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The video-on-demand market for paid rentals is currently ruled by pay TV services, but the Internet-on-demand market is growing in strength, according to the NPD Group.

Pay TV VOD services hit $1.3 billion in revenue for 2011, according to the market research company, while the iVOD market reached $204 million. The report found that 4 million fewer pay TV users paid additional fees to watch movies in August 2011 vs. a year earlier.

Including the services of iTunes, Amazon, Vudu and others, iVOD reached 7 million users compared to 40 million for pay TV VOD. Internet VOD also poses a possible challenge for pay TV’s non-movie services.

“IVOD users reduced their time spent watching TV shows, news and sports via pay TV companies by 12% between August 2010 and August 2011,” said Russ Crupnick, senior veep of industry analysis for the NPD Group. “Pay TV operators now must not only defend their movie VOD revenues but also counter an emerging threat to basic programming.”

According to NPD, users perceive iVOD as offering a better value and better movie title selection than pay TV.

All findings are based on NPD’s VideoWatch tracking service, which does not consider free or paid viewings of TV shows, subscription services such as Netflix streaming or free movies included in pay TV subscriptions.