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Why TV ads are making their way over the top

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Television commercials may soon start going over the top. For anyone looking to break pay-TV providers’ current stranglehold on the business, that’s a good thing.

Last week Adobe acquired online video ad management company Auditude for a reported $100 million. The deal will enable Adobe to integrate ad-serving capability into the Flash video-streaming platform used by many over-the-top video providers to reach connected TVs and set-top boxes.

“With this acquisition, Adobe can now offer an unparalleled platform for authoring, distributing, analyzing and monetizing digital video experiences everywhere — simplifying workflows, increasing consumer engagement, delivering insights and driving increased revenue for content publishers,” Adobe senior VP of digital media David Wadhwani said in a press release.

Also last week, LG Electronics signed a multiyear agreement with ad-services provider YuMe to bring video ads directly to LG’s connected TVs via the LG app store. Toyota has signed on as the first sponsor under the new deal, using LG TVs to promote the 2012 Camry.

The sponsorship is “a great opportunity to learn more about the connected-TV space,” national marketing media manager Dionne Covin told the New York Times. “[It will] build on the knowledge we’ve already gained” through earlier tests.

Plenty of OTT video carries ads already, of course. Most Hulu and professional YouTube content is ad-supported, as is most content streamed directly from programmers’ own websites. But those are designed largely to protect existing relationships among advertisers, programmers and distributors, not to disrupt them. As often as not, online ad time in network shows is sold as a package with broadcast or cable time.

Though they’re still baby steps, the LG and Adobe deals point to the evolution of IP delivery platforms themselves into a channel that marketers could use to reach consumers in their living rooms without needing to pay the high advertising CPMs that traditional broadcast and cable networks command. The shift could someday provide a critical new revenue stream for would-be new entrants looking to break up the pay-TV bundle and offer consumers new à la carte options.

The TV business rests on two pillars: the subscription fees pay-TV providers collect from consumers, a goodly portion of which get remitted to programmers via carriage and retransmission fees; and advertising. Any over-the-top video provider hoping to disrupt the current business will need access to at least one of those two revenue streams. Of the two, advertising is the most promising.

The current subscription revenue stream remains tightly bound to the incumbent service providers, making it difficult for new entrants to grasp. Some OTT services like Netflix, Hulu Plus and MLB.com have managed to establish their own subscription relationships with viewers, but those services have positioned themselves largely as supplemental to the viewer’s existing pay-TV service rather than as a substitute for it.

The advertising revenue stream is less platform-dependent, however, and thus more ripe for poaching, which is what makes the Adobe and LG deals (and Roku’s earlier deal with mDialog) potentially significant.

If IP video platforms develop an efficient and effective infrastructure for serving targeted ads directly to viewers, independent of any particular program or programmer, it would give OTT service providers the monetization engine they need to compete for high-value content deals.

As marketers seek out the growing pool of digital viewers, moreover, advertising dollars might begin to shift from traditional programming channels to the newer channels. Over time, that would further weaken ties between programmers and traditional pay-TV service providers by making distribution on new digital platforms more commercially viable and attractive.

None of that will happen overnight, of course. The Adobe, LG and Roku deals are just starting points. But if OTT services are ever to compete with pay-TV providers for the affections of programmers, they will need their own revenue stream.

Question of the week

What does Apple need to do to disrupt the pay-TV business?