Telcos are getting into the video game just as consumer expectations of video content and delivery are changing radically from the way we have known them for the last half century or so. TiVo, YouTube and iTunes have spoiled consumers, who increasingly expect to be able to watch whatever video content they wish whenever they want. Even Amazon.com announced a new movie download service this month.

These trends are shaping the trajectory of video-on-demand (VOD) services in particular, which telcos will have to learn how to master in the footsteps of their cable competitors. And although VOD is a much younger service than television, VOD is changing rapidly, too.

Although about 63 million U.S. households partake in VOD services today, a third of all the TV-watching households worldwide will use VOD by the end of this decade, according to Informa Media and Telecoms. Of the $211 million in revenue generated by IPTV services last year, $11 million — or about 5% — came from VOD, according to Informa. It will be about the same fraction in 2011, when VOD revenue will reach $132 million in an IPTV services market of $2.2 billion.

Although the VOD market won't change much in the next five years, according to Informa, “the new decade will see an explosion in ‘true’ VOD, where TV viewers can choose exactly what they want to watch at a time that suits them.”

If that sounds a lot like personal video recording (or PVR, the practice of time-shifted TV viewing made popular by TiVo), it should. VOD services and PVR services are growing increasingly similar, differentiated in some cases by subtle nuances in consumer preference.

For example, Comcast has added CBS's primetime programming to its VOD library, allowing people to order and watch individual episodes of “Survivor,” “CSI” and other shows. At first, Comcast offered each episode for 99¢, but it's now moving the CBS shows to a free, ad-based model. So Comcast customers who like “Survivor,” for example, now have their choice of either watching the show live, watching it through the PVR service or watching it on-demand. If they don't like watching ads, they can buy a PVR. If they don't want to spend money on a PVR, they can order it on-demand. Or if they just can't wait a single second to see the show, they can watch it the old-fashioned way, live.

Video providers must develop a mix of business models to accommodate a range of user preferences. “The potential is there to literally make anything available as an on-demand product,” said Gerry Kaufhold, In-Stat analyst. “The problem is the business model. If everything's on-demand, the advertising model gets a lot more complicated.”

At the same time, asking consumers to add another fee to their monthly cable, premium TV, DVD rental and theater movie budget may not be easy, which is perhaps why 95% of Comcast's VOD content is free of charge. “People in this market think that's the best way to go,” Kaufhold said.

As consumers increasingly expect every movie they can think of at their fingertips, the home-based storage of a PVR may start to seem too small. “When you expect a universe of content to be served to you, you'll definitely have a VOD server satisfying a particular community,” said Venkat Krishnan, director of IPTV platforms for VOD equipment firm SeaChange.

Akimbo Systems, in which AT&T recently invested after using the vendor for its HomeZone satellite TV bundle, has amassed the rights to a VOD library of 12,000 programs.

Comcast's VOD system currently supports “7% concurrency,” according to the Diffusion Group, which means only 7% of households that have access to Comcast's VOD service can use it simultaneously.

With the spread of PVRs, consumers are becoming increasingly accustomed to watching programs on their own schedule, which will lead to spikes in simultaneous on-demand viewing that exceed the capacity of today's VOD systems.

“VOD systems will have to work much harder than they did before,” said Colin Dixon, manager of Diffusion's IP media practice. “Seven percent concurrency just doesn't cut it anymore. In fact, there's a general acceptance in the industry that we're heading toward 100% concurrency, or one stream per household. In the U.S. alone, that's 80 million streams.”

As the VOD market expands to include telco carriers, the equipment vendors have snatched up the newest generation of VOD suppliers in an effort to reap the upside. This summer, Motorola acquired Broadbus, Cisco Systems acquired Arroyo Video Solutions and Harmonic acquired Entone's video software business.

The good news for telcos in this wave of consolidation is they're getting the second generation of VOD gear at the same time as their cable competitors. Whereas the first generation of VOD gear allowed users to pause, play, rewind and fast forward, the next generation will allow much more interactivity, perhaps adding relevant windows of text, data or images. Toward the end of next year, two new disruptive entrants — Microsoft's Vista operating system and Intel's Viiv technology — will accelerate the move to that next incarnation of TV.

“People will be able to manage their fantasy football picks while they're watching the game,” In-Stat's Kaufhold said.

The bad news for telcos is that they're deploying essentially the same technology as their cable competitors, giving them little room to leverage technology as a competitive advantage.

Competition between cable companies and telcos in the VOD space won't really heat up until next year, Kaufhold said, when both camps' network technology will be on roughly even playing fields. “Any technological advantage telco TV services have will be minor,” he said. “DOCSIS 3.0 positions the cable guys in 2007 to be able to do just about anything the telcos can do. It's all going to be about what services they can deliver and how they can package and market them to make them look sexy.”

Time Warner Cable has a unique on-demand offering (essentially a PVR offering streamed from a VOD server) called Start Over, which allows viewers who tune in to a live program halfway through to rewind and watch it from the beginning — for free. Some content providers aren't crazy about the idea and have taken Time Warner Cable to court over it. But in China, where digital rights management law is very different, one IPTV provider is using UTStarcom equipment to allow viewers to rewind through as much as a week's worth of programming, according to Diffusion.

One differentiator telcos might take advantage of is mobile services, perhaps letting consumers order on-demand content on their mobile phones, for example. But that wouldn't come for some time, and when it does, it might be too late; joint ventures between Nextel and cable operators might give the cable crowd access to mobile offerings as early as this year.

“While adjusting price points can attract subscribers to a voice or broadband offering, the same cannot be said for VOD and pay-TV in general,” said Adam Thomas, Informa media research manager. “Customers don't pay to simply receive a particular technology; they expect to receive the best content. So unless the telcos can license compelling premium content, even the most attractive triple- or quadruple-play offering will have only limited appeal.”

“Telcos have to up the ante by doing something even more interesting,” Kaufhold said. “The cable guys are already looking over their shoulders, working on ways to differentiate their VOD.”

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