A bad first quarter is notable for the industry because that’s when it is usually the strongest. The industry added an estimated 445,000 subscribers in Q1 of 2012, and 470,000 in Q1 of 2011. But even with additions from satellite and phone companies, this year’s first quarter was only up around 194,000 – not enough to make up for previous-quarter losses.

From April 2012 to March 2013, the industry lost a total of 80,000 subscribers, according to Leichtman Research. That’s the first time the research company has ever seen subscriber losses over a 12-month-period, leading president Bruce Leichtman to this assessment:

“First-time ever annual industry-wide losses reflect a combination of a saturated market, an increased focus from providers on acquiring higher-value subscribers, and some consumers opting for a lower-cost mixture of over-the-air TV, Netflix and other over-the-top viewing options.”

That’s quite a statement, especially considering that Leichtman has been an outspoken skeptic of the cord cutting phenomenon. In a 2010 New York Times story, he famously called cord cutters “really just a bizarre breed of people, usually in New York or San Francisco, who don’t watch a lot of television in the first place.”

Three years later, he rightfully cautioned that the numbers don’t necessarily point to a “more dramatic near-term market decline,” even though we can expect further losses in Q2. But there’s reason to be nervous, and a closer look at Leichtman’s numbers shows why:

Cable has been bleeding for years, and it’s no surprise to see this continue – even though many had expected a stronger showing for Comcast and Co. But really concerning is the slowing growth in the satellite TV segment, which is where price-conscious consumers have been fleeing to in previous years.

DirecTV added 184,000 subscribers in Q1 of 2011, and 81,000 in Q1 of 2012. This year, it only gained 21,000 new subscribers in the same time frame. Things didn’t look better for DISH, which dropped from 104,000 subscribers in Q1 of 2012 to 36,000 in Q1 of 2013.

That’s a sign that people aren’t just looking for a cheaper pay TV option anymore, but actually want to get rid of the traditional pay TV bundle altogether.

Image courtesy of Flickr user Jason Rosenberg.

In a new court filing (embedded below), the broadcasters claim the decision “threatens to cause massive disruption to the television industry” and “will wreak commercial havoc,” and request a full panel of the US Second Circuit Court of Appeals to revisit the ruling.

The start-up Aereo has been at the center of a storm in recent months because its technology threatens to blow-up the existing model of pay TV, which is based on selling viewers a bundle of channels, that include over-the-air stations like NBC, ABC, CBS and Fox. Aereo is backed by a $58 million investment from media mogul Barry Diller and others, and lets customers watch and record TV without a subscription for $1 a day or $8 a month.

In the past, other companies have retransmitted TV signals over the internet but broadcasters quickly smashed them for copyright infringement. Aereo, however, has survived two major court challenges thanks to its technology which assigns a mini-antenna (see pic below ) to each subscriber; the service is now live in New York City and is slated to arrive imminently in 22 more markets.

In the new filing, broadcasters howl that Aereo’s individual antenna system is just a loophole to get around a copyright regimes that requires any company that plays over-the-air signals, including cable and satellite firms, to pay retransmission fees. The brief also cites a paidContent story to warn that Aereo wants to team up with distributors like Dish network and Time Warner Cable to expand its reach.

On a broader level, the legal manœuvreing is part of a great game between Aereo and the broadcasters over the future of TV that could end up at the Supreme Court. In the coming battle, the broadcasters are pinning their hopes on a recent California court case, which shut down an Aereo clone and rejected the theory that a private antenna means a transmission is not “public” under copyright law – a theory accepted by two out three judges on the Second Circuit court.

In the new filing, the broadcasters rely heavily on the opinion of dissenting judge Denny Chin, who described Aereo’s technology as a “sham” and a “Rube Goldberg” device that “over-engineered” to dodge copyright.

While the dissent and the California case provide the broadcasters with ammunition, the request for a review by all of the judges on the New York court is a long shot. This is because, unlike other appeals courts, the Second Circuit almost never agrees to hear so-called “en banc” appeals; in the event it did rehear the case, the judges would be reluctant to accept the broadcasters’ invitation to declare that they were wrong on an earlier case that formed the basis of their opinion for Aereo.

This means the Supreme Court — or Congress — is the broadcasters’ best hope. Time is not on their side, however, because it would take years for the legal case to be heard and decided. By that time, technology and consumer habits for TV may have changed dramatically.

The CEO of Aereo will offer his two cents on the bigger picture of TV at paidContent Live which is taking place on Wednesday in New York City.

Legal types — here’s a marked up version of the broadcasters’ very well drafted legal brief:

Aereo en Banc Petition

Here’s a plain English explanation of the decision (embedded below), in which the US Court of Appeals for the Second Circuit ruled that Aereo’s technology is legal, and why it’s so significant for the TV industry. (Note that Aereo CEO Chet Kanojia will be speaking at paidContent Live).

Aereo’s legal loophole

Aereo captures over-the-air TV signals by means of tiny antennas and streams them to subscribers who watch and record shows on their mobile devices or computer browsers. Aereo’s antennas are not just a marvel of technology (see photos here) — they’re also the key to a legal strategy that helps the company avoid copyright infringement.

To get a better idea of both Aereo’s technology and its legal strategy, it’s helpful to consider how it works for consumers. According to the Second Circuit, “Aereo functions much like a television with a remote Digital Video Recorder (“DVR”) and Slingbox” — allowing subscribers to use internet technology to capture live broadcasts on stations like CBS or Fox and and watch them later.

Aereo argues that its “one antenna for one subscriber” operation means it’s just like a personal recording tool.  The country’s broadcasters disagreed and sued Aereo, arguing that it’s illegally retransmitting their signals to the public.

Aereo won the first round last year when a US District Court in New York refused to grant the broadcasters  a preliminary injunction, saying that Aereo’s service was on all-fours with a previous Second Circuit ruling that found Cablevision’s remote DVR’s to be legal because they involved one copy of a show being transmitted to one subscriber.

On appeal, the broadcasters repeated their argument that Aereo’s mini-antenna system was built specifically to get around copyright law and that Aereo was different than the situation in Cablevision because Aereo offers live TV without a license.

The Second Circuit, however, ruled on Monday in a two-to-one decision that each Aereo subscriber controls the TV stream they receive — including the ability to pause, rewind or record any given show. This means that Aereo is not transmitting to the public and that the service is consistent with the Cablevision decision. The court added that it didn’t matter if Aereo didn’t have a license to show the original programming or that it had created the mini-antenna service specifically to take advantage of the copyright loophole.

The decision was not unanimous, however. In a lengthy dissent, Judge Denny Chin blasted Aereo’s service as a “sham” and “a Rube Goldberg-like contrivance, over-engineered in an attempt to avoid the reach of the Copyright Act and to take advantage of a perceived loophole in the law.”

A major blow for the TV industry

The TV business has long been based on selling customers large bundles of channels at ever-increasing prices. Unlike the music industry, which has been thoroughly disintermediated by services like iTunes, the television incumbents have so far been able to resist the forces of digital disruption.

The arrival of Aereo thus represented a major threat to the TV business because it offered consumers a way to get broadcast channels where and when they wanted. And unlike other would-be disruptors, Aereo arrived well-funded and prepared to fight: it has top-notch lawyers and has already received at least $58 million in backing from media mogul Barry Diller and others.

Aereo alarms the TV industry not only because it encourages subscribers to watch shows where and when they want to, but also because it refuses to pay “retransmission” fees that cable and satellite companies give broadcast networks to retransmit over-the-air shows. At the same time, Aereo is promising to upend the cable industry by training users to come and go as they please — without expensive set-top boxes or installation fees or contracts. Instead, Aereo users can simply $1 a day or $8 a month.

For now, the broadcasters still have the upper hand in one way in that they own many popular cable channels such as ESPN that they can withhold from Aereo. This may help them in the short term but it does not address the bigger problem of changing TV-watching behavior of the sort that Aereo is ushering in. And in the meantime, Aereo has added one speciality channel (Bloomberg TV) and is likely to add others soon.

In the long run, Aereo’s CEO, Chet Kanojia, has vowed to break the current system which he has described as “an abusive system set up in an artificial way” and instead offer “rational bundles.”

Is the genie out of the bottle?

The significance of Aereo’s win at the Second Circuit is not just that can it continue operating. It’s also a big symbolic boost from the country’s most influential appeals court.

This symbolic support is likely to draw in more investment money and to facilitate Aereo’s expansion. Right now, the service is only available in New York City with plans to open soon in 22 more cities — Aereo is likely to treat the court ruling as a greenlight to open shop in the new cities sooner than later. At the same time, the new legal legitimacy is likely to speed Aereo’s existing partnership discussions with distributors like AT&T and Dish Networks.

Things aren’t all smooth sailing for Aereo, of course. The ruling only addresses a preliminary injunction, and the broadcasters will almost certainly appeal to a full panel of the Second Circuit and to the Supreme Court. At the same time, a California court has already ruled that a service offered by a would-be Aereo competitor amounts to copyright infringement — meaning that Aereo has no hope of coast-to-coast distribution for the foreseeable future. (The California case is at an earlier stage and could still be overturned; if not, it could set up a circuit split to be resolved by the Supreme Court).

But while it’s legal status remains uncertain, Aereo now has time on its side. Any future court decisions are likely to occur a year or more from now, providing the company with ample time to further ramp up its service. As it does so, consumers will become more familiar with Aereo and other over-the-top TV options — meaning it will be harder than ever for the traditional TV industry to persuade consumers to stick with an expensive bundle-of-channels model.

AEREO Decision

For anyone unfamiliar with Aereo, the Barry Diller-backed company lets subscribers rent mini personal antennas that can beam and record over-the-air TV to mobile devices and laptops under two plans. One costs $1 a day, or there’s a monthly subscription for $8. For those eager to hear more, Aereo CEO Chet Kanojia will be speaking at paidContent Live on April 17 about his plan to disrupt the TV industry.

News of Aereo’s discussions with Dish, AT&T and others comes by way of a Wall Street Journal report that says such a partnership could let Aereo quickly expand its footprint. Aereo has already announced plans to expand soon to 22 new markets beyond New York City where it is already available.

Aereo’s desire for a partnership with a major ISP or TV provider is probably not related to money or infrastructure; the company has told me in the past that rolling out a new antenna farm is quick and easy. Instead,  any partnership is likely tied to deeper strategic goals. From the Wall Street Journal story:

In one scenario that was discussed, AT&T would sell broadband or wireless data subscriptions paired with Aereo’s video service, people familiar with the matter said.

In other words, such an arrangement with AT&T would let Aereo subscribers use the service heavily without fear of exorbitant data bills.

Meanwhile, the talks with satellite TV-provider Dish Networks may have centered on an acquisition. Although Dish CEO Charlie Ergen said on a February investor call that Dish had no plans to buy Aereo, he added “we never say never.” Ergen has also repeatedly expressed admiration for Aereo and, unlike other incumbents in the TV industry, acknowledged the reality of consumers quitting established TV models in favor of “cord-cutting.”

“We thought it was a fairly benign message,” Antennas Direct President Richard Schneider told me Thursday. Charter disagreed – and rejected the spot for competitive reasons.

The spot was part of a bigger marketing campaign that Antennas Direct is currently running for its products, with six different spots already airing in 15 markets and plans to show them in two dozen additional markets soon. Here’s one of them:

Antennas Direct has been one of a number of antenna manufacturers that has profited from interest in cord cutting. And over-the-air TV has also started to find its way into new technologies, including Boxee’s cloud DVR and Aereo’s TV streaming service. (Speaking of which: I’ll be interviewing Aereo founder and CEO Chet Kanojia at our paidContent Live conference in New York next month. Check out the full program for that event on the paidContent Live site.)

Schneider told me that the company’s early customers were mostly home theater enthusiasts interested in getting uncompressed HD TV signals. Then, some 18 months ago, more and more average consumers started to look for antennas – a trend that he largely attributes to the growing popularity of online streaming services. “Hulu and Netflix are helping revive antenna sales,” Schneider said, adding: “Over-the-air digital is really the new basic cable.”

Consumers would increasingly watch the basic broadcast channels for free, and then pay for catch-up and on-demand viewing, he argued. Of course, cable execs tend to argue that cord cutting doesn’t exist, even though people like Dish’s Charlie Ergen disagree. Asked about these arguments, Scneider responded: “Someone is buying all these antennas.”

Antennas Direct’s sales have nearly tripled last year, and the company is expecting to generate close to $15 million in revenue in 2013 – even without those ads on Charter.

Pay TV providers have long complained that TV networks force them to carry channels they don’t want. But in recent weeks, those complaints have turned into action, with Cablevision suing Viacom to break up the network’s bundle, and Verizon starting to talk about paying programmers based on their performance, as opposed to a flat fee for a bundle of channels.

So who is trying to break up the bundle, and how? Check out our list:

Verizon: Putting its money where your eyes are

Verizon execs have been talking for some time about changing things up, to the point where director of consumer video services Maitreyi Krishnaswamy, who is responsible for the company’s FIOS TV service, said last year that cord cutting wasn’t growing fast enough for the company. The logic behind those remarks? If consumers cut the cord, then programmers are going to be more willing to rethink the deals they’re having with Verizon.

Verizon sells bundles – but it would like to change them.

Looks like this is now beginning to happen, at least on a smaller scale. The Wall Street Journal reported this weekend that Verizon is pressing smaller channels to pay them based on their actual performance, as opposed to a flat fee per subscriber. The result wouldn’t actually be a pick-and-choose TV lineup. Instead, Verizon would potentially distribute even more channels — but only pay the ones that are actually attracting eyeballs.

Making this model work won’t be easy for Verizon, especially when it comes to the biggest cost drivers, which are sports channels like ESPN. But some smaller channels might be eager to sign on. This could potentially lead to some cheaper bundles that offer actually more content, save for some of the most expensive fare.

Cablevision: Suing to get rid of the duds

Cablevision has chosen to take its attack on the big bundles to the courts: The company sued Viacom last month to get out of a contract it struck just two months earlier, arguing that Viacom is forcing the company to carry a number of channels its customers don’t want. The lawsuit is about a total of 12 channels like MTV Hits and VH1 Classic, but it could ultimately threaten the whole concept of a bundle — which is why it will likely get settled out of court.

Aereo: A new kind of bundle

Aereo is circumventing the cable bundle altogether with an offer that’s squarely aimed at cord cutters: The company offers streaming of broadcast networks like ABC, CBS and NBC for as little as $8 a month.

Aereo’s tiny antennas could have a big impact on bundles.

It’s undercutting the cable companies through the use of a legal loophole, which involves an elaborate setup of miniature antenna farms, and resulted in a lawsuit brought against the company by those very broadcasters. However, the company won a first round last year, and is now looking to expand to close to two dozen cities this spring.

To learn more about Aereo and the company’s take on the future of television, check out our upcoming paidContent Live conference, where I’m going to chat with the company’s CEO Chet Kanojia about these very issues.

Boxee: Unbundling the DVR

Boxee’s new Boxee TV device comes with a promising proposition: The device won’t just let you watch major broadcast networks without paying for cable, it will also upload any show airing on those networks to a cloud DVR with unlimited storage and streams them not only to your TV, but also to your iPad or computer. Boxee’s cloud DVR is currently only available in limited markets, and the device itself has been met with mixed reviews – but the idea behind it is definitely disruptive, because it’s essentially TV Everywhere without the expensive cable price tag.

Netflix: Showing that you can succeed without a bundle

Netflix has long shied away from discussions around cord cutting and cable bundles, with execs insisting that that wants to be complementary to cable, and that it will eventually just be another channel that consumers subscribe to, just like HBO.

Netflix’s House of Cards is like a cable show, but without a cable bundle.

However, the big difference is that you can only get HBO as part of a premium cable bundle. Netflix, on the other hand, is available to anyone, no matter whether they pay $50, $120 or nothing at all for cable.

That strategy has been working well for the company: Not only does Netflix now have 33 million subscribers, investors have also given the company a thumbs-up on its original content strategy, with stock roughly doubling since the beginning of the year.  And with new, original shows about to debut on Netflix every month this spring, the company seems to demonstrate HBO that you can, in fact, succeed without being part of a bundle.

Image courtesy of Flickr user HarshPatel;Photographer.

For the unfamiliar, Aereo is a subscription service that lets users sign up for $1 a day or $8 month to watch over-the-air TV on their mobile devices and to record shows for later viewing. The technology involves assigning two dime-sized antennas to each subscriber which beam the TV from Aereo’s offices (you can see photos of the antennas in action here).

Until now, Aereo has kept a low profile, offering its service with little fanfare in New York City. But at the Consumer Electronic Show in Las Vegas this January, it said it would roll out to 22 new markets in coming months. The decision to go live in the new areas around New York City — see the full list below — was announced by Aereo this morning and appears to be the first step in the planned expansion. Aereo is also expected to soon offer the service for more non-Apple devices; right now, users can watch Aereo on the iPhone and iPad as well as on computers via various internet browsers.

To publicize the service, Aereo said it will advertise on New York City billboards as well as major transit hubs and commuter rail services in the region.

The expansion comes as Aereo remains locked in a bitter legal battle with ABC, CBS, NBC and Fox which are suing to shut it down. The networks argue that Aereo is infringing its copyright by retransmitting its signals without permission; Aereo counters that its personal antenna system means the transmissions are private and within the law (you can read legal details here).

“Today, consumers are tethered to expensive and outdated technology that limits how, when and where they can enjoy their own television programming,” said Aereo’s CEO Chet Kanojia in the news release. “Aereo’s technology now lets us provide simplicity, ease of use and rational pricing – three things that have all but disappeared for the consumer.”

To learn more about how Aereo is disrupting TV and other cutting edge media topics, come hear Kanojia speak at paidContent Live in New York on April 17.

The list of counties that can now tune into Aereo include: New York’s Bronx, Kings, Queens, Richmond, Nassau, Suffolk, Westchester, Putnam, Rockland, Ulster, Sullivan, Orange, Dutchess; Connecticut’s Fairfield County; Pennsylvania’s Pike County; New Jersey’s Bergen, Warren, Union, Sussex, Somerset, Passaic, Ocean, Morris, Monmouth, Middlesex, Hunterdon, Hudson, and Essex. Check zip code eligibility here.

Correction: an earlier version of this article incorrectly listed Chet Kanojia’s last name as Atkins.

The Nielsen news was first reported on Wednesday by The Hollywood Reporter, which said that by September 2013 “Nielsen expects to have in place new hardware and software tools in the nearly 23,000 TV homes it samples.” Nielsen confirmed the news on Thursday, with Nielsen SVP Pat McDonough telling the New York Times that the company’s definition of “television household” will now include “those households who are receiving broadband Internet and putting it onto a television set.” According to the AP:

“This will add roughly 160 homes to Nielsen’s current sample of 23,000 houses nationwide with meters monitoring viewing habits.

More significantly, Nielsen will return to its sample to find homes that have cable or broadcast, but also separate TV sets hooked up through broadband. This will add an estimated 2,000 more broadband sets, significantly increasing the sample size.”

The company is also working on ways to track viewing on smartphones and tablets.

Separately, Billboard has begun including official YouTube music video views (from the U.S.) in its rankings. “All official videos on YouTube, including user-generated clips that utilize authorized audio, will now factor into how a song’s popularity is determined,” YouTube said on its blog. Billboard’s charts have included digital download and streaming data, tracked by Nielsen, since last year.

The TV business is still based on an archaic business model that forces customers to buy arbitrary bundles of channels. Fans of arts programming, for instance, often have to shell out $5 a month for football shows — even if they hate football.

This isn’t a technology issue. It’s instead the problem of what media doyen Peter Kafka calls the “TV industrial complex” — a cabal of broadcasters and cable distributors that refuse to surrender their bundled TV business model.

That’s why upstart Aereo, which uses tiny antennas to stream TV signals to mobile devices, is so intriguing to watch. The company is offering a way for people to watch shows where and when they want — and has so far withstood the TV industry’s lawsuits. Yesterday, we showed off photos of Aereo’s tech. Today, we’re exploring the vision and strategy of the man who wants to kick in the door of the TV industrial complex once and for all.

The quest to end an “abusive” system

Chet Kanojia, who is speaking at paidContent Live in April, is a soft-spoken engineer who likes stylish shoes. At 43, he’s already built an advertising company, Navic Networks, and sold it to Microsoft — and presumably made himself a fortune. When we chatted at Aereo’s site in Brooklyn this week, the first thing I wanted to know is why he picked this fight. Why, that is, did he decide put so much energy into Aereo when the TV industry might crush the company in a second like it has done to others before?

“I had the option to be a VC, to do nothing or to do something really really meaningful,” said Kanojia. “In my heart of hearts, I belive that when businesses are created or preserved with analogue mentalities, they’re artificially constrained and ripe to to be recast in a different way.”

He adds that he loves TV content like 60 Minutes, Parenthood and Downton Abbey. But he is exasperated by the TV industry’s ossified pricing model.

“Why can’t there be a simple way to pay for this? It’s just irrational that it should cost hundreds of dollars a month. It’s an abusive system set up in an artificial way.”

Broadcasters like NBC and Fox, of course, would argue that we need a system that provides revenue to produce the content that people like so much. In recent years, these networks have been leaning on distributors to pay them for carrying over-the-air channels — and presumably think Aereo should too.

Kanojia is having none of it, saying the broadcasters are already making money from public spectrum through advertising and that it’s unreasonable for them to ask for more. Also, Aereo is not part of the regulatory regime that requires big TV companies to offer their channels for sale to cable and satellite distributors; this means that, for now, Aereo is unable to sell channels like ESPN (owned by ABC) to its customers.

Kanojia adds that pure “a la carte” TV is not the only solution to the TV muddle. He would also settle for “rational bundles.”

A high stakes bet

Aereo’s disruptive potential lies in the fact that, unlike other forms of pay TV, subscribers can add or drop it without the hassle of set-top boxes or contracts. For now, Aereo is available only in New York City but is about to roll out to 22 new markets across the country for the same price of $1 a day or $8 a month to watch and record shows. Kanojia believes this will change people’s conception of how we get access to television.

“You can come in five or ten times a year and a pay a dollar. We have lots of habitual one dollar buyers. It’s a massive dent in the psyche.”

For Aereo to have a long-term impact, though, it will still have to survive an ongoing legal gauntlet. On this front, it has a decent chance because investors and lawyers designed the company as a high-stakes bet, counting on a 2008 appeals court ruling that said private remote DVRs don’t violate copyright (you can read the legal details here). After broadcasters sued it last year, Aereo won the first round and the case is now on appeal.

The price tag for the loser will be high. On one hand, media mogul Barry Diller and others have put at least $58 million into Aereo, money that could evaporate if Aereo is shut down. On the other hand, GigaOM Pro analyst Paul Sweeting (who has written about Aereo) said the initial court decision was a “disaster” for the networks and that a loss at the appeal level will open the floodgates.

“If the networks don’t win, what it means is that all you have to do is bounce a signal off a cloud-based DVR and you can do what you want,” said Sweeting by phone.

Whatever the outcome of the court case (which could go to the Supreme Court if courts in New York and California continue to disagree), Kanojia thinks he will have made an inexorable dent in the current tv structure. He also thinks the litigation will help other pioneering TV companies.

“The legal situation is unfortunate, but it forces clarity and that’s a good thing.”

The stats come by way of research group TDG which presented the findings in this chart:

While a five percent decline is hardly earth-shaking, TDG describes the end of cable TV’s growth as a tipping point with ”long-term tectonic implications.”

This makes sense. The price of cable bundles is climbing ever higher, at the same time as a bevy of new distribution options is increasing consumer frustration at having to purchase channels they don’t want. Meanwhile, a rising generation of “cord-nevers” thinks buying a cable package to watch one show makes as much sense as buying a CD to hear a single song.

But don’t count out the TV industrial complex just yet. The industry still has the best content goodies, including sports and HBO fare, and will continue forcing consumers to buy bundles to access them. It will also keep dangling cable passwords as a requirement for people to watch content on mobile devices.

Meanwhile, the brave new world of cord-cutting is still not ready for primetime. As my colleague Stacey Higginbotham explained, the online video world still has too many parts and too little accountability – meaning consumers will be stuck with unreliable service for some time to come. The first cable decline is a tipping point, not a revolution.

(Image by lev dolgachov via Shutterstock)