Recently, several industry executives have questioned the wisdom of deploying pay TV. The question stems from the success of Internet video: comScore Inc. found video viewing grew 65 percent in February 2008, compared to February 2007. In that month, 135 million Internet users spent an average of 204 minutes viewing online video – more than 40 percent of the U.S. population. YouTube Inc. generated 2.6 billion video streams in December 2007, underscoring the power of user-generated video. Declining PC and digital camcorder prices and inexpensive PC-based editing software will continue to fuel this trend.

So then have the billions of dollars poured into pay-TV initiatives by AT&T Inc. (NYSE: T) and Verizon Communications Inc. (NYSE: VZ), among others, been a mistake? I don't believe so, and here's why.

In part, offering pay TV was a justification for fiber deployment (both FTTH and FTTC) necessary to gain and hold onto broadband subscribers. Cable held a two-to-one subscriber advantage, and telcos needed to compete on more than price.

Gaining broadband subscribers is particularly important for two reasons. Firstly, broadband is becoming the channel for all other services, including communications and entertainment. Second, single-service competition is being replaced by competition for multiservice bundles. Extensive research has shown that churn among bundled households drops sharply, and bigger bundles drive lower churn.

Let's also look beyond the first layer of numbers for broadband video. While viewership is exploding, it's not a rate that will threaten conventional TV anytime in the foreseeable future. Even today, Internet video is driven by an aggressive minority. ComScore found that 80 percent of online video viewers spent fewer than three minutes viewing video per day. Compare that to the average of more than four hours daily TV viewing per person in the U.S. Plus, TV viewership is not showing dramatic declines, even among younger segments.

The revenue picture is even more telling. Service providers today have no clear way to benefit from online video, so they would have no revenue stream to speak of. But online video revenue is hard to come by for the entire value chain. Forbes estimates that even poster child YouTube makes just $200 million, and that's with the ad network, knowledge, and scale of parent Google (Nasdaq: GOOG) behind it. TV generates $75 billion in advertising revenue in the U.S., and a further $60 billion or so from pay TV subscriptions. The online video market is about 1 percent of that total.

So, while online video is the next big thing, and the ability of the Internet to aggregate audiences continues to suggest its eventual success, we are not anywhere near there yet. Meanwhile, line losses and subscriber churn are here today for service providers. And that's why offering pay TV still makes sense.

– Aditya Kishore, Senior Analyst, Heavy Reading