In the next five years, smarter TV devices and content will dramatically shift how viewers consume television programming. The result, according to a new Report from Forrester Research, Inc. (Nasdaq: FORR), will be a significant shift in the business model for television. Even as they drain $18 billion in ordinary TV advertising revenues, smarter devices will create $25 billion in new revenues from viewers interacting with their TV screens.

“In contrast to the interactive TV hallucinations of the early 1990’s, television is about to get a whole lot smarter,” said Josh Bernoff, principal analyst at Forrester Research. “Smarter TV devices like personal video recorders (PVRs) and interactive digital cable boxes will move viewers beyond the passive viewing experience, allowing them to watch TV on their own schedules, interact, and connect to on-screen services.”

Smarter TV devices are here today — by year-end, 34 million US households will use interactive program guides (IPGs), 5 million will interact with programs and commercials on systems like Wink, and 750,000 will record programming on PVRs like TiVo and Replay. Smarter TV device penetration will advance rapidly — 2005 will see 87 million IPG households, 65 million households that can interact with video, and 53 million PVR users.

From now through 2002, providers will exploit these devices to generate new revenues. Cable and satellite operators will build “walled gardens” — captive collections of commerce and ad-supported content — generating more than $3 billion in commerce by 2002. But the true potential of smarter television won’t arrive until 2003, when the networks and operators will finally agree on standards for metadata — information about programs and commercials embedded in video streams. Metadata will unlock the door to new TV behaviors — programs with embedded commerce, customized video assembled to viewer preferences, and layered commercials that invite viewers into ever-deeper interactions. These new behaviors will generate new revenue streams: $7 billion in subscriptions, $17 billion in marketing fees and advertising, and $23 billion in commerce by 2005.

“Smarter TV is built on the foundation of today’s television — the same video, the same commercials, and the same cable and satellite distribution,” added Bernoff. “But rather than destroy traditional television, it will rejuvenate existing content and bring affluent viewers back to television. And the timing is right — the same technologies will enable viewers to skip 30% of commercials in 2005, causing an unprecedented decline in traditional advertising revenues.”

Smarter television revenues will create new roles for TV industry players. Targeted networks like Discovery will embed commerce in programming while real-time information providers like CNN will embed codes in their content so that smart devices can reassemble and manipulate it. Broadcast networks will pursue product placement and divide programming into two categories — mass-audience passive dramas like ER and interactive-friendly programming like game shows and sports. Advertisers will target individuals based on the viewing data collected by smarter TV devices, raising privacy far beyond today’s Internet data collection debates.

“Smarter TV is good news for companies in the TV industry — if they prepare for it now,” said Bernoff. “Smarter TV will solve the cash-flow problems of cable and satellite operators and free broadcast networks from ratings fixations. But companies wedded to the metrics of plain old TV — audience sizes and prime-time schedules — will see these new revenue streams pass them by.”