Last Updated: March 8, 2008: 4:59 PM EST
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A new way to watch TV

Watch out YouTube. Two old-media dinosaurs, Fox and NBC Universal, have created one cool venue for their hottest shows.

Hulu CEO Jason Kilar is obsessed with making Hulu as easy to use as old-fashioned television. You can watch in either partial- or full-screen mode.
Hulu's U.S. programmers work into the night (above), send specs to Beijing (below), and get code back in the morning.
CEO Kilar and top technologist Eric Feng are more Silicon Valley than Hollywood - and proud of it.

(Fortune Magazine) -- When Fox and NBC Universal announced last March that they would join forces to put their TV shows online, the pundits of Silicon Valley howled with derision. Old media doesn't get the Internet, they said. Michael Arrington, the influential editor of TechCrunch, rattled off the reasons the project would never succeed and suggested that Fox and NBC quickly name their joint venture before it got stuck with the moniker insiders at Google had reportedly given it: Clown Co.

So there was huge relief at Hulu, as the company is now called, when it previewed an early version in late October and the first reviews started coming in. The very people who had thrown brickbats were now tossing raves. "In one word: brilliant," wrote blogger Om Malik. Even Arrington declared himself "very impressed."

Hulu CEO Jason Kilar calls that the company's "defining moment." Says Peter Chernin, president of News Corp. (NWS, Fortune 500), which owns Fox: "They said big media was too stupid to do anything appropriate on the web, and that NBC and Fox were incapable of partnering. Both charges have been wrong from day one."

Whether or not that's true, the world will soon judge for itself. After one year and an estimated $15 million worth of development costs, Hulu, a video website supported by advertising, is set to debut in early March. A project that is the TV and film industries' best effort so far to carve a place for themselves in the rapidly changing world of digital media is about to have its first major screen test.

Life used to be simple for media giants like NBC (GE, Fortune 500) and Fox. They produced content, the public consumed it, and advertising and ticket sales generated gushers of profits. Today viewers have their choice of all sorts of venues - digital and analog, legal and illegal - from Apple (AAPL, Fortune 500) to Netflix (NFLX) (see table). Some of the most popular videos are the ones viewers produce themselves and post for free on YouTube.

Into this shifting landscape was born the project that would become Hulu - a made-up word that happens to sound like Chinese for "interactive recording." It was early 2006, and everybody in Hollywood was afraid the Internet would do to video what Napster had done to music. Indeed, a lively trade in pirated TV shows had already begun. Sure, some online outfits were willing to pay for access to high-quality programming. The problem, says NBC Universal CEO Jeff Zucker, was that "nobody was willing to pay us what we thought it was worth."

Fox's Chernin and NBC's Zucker had independently concluded that the TV industry needed its own website - one that would provide a convenient and legal venue for its content while capturing some of the ad dollars that were shifting online. The idea gained more urgency in the fall of '06, when Google (GOOG, Fortune 500) bought YouTube for $1.6 billion. The two began seeking industry partners; Viacom (VIA) almost joined before CEO Tom Freston was ousted in late 2006. Reluctantly, Chernin and Zucker decided to proceed alone.

Money, it turned out, was not an object for Hulu. In May, Providence Equity Partners offered a cool $100 million for a 10% stake - giving the nascent operation an astonishing valuation of $1 billion.

But the secret of Hulu's initial success - the thing that made believers out of the skeptics - is the power and simplicity of the website itself. Hulu's creators focused with almost obsessive attention to detail on the user's experience. The first thing you see when you visit Hulu is a big screen offering a TV clip with a prominent "watch now" button. You can scroll through a half-dozen of these featured offerings, browse the most popular episodes, or search shows by name - from vintage NBC series like McHale's Navy to the latest episode of Fox's The Simpsons. Hulu even lets you search for competitors' content, like ABC's Desperate Housewives. "If it's legally available anywhere on the web, we want to take you to it," says Kilar.

Much of what's right about Hulu can be traced directly to Kilar, a tech industry veteran who worked at Amazon for nine years. The first thing Kilar did when he was brought onboard as CEO last July was to declare in ways large and small his independence from his corporate parents. He promptly abandoned the palatial corner office he'd been assigned in Santa Monica for a near cubicle. "We asked ourselves, 'If we were starting this in a garage, what would we need to be successful?'"

Superb software was one answer. Kilar's first hire was friend and former Microsoft engineer Eric Feng. Together they assembled two technical teams - one in Santa Monica and the other in Beijing, where Feng had come to know some of the most talented programmers in Microsoft's Chinese research lab. It was a classic transpacific skunkworks operation. Each night the U.S. team sent specs to the team in Beijing, which had code ready for the Californians when they got back to work the next day.

The result is the elegantly transparent interface that has wowed even its biggest detractors. Greg Smith of Ogilvy & Mather says he watches more video on Hulu than TV now. "It's just simple," he says. "But TV is simple too. That's the genius of it."

Like TV, there are ads on Hulu, although the site - or any online TV service - is a long way from matching the massive revenue of broadcast television. Hulu shows only one-quarter as many ads - two minutes for every 22 minutes of content, as opposed to eight on TV. And while its ad rates are actually higher per viewer than primetime's, it has vastly fewer viewers. (On the other hand, you can't fast-forward through ads, which marketers appreciate.)

Hulu also gives viewers controls that don't appear on any TV set - controls that play into today's "mash-up" culture. For instance, Hulu lets you edit shows down to a clip as short as a few seconds - only Jay Leno's first joke, perhaps. You can e-mail a link to that clip or embed it - or the full show for that matter - directly into another website.

The drama surrounding Hulu's launch heated up last August when NBC abruptly pulled its content off the Apple iTunes store - where NBC shows like The Office and 30 Rock had accounted for 30% to 40% of iTunes' video downloads. "Apple sold millions of dollars worth of hardware off the back of our content," Zucker later complained. Zucker may yet come to terms with iTunes. Meanwhile, he's happy to showcase his hit series on Hulu and Amazon's iTunes competitor, Unbox.

Impressive as it is, Hulu will to have fight hard to stay relevant. "It will be big," says David Verklin, CEO of Carat Americas, one of the U.S.'s top five ad buyers. "But it's a transitional technology." The immediate challenge will be for Hulu to expand its offerings. In the past six months it has signed on a couple of important partners, chief among them MGM and Sony. Viacom executives hint that they may join soon, and Chernin says promising talks are underway with Time Warner.

But Quincy Smith, who heads digital initiatives at CBS, speaks for many when he expresses his ambivalence. On the one hand, Hulu's vision strikes him as too narrow. "If the web is just another way to watch TV, I think I'm going to slit my wrists," he says. He thinks Hulu should focus much more on facilitating interaction among the passionate fans who make up the online community. CBS, for instance, encourages viewers to gather after each episode of Survivor to discuss who was voted off the show, and who should have been. Kilar - whom Smith says calls him almost daily trying to recruit CBS - insists that such things are on the drawing board. But even if Hulu gets them right, Smith is unlikely to share as much of the ad revenue as Kilar wants. (Hulu has asked some potential partners for as much as 30%.) Says Smith: "The economics have to change."

They probably will, if that's what it takes to make Hulu - or something like it - succeed. For Hollywood and the TV industry, there's too much at stake. To top of page

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