June 1st, 2009
The cure for YouTube's ills: Charge for uploads
Business models that revolve around “free” are never free since someone always foots the bill. Meanwhile, far more companies think they have more growth and scale to lower costs than they actually do. YouTube may be one of those companies that merely thinks it has the scale to eventually make money. In fact, those 20 hours of video uploaded every minute on YouTube costs money—too much money. The solution? Charge a small fee for uploads.
That’s the crux of an argument by Bernstein analyst Jeffrey Lindsay. He maintains that YouTube’s business model is doomed and that network effects—the increased value derived from increased usage—are never an excuse to avoid coming up with a business model. The argument is notable given all the hubbub over free vs. subscription (micropayments and otherwise) are front and center. Let’s dismiss the backlash that would ensue if YouTube started charging and listen to the argument.
In his weekend missive, Lindsay wrote:
In contrast to the latest wave of business articles about “free” as the new business model, we would argue there is no such thing as free – someone always pays. YouTube is an interesting case in point. Revenue estimates for 2009 are in the $200 to $250 million range, but costs are estimated to be somewhere in the $400 to $700 million range. Who makes up the difference? Google shareholders, of course. For those of us who lived through the “new economics of the Internet” in the late 1990s, seeing it happen all over again with Google brings a wry smile. In fact, what seems to be emerging is an Internet variant on an old GM adage: “we lose money on every car – but we make it up on volume.” Substitute video for car and you have a pretty accurate description of YouTube’s current business model.
And then there’s this history lesson:
Network effects were known long before the Internet. They came to prominence in the 19th century with telephony – if only one person has a phone, telephony has zero value; if two people have phones they can call each other and the service has some value; if almost everyone has a phone the service becomes one of the most successful industries of modern times. The interesting thing about the pioneers of telephony is that they seem to have been much better at devising business models than their modern Internet counterparts. Charging for calls by the minute was smart, but charging by time of day and distance was pure genius— establishing a business model that has lasted over a century. Imagine what would have happened if Bell Telephone had allowed people to call anyone anywhere at any time, for as long as they liked for free—not for a fixed monthly rate, which may have made some sense, but for absolutely nothing. Had the industry survived, which is highly unlikely, it would look rather like Skype today.
The problem: Many Internet businesses have network effects, software effects or market effects. The rub: Most of them don’t. This network effect delusion leads companies to grow at any costs in hopes of being valued by subscribers instead of revenue growth. Through the lens of the late 1990s, only AOL, Amazon, eBay and Yahoo had true network effects. The rest: Pets.com, eToys, Webvan etc. YouTube may fall into that latter category (we’ll never completely know since it’s part of Google).
What we have here is a lack of business model innovation. Lindsay notes that AOL, Yahoo, eBay and Amazon tapped into real business models. Those companies were hungry. In addition, the latest dot-com heroes are mired in a corporate structure that forgoes joint ventures and other models that may work. In the end, the model doesn’t matter—as long as you cash out in time.
Getting back to his YouTube example Lindsay says that YouTube goofed by not partnering with Viacom. In fact Hulu will be the Amazon while YouTube will play eBay.
The problem remains that YouTube is generating only modest ad revenues but has almost exponentially growing costs. Granted, Google has the most efficient server farms in the world and, granted, they have lots of dark fiber to light up and, granted, they can ride Moore’s law down its two-year exponential cost curve, but the problem is that people are now uploading 15 hours of video every minute and many of these videos are being watched overseas – where the ad revenues are meager if they exist at all. Consider YouTube fans in, say, Eastern Europe (there are many—the service is very popular there), along with the Middle East, Turkey and North Africa. Eastern European users upload videos in their native land, and most are stored on YouTube servers in the U.S. or Germany and then streamed back to be watched in Eastern Europe. Even if a major brand advertiser could be persuaded to buy an ad slot, would it pay to stream its ads in Uzbekistan? Moreover, consider the viewer stats. Very few Uzbek videos, for example, will have large viewership – eliminating the value of any edgeserving strategy and so destroying any economies of streaming at scale. Can Google ever make any money in these markets with YouTube?
Things might not have been so bad for YouTube had it not been for Hulu. The fundamental problem with user-generated material is that it cannot support a large advertising load. People will put up with video pre-rolls and interruption ads but really only on professionally-produced content.
Lindsay’s eBay-Amazon analogy with YouTube and Hulu goes further. YouTube looks like a flea market (like eBay). Hulu looks professional. YouTube quality is lacking. Hulu’s isn’t. Lindsay’s point: Professional content will eventually win and ads will follow. YouTube’s chore: Minimize the cost of the video it can’t sell.
Unless Google can pull something unexpected out of the hat with, say, targeting, it is unlikely that advertisers will favor YouTube over Hulu or the Web properties of the broadcasters, for that matter. That leaves the cost side. Is it really a good idea to allow users to upload video of anything? One of our colleagues regularly uploads videos of his pet mouse. Some members use YouTube as a way to share family videos with relatives. Hosting these videos forever has real cost. Is the community really enriched by this service?
So what should Google do with YouTube? Charge small listing fees just like eBay does.
Why not, like eBay, use low but non-zero listing fees to stop people listing rubbish and cover at least some of the hosting cost? If videos score well in user metrics, then they could get a break in their listing fees which, for very popular and advertisable clips, might quickly go to zero. Ad revenues would be split with content providers as now, but if revenue fell below a certain threshold a hosting fee could be applied.
The goal: Prevent folks like Lindsay’s co-worker who constantly uploads video of his pet mouse.
Lindsay acknowledges that YouTube usage may plummet, but by eradicating the site of “irrational uses” Google would discover what people really want. Anything that was good enough to garner advertising would be free. The rest would pay 5 cents an upload. In the meantime, Google should pursue more joint ventures.
Sounds great—in theory. The backlash to YouTube would be stunning if it started charging even a few pennies. You can almost hear the screams of “sell out!” now. Lindsay writes:
We think that if Google is going to survive in the media world, it is going to have to start to look and behave more like a media company. This may run counter to the grain of the Internet management team, but the media companies have been successful for a reason – they have established their business models over the last 50 years, and they work.
More from Lindsay: Twitter: A fine ‘pre-business’ but un-monetizable and a deadly acquisition target
More on YouTube: Did YouTube just find some monetization help?
Download: ZDNet Undercover: YouTube’s video ID system: Is 75 percent accuracy good enough?
Larry Dignan is Editor in Chief of ZDNet and Editorial Director of ZDNet sister site TechRepublic. See his full profile and disclosure of his industry affiliations.
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