Cashing In Online

Remember dear little YouTube? That offbeat, online video site that served up billions of videos each month, but didn't have a clue about how to turn a profit? It looks like it might be finally turning a corner.

Just a week after a Barclays analyst estimated that the site would show a profit this year (with revenue rising 55% to $700 million), Google (Nasdaq: GOOG  ) CEO Eric Schmidt decided to tell The Financial Times yesterday that he "assumes" YouTube is now profitable. Not exactly a ringing assurance, but it still caps a remarkable turnaround for a division that Credit Suisse estimated last April would lose a whopping $470 million in 2009.

How did YouTube pull it off? I think three factors were at work:

  • Google's ad sales machine kicked into overdrive. People often forget that Google's insane profitability isn't just the result of its search prowess, but also of its unparalleled skill in monetizing Internet traffic. In the case of YouTube, this has meant signing up 90% of the Web's top 50 advertisers, delivering a variety of ad formats that generate revenue without driving away viewers, and, most of all, figuring out how to match quirky, user-generated content with relevant ads.
  • Server, storage, and bandwidth costs have been plummeting. You don't need to be an expert on the IT world to know that stuff gets cheaper over time, but all the same, the numbers can be staggering. Streamingmedia.com has estimated that it now costs Netflix (Nasdaq: NFLX  ) only $0.05 to stream an average movie to an Xbox 360. That's compared with $270 for using up a similar amount of bandwidth back in 1998. Since Google reportedly owns quite a bit of its own fiber capacity, its bandwidth costs might be even lower.
  • Advertisers have become more comfortable with YouTube's content. There have been grumblings over the years that advertisers don't want to deal with YouTube's user-generated material. That they'd much rather be tied to streams of TV shows and music videos than clips of dog tricks and breath mint/soda pop stunts. But this attitude always struck me as misguided: As long as the content is merely offbeat, and not offensive, there's no need for advertisers to feel squeamish. And judging by Google's claim that more than a billion YouTube video views are monetized each week, a lot of advertisers now seem to agree.

YouTube can't rest on its laurels, though. While its status as the king of consumer-uploaded Web video is unassailable, it has a lot of work to do if it wants to match a site like Hulu, which is backed by the likes of News Corp. (Nasdaq: NWS  ) (Nasdaq: NWSA  ) and Disney (NYSE: DIS  ) , as a hub for professional content. Or, for that matter, challenge Apple (Nasdaq: AAPL  ) and Amazon.com (Nasdaq: AMZN  ) in the realm of paid video downloads and rentals.

Part of the problem is that while YouTube has become an easy site to search, it (unlike Hulu) is far from an easy site to browse, given the torrent of user-generated content that gets uploaded every day. And the fact that this content often gets placed right next to the professional stuff probably doesn't sit well with more image-conscious studios.

If Google can get a handle on making YouTube's professional content stand out and be easy to browse, all without damaging the user experience for accessing the other stuff, its massive clout in the online video world could allow it to play catch-up against the likes of Hulu and Apple. But if Google can't, then its failure will put a limit on just how much money this suddenly viable business will make.

Fool contributor Eric Jhonsa has no position in any of the companies mentioned. Walt Disney is a Motley Fool Inside Value recommendation. Google is a Motley Fool Rule Breakers selection. Apple, Amazon.com, Walt Disney, and Netflix are Motley Fool Stock Advisor picks. Try any of our Foolish newsletters today, free for 30 days. The Fool's disclosure policy is not economically sensitive.


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