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YouTube could undercut its competitors in music streaming.
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YouTube CEO Susan Wojcicki wants to sell you a YouTube subscription. Source: TechCrunch/Flickr
YouTube could soon explore new ways to monetize its content.
YouTube CEO Susan Wojcicki, speaking at Re/code's Code/Mobile conference recently, noted some users might be interested in paying a small fee or a subscription price in order to remove ads from videos.
YouTube is a growing part of Google's (GOOG +0.00%) (GOOGL +0.00%) overall ad revenue. Last year, YouTube accounted for approximately 11.1% of gross ad revenue at the company, according to eMarketer. That's more than double its revenue contribution in 2011.
But YouTube could probably make more money by adopting a multipronged approach, one similar to the free and paid tiers offered by Pandora (NYSE: P), Spotify, and Hulu. Removing ads is supposedly one of the perks of YouTube's long-awaited music service, but only for music videos hosted on the website. That service is expected to cost $10 per month, but could YouTube get away with charging less?
How much would YouTube have to charge?
Last year, YouTube generated an estimated $5.6 billion in gross ad revenue. Surprisingly, most of that did not come from pre-roll video ads. YouTube only generated $850 million in video advertisements in 2013; the rest came from display ads and promoted videos.
YouTube accounts for a little less than 20% of total U.S. digital video advertising spending, and that number has remained consistent as the entire market grows. In five years, digital video ad spending is expected to grow to approximately $14 billion, and at that 20% YouTube would gross approximately $2.8 billion.
Using those estimates and applying the 80/20 principle to YouTube's revenue (i.e., 20% of users account for 80% of revenue), I estimate about 200 million YouTube users (20% of its 1 billion monthly users) would generate approximately $2.25 billion in gross video ad revenue. In other words, each of those users would generate about $11.25 in 2019.
As such, YouTube could get away with charging as little as $1 per month to get rid of all of its pre-roll video ads.
That rate is extremely low, considering Pandora subscribers pay $5 per month to avoid ads on its Internet radio service. Pandora only plays four to six 30-second ad spots per hour, while most popular YouTube videos have a pre-roll video ad. With YouTube's popularity as a music streaming service, eliminating the ads would vastly improve the experience. Pandora pegs it at $5 per month, but YouTube could undercut that amount.
Would people actually pay for YouTube?
While there isn't overwhelming demand for an ad-free YouTube experience, there's more than enough to make the experiment viable. According to a survey from MIDiA Research, 7% of YouTube users would pay to remove ads from music videos. That's 70 million people.
That survey specified music videos only, so the market for YouTube subscriptions might actually be bigger, perhaps closer to 100 million. At $1 per month, the revenue from 100 million subscriptions would match YouTube's total expected video ad revenue for 2014. The rest would be gravy.
YouTube would likely test the price elasticity of such a subscription service, but even at rock-bottom pricing the company would benefit.
Combining Google's technology acquired from Songza, as well as the "Mix" technology built on top of YouTube's platform, YouTube could offer a competitor to Pandora at a lower price. There's clearly a market out there for a YouTube subscription. It's just a matter of how much the company wants to charge.
What this means for investors
For Google investors, YouTube is a growing part of the business. But much of YouTube's revenue comes from ads outside of videos. That's not a bad thing, especially considering the next few years should experience strong growth in digital video ad spending, where YouTube is at the forefront.
Consider, however, that video ads are the most annoying ads on the platform, and a good portion of power users would pay a premium to get rid of those ads. Introducing things like YouTube Music Key or a paid subscription tier would only boost YouTube's total revenue.