The Tycoon Report

Why you should not invest in this technology yet

Unless you’ve been hiding under a rock all year, chances are you’ve read at least 1 story about the battle taking place in the Online Video market.  After Google (Nasdaq: GOOG) launched its video service, Google Video, last year, many companies have thrown their hats into the ring to take on the search engine Goliath.

However, the company that dominates this space isn’t Google, or Microsoft (Nasdaq: MSFT) or Yahoo! (Nasdaq:YHOO) or even AOL (Nasdaq: TWX) – it’s the tiny Silicon Valley start-up, whose offices are above a Pizza shop in San Mateo, California: YouTube.com.

This company is the clear leader in the delivery of online videos – serving up approximately 70 million videos each and every day.  The interesting thing is that most of these videos aren’t full length feature films, they aren’t even 30 – 60 minute episodes of “hot” TV shows (as we find on Apple’s iTunes service).

YouTube is best known for serving up short, 2 minute clips – most of which happen to be ripped from copyrighted content sources, but more on that later.  Regardless of the original source of the content, ALL of YouTube’s videos are posted by its users.  The site simply acts as a “hub” where people come to post videos they like or videos of their own.  Then other users come along and check them out, all free of charge.

The bottom line is that the online video market is a hot sector right now – actually it always has been.  I remember back in the good ol’ “dot com days” when sites like Pseudo.com were serving up their own TV shows right over the web.

The only problems back then were the costs and the technology – it cost too much to serve and store the content, and broadband connections just weren’t as widely adopted as they are now.

Now, the majority of the Internet connections in this country (home and office) are on high-speed cable or DSL lines.  Downloading large video and sound files is no longer an issue for most folks.

Combine that with the drop in storage and bandwidth prices corporations pay, and you have the makings of a new genre of web sites: Web sites that can serve up terabytes of content for very little money (relative to their “dot bomb” counterparts at least).

Video Business is BIG Business

IDC estimates that in 2005 the online video market generated roughly $230 million in revenue, and by 2010 that number will explode to $1.7 billion!

However, not all of that is going directly to the sites that share the videos.

Much of that revenue is being generated by the backend companies that supply the bandwidth for delivering these videos on the sites.

For example, YouTube uses privately held Limelight Networks to serve up its video content.  Other companies use publicly traded Akamai Technologies (Nasdaq: AKAM) – it’s estimated that Akamai serves up over half the video content on the web! 

(Could be some profit opportunities here as well – Akamai has done very well over the last 12 months.)

Interestingly enough, Google and Yahoo! have built their own content delivery systems and don’t use a 3rd party provider.

Which actually brings me to my next point …

Why are companies getting involved in this space anyway?

Well, for a company like AOL, with Time Warner as a parent company, which owns a motion picture studio and a ton of TV networks, the benefit is obvious.

The company will have a venue to showcase its shows and movies.  Or it can even test pilot episodes on real consumers and get instant feedback.  Not to mention all of the advertising dollars these types of clips could generate.

And for premium content – full length films and TV episodes – AOL can simply charge users on a pay-per-view or subscription basis.

Companies like Google, Microsoft and Yahoo! will be forced to cut deals with Time Warner and other media companies in order to serve up the same content and command the same advertising dollars.

For the pure-play web companies, that’s all it’s about:  Get as many users to the site as possible, and serve the most targeted advertisements to them.

But YouTube has built its business on serving up content its users post, without regard for the original source.  This has both hurt and helped the company.  Let me tell you what I mean.

By allowing users to post their own content, YouTube opened the flood gates for hobbyists and independent directors alike.  People now have this great medium from which they can push their own short films or even funny home movies.  I have to admit, there is some good stuff on the site.

But for the most part, the high-trafficked content on YouTube is from copyrighted sources. 

For example, I find myself watching music videos more than anything on that site. My friend enjoys downloading Saturday Night Live clips.

YouTube has made it a point to cooperate with Copyright holders as quickly as possible when they request to have content removed from the system, but the company doesn’t proactively remove copyrighted clips.

This is probably why the company has yet to implement a real advertising solution.

Right now YouTube simply offers standard banner and pay-per-click advertisements at the top of its web pages (which are provided by Google actually).

Furthermore, the company states that it isn’t profitable yet. 

Serving up 70 million videos daily would give the company the opportunity to serve up 70 million advertisements – which could be a lot of revenue, but might not be a lot of profit.  Let’s talk about YouTube’s costs.

It’s estimated that it costs roughly $.001 to serve a single minute of video over the Internet for “bulk providers” like YouTube.  That means if the company is serving up 1 minute clips, 70 million times per day, the company’s daily infrastructure costs should be in the neighborhood of  $70,000.  This equates to $2.1 million per month (a Forbes article back in April pegged this number at about $1 million per month, but traffic has gone up dramatically since then so the real number is likely somewhere between the two).

So is it profitable for a pure-play video company to compete in this space?

In my opinion, no it’s not.  

Once copyrighters realize how much money they’re losing by allowing their footage to be pirated across YouTube, they’ll eventually take action.

Once that happens, YouTube’s core audience will jump ship to services that carry these videos legitimately.

YouTube’s best bet is to be acquired by a larger company. 

In my opinion, AOL should be the one to do the deal.  With a vast repository of its own content, an existing distribution network work would instantly allow the company to begin monetizing the YouTube brand.

AOL would also be able to reduce YouTube’s cost structure due to reaping the benefits of AOL’s economies of scale.  The company would also be able to maximize revenue due to the existing advertising agreements AOL already has in place with other companies including Google.

To me, it’s a match made in heaven – but AOL hasn’t been the company running out to buy up other tech outfits.  Yahoo! and Google have really stolen the show when it comes to gobbling up Web 2.0 companies.

It’ll be a sad day in the Valley if AOL lets Yahoo! or Google steal this company away too.