The short version is that unlike its broadcast peers, CBS (CBS) has been reluctant to make many of its shows available on the Web because it worries that doing so cuts into its core TV business.

So while GE’s (GE) NBC Universal and News Corp.’s (NWS) Fox put Hulu together, CBS stayed away. And when Disney (DIS) decided to join the joint venture earlier this year, CBS executives argued strenuously against the deal. Instead, CBS has been content to use the Web as a promotional tool for TV via outlets like Google’s (GOOG) YouTube.

The longer version is below, via the transcript of a brief chat I had with Smith this afternoon to discuss his plans and the network’s. This is stuff he’s talked about before–to reporters, in industry forums, and even via emails he wishes he hadn’t written–but I’m running it at length here.

Because 1) I think Smith does a good job of explaining the push-and-pull of Web viewership vs. Web economics that everyone in big media is grappling with, and 2) I want people to see just how difficult it is to keep up when Smith talks. He can get out a lot of words in a relatively short time.

I also had a quick chat with CBS CEO Les Moonves, who made many of the points Smith did, but with less verbiage: I’ll get you that transcript shortly, too.

Peter Kafka: Since you’re going to be advising CBS’s Web video strategy, why don’t you lay out, for the record, where things stand?

Quincy Smith:

We recognize that the Web is two things. It’s both a new medium…and there my example has always been, look at fantasy football: When you’re nice enough to watch the Jets just pound the snot out of the Raiders on Sunday, on a CBS channel…on fantasy football on CBSSports.com, you start on the Tuesday before and end the Wednesday after.

And what are you doing? You’re personalizing it, you’re becoming more of a fan of the game [Smith goes on to praise CBSSports.com's feature set]. All of those things are additive, so when Sunday comes in, you’re actually more of a fan, and you’ve even more convinced you’re going to watch that broadcast show.

Now, I realize that sports is reasonably bulletproof, and a good case study to begin with versus some of the other programming, but the fact is, the Web is a new medium. So what do I also mean? Tech reviews on CNET, Money Watch being watched on BNET. GameSpot videogame reviews.

Access to content that CBS didn’t already have, that are additive–both in their own right online, with the margins that the CNET business is used to, and where we’re getting just stronger and stronger from a margin perspective–and potential content that can also be applied to our [local TV stations owned by CBS], our affiliates, our broadcast news, as well as the radio. So that’s the side of our business that is $600 million revenue and $50 million-plus profit on the bottom line.

The other side of the Web, the side that is most thought of by many journalists, is the threat of an IP-deliverer of video. And how you turn that threat into an opportunity.

And so, from that perspective, as  you know, we didn’t go ahead and say, “Okay, we’re going to lock down and stream, with all of our other peers in broadcast, and come up with the same rules, and embed and right-click this and go away.” I’ve never had a beef with Hulu. Hulu’s always worked as a great service. That’s part of the problem.

As a network, we need to make sure that our content is being seen where the dollars matter. And right now that’s on air. Opportunities like TV Everywhere–we’re not putting all of our eggs in that basket, though we are big advocates of it–are ones where you can actually take and expand and extend the television market online, so it doesn’t matter what screen you watch “CSI” on; what matters is that you watched it, it counts and you saw the ads.

But until that happens, it’s crazy to just stream the shows for zero economics. When in fact you can make a lot more money doing things that are additive and complementary to the rest of the CBS line. That’s where CBS interactive comes in now.

Kafka: But TV viewers are showing an increasing interest in watching their programs on the Web, whether from legal services like the Web or illegal torrents and pirate sites. Don’t you need to reach them where they are?

Smith:

Now, if you really look at those numbers, what they’ll say is [online and offline video are] both growing, right? We’re having the best year ever as America’s largest broadcast network, and I think that 99.9 percent of that–this is the quote I’ve never been able to get in there–is that’s [because] of the great content that we have. There’s some infinitesimal basis point that’s relevant [to CBS ratings because] we are making sure that when people watch it, they’re more inclined to watch it on television. For now.

Once that solution moves, once those economics move–whether that’s more ads, [higher] CPMs, more ad buyers….You and I can say all day long, “We’re sold out on Web video. That’s going really well. It’s sold out.” Well, no kidding, it’s sold out. It’s a $700 million market. The television market is $120 billion. And of that, $700 million, half of those [ad buyers] are spending  90 percent of their time doing Google keywords, not buying online video.

The key is, how do you turn television buyers into video buyers? And that’s where a solution like TV Everywhere comes into play.

And by the way, looking at [Hulu CEO Jason] Kilar’s comments the other day, in Colorado [at an industry convention], he sees that too. He’s more sophisticated on this stuff than most anybody. From the perspective of, he understands that’s where the big dollars are. And so he probably went at it as, “I’m going to aggregate all the people first, so hopefully things like TV everywhere come to us.” From our perspective at CBS, we’ve got to go to them.

I don’t hate Hulu. Hulu’s world-class video viewing. What I don’t understand is, why license all that content to something that works that well, that seamlessly, yet–without the economic model around it?

Shapiro says the company, which has been primarily focused on playing video and selling ads on its own site, will now be concentrating on a new “Video Compass” player that users will have to download onto their Web browsers.

Shapiro says the company is laying off 25 people and will have a staff in “the mid-40s” when the restructuring is over. That’s less than half its size in June of last year, when the company raised another $30 million, bringing the total capital it has raised to $70 million. At the time, Veoh’s investors–which included Goldman Sachs (GS), Intel (INTC), Time Warner (TWX) and Spark Capital–valued the company at about $125 million, pre-money. VentureBeat first reported the layoffs and restructuring last night.

But Veoh’s video Web browser is one of several players in a field dominated by Google’s (GOOG) YouTube, and now Hulu seems to have established itself as a clear second place.

Comscore (SCOR) says Veoh’s audience peaked in March of last year, when four million viewers watched 33.7 million videos on the site. It says that by February of this year, Veoh’s audience had shrunk to two million viewers watching 16.5 million videos. Every Web publisher disputes third-party measurements, but in this case, Veoh says Comscore’s data are way off: It says it has 23 million unique users watching 200 million videos.

Shapiro insists that the company will continue to support its original video site, but argues that there are more opportunities with its new browser plug-in, which suggests videos to users who are searching for things on other sites. So if a Compass user was searching for, say, “CSI” on Google, it’s possible that the Compass plug-in would offer up a clip or episode of the CBS (CBS) show, via a player that would launch on top of the site.

“The website is extremely mature. It’s been around for 3 and a half years. It’s extremely successful,” Shapiro said. But “quite frankly, there are a lot of things like that. We love it and will continue to invest in it. It’s just that we also see that we have something that no one else has in Compass, and we’re saying we are going to be investing in and supporting that.”

Mitgang came to Veoh in July 2007 from Yahoo (YHOO), and shortly after that the company became enmeshed in a high-profile copyright lawsuit with Universal Music Group. The suit is still ongoing, and though Veoh has won several recent points, people familiar with the company tell me that the legal bills have been significant. I asked Shapiro if the cost of the suit had anything to do with the restructuring, but he declined to comment.

Here’s the press release:

VEoh NETWORKS TO Intensify FOCUS ON ITS SUCCESSFUL
VEOH VIDEO COMPASS™

Company to Streamline Efforts around Omnipresent Video Discovery

SAN DIEGO, CA (April 1, 2009) – Veoh Networks, one of the leading innovators in the online video arena, announced today that the company will be focusing its efforts around its highly successful Veoh Video Compass™ application.  Video Compass is a browser plug-in that makes video discovery a truly seamless experience, enabling video to be played while on every major search engine, portal and commerce site.  It enhances the browsing experience by surfacing recommended videos that are relevant to a consumer’s search terms.  These video recommendations – based on the viewing behavior of millions of online video users – make it easy for consumers to discover and watch videos from an index of millions of videos from around the Internet.  Veoh adds over 25,000 new Video Compass users daily and supports millions of recommendations each day on major web sites such as Google, Yahoo!, YouTube, Ask, MSN, Amazon, IMDB, Craigslist, eBay, Wikipedia, etc.

Meanwhile, Veoh.com, the company’s popular video portal, continues to generate more than 200 million video streams each month from a wide range of independent and traditional content publishers such as ABC, CBS, ESPN, Viacom, and Warner Bros.  The site reaches over 23 million unique users each month with average engagement time at more than 100 minutes per user, and helps dozens of blue chip advertisers reach a broad and highly targeted audience.

As part of Veoh’s continued focus on innovation, Dmitry Shapiro, Veoh’s Founder and Chief Innovation Officer, will be stepping in as CEO.  Shapiro replaces Steve Mitgang.

Shapiro stated, “Veoh was founded in early 2005 when video on the Internet was at its very beginnings.  Today after four years of being a pioneer in the online video space, we know a tremendous amount of what viewers, publishers, and advertisers want.  We have always believed that video discovery and personalization are ultimately the important problems to solve in the world of billions of videos, and have invested heavily in technologies to support that belief.  Video Compass is the latest innovation from Veoh that makes video discovery omnipresent.”  Video Compass can be downloaded at http://www.veoh.com/videocompass/.

As part of this new concerted effort, Veoh will be streamlining its organization to better enable the company to focus on providing compelling offerings to consumers, partners, and advertisers.

About Veoh Networks
Veoh Networks is an innovative Internet Television company that delivers broadcast-quality video programming via the Internet. Veoh has more than 100,000 content publishers – from CBS, Viacom’s MTV Networks, ABC, Warner Bros. Television Group, ESPN and Lions Gate to thousands of independent filmmakers and content producers.  For advertisers, Veoh offers compelling ways of engaging with a targeted audience and measuring performance of their ad buys.

Veoh Networks is a privately held company that is backed by leading technology and media investors, including Shelter Capital Partners, Spark Capital, Michael Eisner’s Tornante Company, Goldman Sachs, Time Warner Inc., Intel Capital, Adobe Systems Incorporated, Gordon Crawford, Tom Freston and Jonathan Dolgen. The company’s principal offices are in Los Angeles and San Diego, California.

But until then, if you want to see your favorite stuff on the Web (legally), you’ll need a well-annotated map: You can see ABC shows like “Lost” on Veoh, but not on Joost. Joost can show you stuff like CBS’s “CSI,” but not NBC’s “Heroes”–you’ll need to go to NBC.com or Hulu for that. Etc.

The newest set of directions: You’ll soon be able to see Viacom shows like Nickelodeon’s “SpongeBob Square Pants” and MTV’s “The Hills” on Sling.com, giving the video site something you can’t get on Hulu or Google’s (GOOG) YouTube–but can get on Joost and DailyMotion.

Except that Hulu already shows full episodes of two of Viacom’s premiere shows–”The Daily Show” and “The Colbert Report”–via a one-off deal with Viacom (VIA). And… Sling redistributes all of Hulu’s content except for those two shows. [UPDATE: Sling will be getting both of those shows under terms of the new Viacom deal, I'm told.]

Confused? Of course you are. Because there really isn’t any rhyme or reason to this.

So while the networks and the video sites spend time on business development deals, it’s hard to begrudge those who throw up their hands and just go find what they want when they want at various torrent sites like The Pirate Bay.

In the meantime, here’s a (legal) clip from last night’s Daily Show, via Hulu.

That is almost certainly a record for a Web-only event. But it’s a nonevent by mainstream entertainment standards.

A poorly performing show on network TV, by comparison, draws millions of viewers: Recall that GE’s (GE) NBC canceled “Quarterlife,” the soap opera that started out on MySpace, after it drew an audience of 3.1 million in its debut. A bona fide hit draws many millions more: Last Thursday’s episode of “CSI,” for instance, garnered more than 18 million eyeballs.

Not fair to compare a weeknight audience to one on Saturday nights? OK. Try this: Last year, before anyone had ever heard of Sarah Palin, “Saturday Night Live” was averaging more than five million viewers.

You can’t blame the modest audience on a lack of effort on YouTube’s part. The video site generated plenty of publicity in advance of the event. And heavy promotion on the site itself all but compelled visitors who ventured onto YouTube last night to check it out.

Part of the issue, I think, is that while the show had a smattering of sort-of-popular singers (Katy Perry, Akon) there was no one really huge. Most of the show was dedicated to viral video stars/oddities like Tay Zonday. And the point of viral videos is that you see them on your own time, serendipitously: You take a couple minutes out of work on a Tuesday afternoon to watch Tay Zonday sing “Chocolate Rain” because your friend sends you the link. Not because he’s appearing live on Saturday night.

Could YouTube rustle up a bigger audience for a live event in the future? Absolutely. It’s one of the biggest Web sites in the world, so if it had a truly compelling show, instead of a niche event, it wouldn’t be hard to get the word out. And if parent company Google (GOOG) wanted to lend a promotional hand, game over.

So maybe that’s coming down the pike. In the meantime, if you didn’t tune in last night, here’s a sample of what you missed: Katy Perry singing “Hot ‘N Cold.”