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Editor’s note: This story is part of our Microsoft-sponsored series on cutting-edge innovation. Peter Yared is founder and CEO of social app development company Transpond.

[Disclosure: my company, Transpond, provides social engagement apps for numerous media companies including CBS and NBC.]

Hulu — a joint venture of NBC Universal, News Corp., and Disney — has had a good thing going. The ad-sponsored video site carries numerous TV shows through agreements with the broadcast networks. And for the past year, it’s made good money selling ad space on network shows and luring in viewers with its quality streaming. But that’s all about to change.

The Hulu value proposition as a destination for premium online video was always doubtful given that Hulu is owned by content companies that stream the same content from their own websites. Sure, there was a window of time there when it was very difficult to stream good quality video with a modern player, but that window is long gone. The networks now all offer excellent streaming high-definition 1080p players (although some properties such as could definitely benefit from a phone call to Brightcove or Ooyala for a player and streaming upgrade). On top of that, with Comcast’s acquisition of NBC, the content itself is now owned by the folks delivering the pipe.

CBS never allowed Hulu to syndicate its content, in a very prescient decision on its way to becoming a top 5 video destination. Viacom recently pulled its popular “Daily Show” and “Colbert Report” shows off of Hulu, really letting the air out of the balloon.

Hulu sells ads on the video it streams, meaning that Hulu’s ad sales team competes with the networks’ own ad sales teams. Hulu’s sales pitch to the networks was, “let us compete with you on your new content and we will help you monetize your older assets”. But Hulu hasn’t been able to monetize the older TV shows it runs. Pull up any TV show over two years old on Hulu, and all of the ads are public service announcements. (Although Google, ever the expert on remnant ad inventory, bought up all of this inventory for a pittance over the Christmas holiday season to play precursors to its Super Bowl ad.) So the Hulu trade off is not working. Yes, it’s profitable, and yes, the number of streams served is growing, but the number of unique users has been flat for almost a year.

If Hulu is not going to be the solution for premium content owners, what is?

The TV networks always complain when they are not in control of when and how a viewer watches their content. They complained about VCRs, and then DVRs, both times because users could skip the commercials. It took a long time for DVRs to finally make the networks money. Nielsen had to start tracking who was watching time delayed commercials, and advertisers had to agree to include these views if they occurred within three days. Video streaming, on the other hand, forces users to sit through commercials. The trouble is, there was no system in place to track the number of views, making it hard for network TV’s ad sales teams to pitch the inventory to advertisers.

The good news is, in January of this year, Nielsen announced that it would start combining TV and online viewing of shows into a single rating. With Nielsen’s move, the networks have an independent auditor that can verify that viewers are watching a particular show. This presents an opportunity to integrate Internet distribution into their existing business model, which they have not been able to do even with on demand video on cable. So from here, we’re going to see some real evolution taking place in TV. It’ll no longer be something simply ported into the online world. Instead, we’ll see the networks fully move online and develop new business models for broadcasting to an internet-based audience.

Following is a prediction of five steps we’ll see these networks take in the coming months:

(1) Allow content to be streamed online at the same time as or within an hour of when it is broadcast over the air. For three days these streams are counted by Nielsen just as if a viewer watched the show live or on a DVR.

(2) If the video is played in fullscreen mode, show all the same commercials as in the broadcast version, just like a DVR, but also force the viewer to watch the commercials. If the video is played within a browser window, use shorter, online-style, 15 second commercials, and place sponsored engagement features such as quizzes and polls below the video player.

(3) After three days, replace the commercials with different commercials that are sold outside of the upfronts. This presents an opportunity to sell popular “season catchup” packages and other such products, so the online ad sales teams continue to have a unique product to sell.

(4) Allow the network’s streaming players to be embedded on any site, so that a thousand Hulus like Boxee, Windows Media Center, AppleTV and can blossom and help increase ad views for a small cut of the revenue. Since the network’s commercials are now being propagated, companies like Boxee can be harnessed as part of the syndication solution.

(5) And the thorniest issue: affiliate stations. It used to be that if you wanted to watch CSI in San Francisco, you could only see it on KPIX, CBS’ local affiliate. Now you can wait a few days and see CSI online from The local affiliates will need to be cut in on the Internet action, and they will also need to adapt to changing times. With cable, satellite, and now Internet streaming, there is no real compelling reason to have the same content broadcast over the air. In fact, it is a disincentive — Disney makes far more money per subscriber from cable systems on ESPN than on ABC, since they are simultaneously broadcasting the ABC content for free. Network affiliates are now differentiated by local ad sales and local programming, not last-mile content distribution. Although it will require some infrastructural changes for both the networks and the affiliates, the networks can extend their ad platform so affiliates can place ads for viewers within their geographic areas that stream shows. In addition, broadcast affiliates should be able to stream the shows from their own websites with additional, local engagement features surrounding the show.

This model I’ve outlined above will enable the networks to sell ads over the air, on cable, via DVR and online at the same time and have them all measured by Nielsen in a single rating number. Affiliates are included in the model since they can also distribute their ads to their local markets. Online ad sales teams can sell additional ads after the initial viewership period. And all the content is embeddable and monetizable across the web. The unique aspect of web content is that it is easy to create engagement — and particularly social engagement — around that content, which accelerates content uptake.

–Ben Elowitz, CEO Wetpaint

Hulu succeeds because they absolutely nail their relationship with a constituent even more important than their network partners: the consumer. The Hulu experience commands (according to 8 times the total attention NBC receives, double the average stay of Fox, and 3 times the visit frequency of ABC. The networks would be foolish to take their traffic and go home, as they would round to zero once those fractions are blended in with their massive broadcast businesses.

It is inevitable that in the digital future, consumers will watch what they want, when and where they want it. As advertisers reach their targets ever more precisely and cheaply, premium content will increasingly need to be paid for directly by consumers. The networks that survive that transition will be the ones who get their content distributed broadly. Those content owners may lose short-term dollars by allowing distributors like Hulu to show content with limited advertisements and to take a cut of the profits. But they will make up for it with long-term billions by building outstanding brands that consumers will pay for.

–Mike Ramsay, venture partner at NEA and co-founder of TiVo.

I see a lot of companies that are trying to aggregate video so you can see it anywhere — on your PC, your TV, your mobile phone. No one has quite cracked the code yet. Two other factors will affect the outcome. The first is distribution deals. Life is more complicated than you might think in this industry, as I learned at TiVo (though I’m speaking here as an observer, not on behalf of TiVo). Take, for example, the TV Everywhere initiative put forward by Time Warner and Comcast, where they will make video available via their broadband connection to your PC as long as you subscribe to their cable network. That’s great, because you get all this video if you subscribe. But on the flip side, it leaves players who are not part of that out in the cold (it’s not clear if Hulu is involved in that or not). They don’t get distribution. The cable companies want to control distribution just as networks do broadcast. It remains to be seen what happens there.

The other big issue is figuring out how to make streaming-video content delivered to the TV. Boxee has been one of the most innovative. They tried to put Hulu on TV. Hulu tried to shut them down, Boxee got up again… I’m not sure if it ended in a place where it’s great for consumers. At Demo, when Hillcrest Labs intended to show Hulu full screen on TV, Hulu shut them down. They’re worried they’ll lose control if broadband content is put on television. Hulu has a lot of financial backing, and it has consumers behind it, and it’s probably going to figure out how to survive. But it has to figure out how to play in a world where the big players are trying to manipulate things to their advantage. Should Hulu be disruptive, or go with flow?

–Jeremy Allaire, CEO, Brightcove

I have mixed reactions to some of the assertions in the editorial. Hulu is clearly overall a stunning success in terms of consumer adoption, as well as overall financial model. Many scoffed at these pre-launch, including myself, and have been proved wrong. The piece, however, makes a couple of key points — that there are structural challenges to the relationship model between Hulu and its parents, that delivering an exceptional experience that integrates into “omni-bus” ad sales strategies anywhere online is becoming easier. To me, the principal question facing Hulu is whether they can convince both their programming partners and the traditional TV distribution affiliates (e.g. cable, satellite, telco) that they should be a trusted domain for exhibiting TV content, so long as they play by the rules of authenticated subscribers. I think that they should and they will, and that in addition to expansion in catch-up TV content on broadcaster websites, Hulu will remain a critical aggregation point for premium online video.

Peter Yared is the founder and CEO at Transpond, and has 15 years of experience helping companies adapt new technology platforms. Peter was most recently the founder and CEO at ActiveGrid, a commercial open source company delivering the LAMP stack to the enterprise. Previously, he was CTO of Sun Microsystems’ Liberty Network Identity initiative. Peter was also CTO of Sun Microsystems’ Application Server Division. Before its acquisition by Sun, Peter served as CTO of NetDynamics, which pioneered the then-leading J2EE application server. Earlier, he was founder and CEO of JRad Technologies, an enterprise Java company acquired by NetDynamics.

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