Should I bother paying for Hulu's new premium service or just get a Netflix subscription?

Those companies -- and many more -- are making a bet that the largest screen in our homes is going to become an operating system like the ones that power our computers and phones -- a platform I can use to open up apps or surf the web. The potential payoffs for tech companies are huge: Google could serve up advertising next to search results on our TV, grabbing a chunk of the $56 billion a year spent on television ads (See The $56 billion Ad question). Apple's (AAPL) iTunes could become the online merchant for all video content. Device makers can sell us even more gear. Cable operators and studios stand to gain viewers and ad dollars by making their shows available -- with commercials -- anytime, anywhere. And for time-starved folks like me, it's TV nirvana.

But Netflix, Google, and Apple can't just swoop in and disrupt the $85 billion home entertainment industry. The challenge lies in navigating the entrenched interests that make up the television business. Here's how it works now: Production companies such as Warner Brothers, a unit -- like Fortune --of Time Warner (TWX), make TV shows and sell them to networks like ABC, NBC, and CBS and to cable channels such as HBO (another Time Warner unit) and Viacom's (VIA) MTV and Nickelodeon. Networks sell pricey advertising spots within the shows and find viewers for them. Until recently, the primary outlet was pay-TV providers like Comcast (CMCSA), Verizon (VZ), and the Dish Network (DISH), which paid the networks fees of anywhere from $.04 to $4 per subscriber to license channels. The studios and networks also got additional licensing fees from repackaging those shows for pay-per-view and full season DVDs. It was -- and still is -- a clubby world of media conglomerates.

The web is breaking this model. Ad rates are much lower on the Internet. Networks can't collect their fees. Cable companies fear losing our business. Someone has to pay for all that bandwidth we're using to stream our shows. And Silicon Valley is littered with the carcasses of tech startups (the original Joost and WebTV) that believed entrepreneurial thinking and engineering smarts alone could change television.

The result is a web TV experience that feels a bit like the Internet circa 1998, before publishing companies embraced the Net and Google arrived to help us find and instantly consume the stuff we're looking for. What changed back then? Software, from search engines to specialized applications, helped make information more accessible -- and it will do the same for entertainment. (And, indeed, practically every company in the television business -- from distributors such as Comcast to aggregators like Netflix to computing companies, including Apple and Google -- is pushing software as a solution to the web TV mess.) Who will win and who will lose? As is usually the case in technology, the prize rarely goes to the pioneer.

The rise (and coming fall?) of Hulu

My 22-year old cousin Drew has a word for TV: "Hulu." When he picked up my call on the fourth ring the other day, he said, "Sorry, I was watching Hulu and didn't hear the phone." Since its 2007 launch, Hulu has grown to become the second-largest video site on the web after YouTube by making many of the shows we love available free. In November, it streamed 1.9 billion videos, more than double the year before. You'd think it has web TV locked up. But you'd be wrong. In fact, its days may be numbered.

Founder Jason Kilar deserves credit for teaching us how to watch TV online. Before Hulu, web TV was grainy video we caught mostly illegally on YouTube or a platform for peer-to-peer sharing like BitTorrent. With backers that included News Corp. (NWS), GE's (GE) NBC Universal, and later Disney's ABC, Kilar drew upon his background as an Amazon executive to create an elegant video player with advertisement spots that users couldn't skip.

TV showing Glee

The life span of a TV show: Television programs such as the Fox hit Glee get a second (and third) life on the web after they are broadcast.

Hulu soon became a victim of its own success. Viewers flocked to the site to watch popular shows the day after they aired (the networks signed deals permitting Hulu to run the shows 24 hours later), and the cable and satellite operators immediately took notice. Comcast, Time Warner Cable (TWC), and others don't want to lose any viewers to Hulu, and they are using negotiations over the so-called carriage fees they pay media companies to pressure the company. Viacom's Comedy Central pulled The Daily Show off Hulu entirely, and other networks have significantly reduced how much content we find there.

Chart showing how the various TV services stack upNow Hulu must figure out how to make more money for its content partners quickly before it loses any more shows. This fall Kilar launched Hulu Plus. For $7.99 monthly, I can watch Hulu on many devices, and often I get access to a larger content library. Kilar says the subscriptions have "exceeded expectations" but won't divulge exact figures. I'm not impressed, though: I still have to sit through an increasing number of commercials -- 10 of 'em during a recent 44-minute episode of Desperate Housewives. Oh, and now that I'm paying for Hulu, suddenly 24 hours after broadcast seems a long time to wait for my Felicity Huffman fix. I'm paying more and getting less.

Is cable an endangered species?

If anyone should be able to figure out web TV, it's Comcast. Don't scoff. Cable operators popularized broadband and still control 56% of the nation's residential high-speed lines. (Phone companies have the rest.) And as the biggest cable operator in the world and the putative controlling stakeholder of NBC Universal, Comcast has tremendous clout with the networks that package television programming. Along with the satellite and telephone companies, cable operators will pay them $35 billion this year. Those are such large checks that the networks wouldn't dare play chicken with them over comparatively puny digital dollars.

Techies will tell you that a growing number of "cord cutters" are quitting cable because they can get the shows they want by cobbling together web services, including Hulu. But data suggest cord cutters are in the minority. Comcast lost 275,000 subscribers last quarter, but part of the reason is that there's more competition from satellite and telephone companies. Verizon's FiOS TV added 204,000 subscribers. The weak economy and high unemployment caused some to cancel their service.

An ESPN analysis of Nielsen data released last fall suggests that just 0.1% of viewers had deserted cable for the web. "People like knowing they can turn on the TV, no hassle, and get access to hundreds of choices," says Comcast executive Matt Strauss.

That's true for now, but even consumers who would never consider abandoning cable are starting to change their viewing habits. I've been known to balance my laptop on the microwave to watch Rachael Ray while I'm trying to make her paprika parsley potatoes. Recently, many cable lovers have commandeered their Xbox videogame console to stream shows and movies. In October, Microsoft (MSFT) announced that 42% of the premium Xbox Gold users who rely on it to view video are watching more than an hour a day, or 30 hours in a month. "If you're a cable provider, that should be terrifying," says Forrester analyst James McQuivey. If viewers stop caring whether they're watching TV via a cable set-top box or a gaming console, they'll eventually migrate to the cheapest, easiest option.

Comcast is preparing for this reality by experimenting with Xfinity TV, a software-based service that offers a backlog of episodes of all your favorite shows, often with fewer commercials. It's part of TV Everywhere, a strategy created by Comcast CEO Brian Roberts and Time Warner CEO Jeff Bewkes that lets viewers watch shows anywhere for free -- with a pay-TV subscription. Other pay-TV purveyors such as Time Warner Cable and Verizon are working on similar services for their subscribers, but since none of those companies -- not even Comcast with its 65% share of the 100 million U.S. cable subscribers -- has market dominance, none can muster the scale necessary to drive down technology costs. More important, the companies with which they compete -- Google and Netflix -- get to ride on their broadband systems without any of the massive infrastructure costs. Comcast spent $120 million in 2009 to operate and maintain a high-speed Internet network over which a growing number of people stream their Netflix.

Netflix: The streaming republic

Ah, Netflix. The company has quickly become the scourge of cable operators like Comcast and content companies such as Time Warner. Netflix's Reed Hastings has done for movie rentals what Steve Jobs did for music when he created iTunes: He has hit upon a business model for delivering movies over the web that pleases most of the people who make movies and those of us who love them. (For more on Hastings, see "Leader of the Pack" on Fortune.com.) Today two-thirds of Netflix's 16 million subscribers watched at least some film on the web last quarter. As a result, Netflix is vying with Hulu for most heavily trafficked video site after YouTube and has started offering streaming-only subscriptions to its service. Time Warner's Bewkes recently dismissed the service, telling a New York Times reporter, "It's a little bit like, is the Albanian army going to take over the world? I don't think so."

Hastings has made a bet that every screen -- TV, iPad, phone -- will be a window to a software platform, a strategy that has operators of hugely profitable cable channels, folks like Bewkes, up in arms. Right now viewers can stream the service on more than 250 devices, including boxes we may already have in our living room, like that old TiVo or your daughter's Xbox, and boxes that are making their debut. Like many software developers, he's indifferent about who powers the platform as long as he can make Netflix available on it. Most of today's TVs don't have the computing power to enable this. That's why we need all the extra hardware. But that's a temporary problem. Over time most of those boxes will go away as the technology is manufactured into new TVs.

Graphic: how to watch the Web on your TV

As with smartphones, there's a race on among tech companies to own that platform. Electronics maker Samsung is trying to get ahead of the Internet behemoths with Net-connected TVs that support apps. Microsoft is trying to turn its Xbox gaming console into a TV service. Apple is following the Jobs playbook by trying to launch a closed system in which, just as with music, we buy all our shows directly from Apple. Google TV is the most forward concept to date: It offers a full web browser and attempts (but mostly fails) to create a seamless experience for the viewer switching between cable and streaming video.

But for any of those platforms to take off, they'll need the networks to participate, and that's proving difficult. ABC, NBC, and their ilk are hamstrung by pay-TV companies, and they're fearful that by putting web TV on real TVs, they'll have to settle for paltry web ad dollars instead of TV's mega ad dollars. Jobs tried to hammer out a $30-a-month iTunes TV service but couldn't work out a rights deal with the networks and gave up. And shortly after Google TV was launched, those same networks blocked it.

So far, Netflix has been an exception because Hastings went after the less threatening video-rental market -- stuff we've seen already. Hungry for new distribution outlets, the movie studios were happy to work with him, and lately some television outlets have joined forces with Netflix. The company recently announced a deal with ABC and parent company Disney (DIS) to stream TV shows, including some within 15 days after their original airdates. NBC also licenses past seasons of some of its hits to Netflix for streaming.

But to many in the media business, Netflix is no longer a benign DVD-by-mail company: Content creators are starting to demand higher fees from Netflix for streaming their programs, and cable companies are none too pleased with Netflix users' bandwidth consumption. A recent FCC ruling that is likely to be challenged says carriers can charge more for higher-quality streaming (but can't restrict subscribers' use of sites). And anxious to take a little of the Netflix pixie dust for itself, Wal-Mart (WMT) bought and has begun to ramp up Vudu.com, a competing service. Hastings, who recently began selling a $7.99-a-month streaming-only subscription, will have to innovate fast -- without losing any of his customers' favorite shows -- to stay ahead.

What will the future of TV look like?

Software platforms are only as good as the developers who populate them. What's an iPhone without its apps? Beyond Netflix, there will be hundreds of applications for the TVs of tomorrow. One of the most thoughtful app makers is Clicker.com founder Jim Lanzone. (He used to run search engine Ask.com.) I went to visit Lanzone at his San Francisco office. We plopped down on a low, green sofa around Clicker's version of a conference table -- a 55-inch screen. Boxes cluttered the pedestal on which it balanced as well as the floor beneath it. Lanzone picked one up -- the cube-like Apple TV box -- held it aloft with the cord dangling, and dropped it again. "All these boxes are like AOL circa 1995," he said. The TV in front of us was connected to the web by a simple HDMI cord plugged into a laptop PC.

Lanzone is tackling one of web TV's biggest problems: how to find stuff. Think of Clicker.com as an online TV guide. It crawls the web in search of any show slightly more upscale than a home video -- everything from AMC drama Mad Men to a lecture on Isaac Newton from the University of California at Berkeley -- and catalogues it in a way that makes it easy for you to discover, search, and retrieve it. Clicker is platform-indifferent -- you can find it on your laptop or your phone or among the spotlighted apps on Google TV. Search for Modern Family, and Clicker will show you every viewing option -- both free and paid -- including Netflix, iTunes, Amazon Video on Demand, Hulu Plus, ABC.com, and Xfinity TV. He's also making a bet on the way we'll discover new shows in the future. He knows the choices our friends make will be just as important as the traditional guides we've always relied on. That's why Clicker has been early to embrace full Facebook integration, inviting users to publish what they're watching to their newsfeeds and keep up on friends' viewing habits.

But Clicker's advantage -- it's a nimble startup with few capital costs -- also is a disadvantage in home entertainment. Let's face it, the barriers to entry are low, and Clicker doesn't have the relationships with studios or distributors that Netflix has (though admittedly those bonds are a bit strained right now). Comcast, meanwhile, is trying to make its onscreen guide more searchable. If it is good enough, subscribers will probably default to the cable operators' service. Google TV may be suboptimal today, but it seems the company whose name is synonymous with search would eventually be able to catalogue all online television options.

All that competition might not be great for Lanzone, but it's wonderful for you and me. It means that while web TV may be a long way off, it is coming. Things will get better. Sometime in the future I'll turn on my TV from the living room -- or the kitchen or even the back row of an airplane -- search for Modern Family, and simply hit play.

Reporter associate Tara Moore contributed to this article.

More from Fortune.com:

The $56 billion Ad question

Reed Hastings: Leader of the pack

Stream this! How Netflix chooses you

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