Internet video hasn't taken over the world, but network operators may find it's a tough competitor if they don't quickly add it to their own IPTV offerings, according to a new report by Heavy Reading.

The report, Internet TV, Over-the-Top Video & the Future of IPTV Services, says that while telcos are investing heavily in their networks in order to offer IPTV services, the growth of Internet video -- a.k.a. over-the-top (OTT) video -- traffic could cause carriers to miss a significant revenue opportunity.

First, the good news: While the amount of OTT video traffic is growing rapidly, over the next five years it will be outweighed by the amount of IPTV traffic running over carrier networks. James Crawshaw, analyst at large with Heavy Reading and author of the report, estimates that "all U.S. residential wireline telecom traffic totalled 5 exabytes in 2006," which "will grow to nearly 80 exabytes by 2011, due mainly to IPTV and Internet traffic."

Similarly, the overall revenue opportunity for OTT video will continue to be small compared with that from traditional media. Crawshaw notes that Apple Inc. (Nasdaq: AAPL)'s iTunes "sold around $100 million of video content in 2006; compare that to global TV industry revenues of more than $300 billion and movie industry revenues of $35 billion."

The largest revenue opportunity from online video will come from advertising, the reports says, but even that will capture only a fraction of overall advertising spend. Crawshaw estimates that "the revenue opportunity from online video advertising could reach $4.4 billion in the U.S. by 2011," but that compares with about $44 billion spent on television ads in 2006.

Even though revenues from OTT video services will pale in comparison to those from new IPTV service offerings, they still represent a missed opportunity for service providers. This is especially true because OTT video will compete with more IPTV services, and over the same networks as carrier offerings.

Deep packet inspection (DPI) vendor Ellacoya Networks Inc. estimates that Google's YouTube Inc. alone makes up more than 20 percent of all Internet traffic today. But for all that traffic sent to end users, carriers don't see a penny of the advertising revenue that Google (Nasdaq: GOOG) collects. With new high-quality, ad-supported video services being launched by companies like Babel Networks Ltd. and Joost , there will soon be even more competition for the attention of end users. (See Ellacoya Studies Web Traffic, Babelgum Launches Public Beta, and Joost Launches Commercially.)

So what's a network operator to do?

One option is to block or limit OTT traffic in favor of a carrier's own service offerings. However, Crawshaw writes that "throttling OTT traffic controversially violates 'net neutrality' principles, and as such could lead to intervention by government regulators, just as service providers caught throttling OTT VOIP providers have been prosecuted in the past." (See Vonage Spreads the Blame and FCC Fines VOIP Villains.)

A better path for operators would be to find a way to insert themselves into the relationships OTT providers could be forging with their customers. One way to do that would be to charge for content delivery and use DPI to guarantee quality of service for certain types of OTT traffic. This could be paid for by either the content provider or the end user.

Another option is to open up a carrier's IPTV platform to OTT content, essentially making OTT services available as a separate channel. This would allow service providers to bring in extra revenue, while also collecting data on consumer viewing habits.

Ultimately, this may be the model that wins out in the end. In a survey of telecom operators, Heavy Reading found that more than 50 percent think Internet video will become widely available in IPTV deployments, while fewer than 10 percent reject the notion.

For more information on the report, click here.

— Ryan Lawler, Reporter, Light Reading