How Google Makes Money From YouTube

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Google (Nasdaq: GOOG  ) finally got fed up with the negative rumors around its YouTube video service, and decided to debunk five of the worst ones. I love the smell of indignant napalm in the morning!

Myths? We don't need no stinkin' myths!
We can boil down the five myths Google wanted to dispel into one simple sentence: YouTube videos are short and low-quality, and there's no way Google is making any money off of them.

All of that makes intuitive sense, of course. The average YouTube user can only upload clips no more than10 minutes long, mostly of cute babies and crazy teenage stunts. What advertiser wants their name attached to some grainy three-minute clip that has nothing to do with their product? And the minority of YouTube videos that don't fall into that category are copyright-breaking rips from TV shows, unauthorized music videos, and other non-commercial abominations. Right?

Not so fast, amigo
While short, user-submitted videos form the bulk of YouTube's content library, there's plenty of commercial fare, too. Major music labels from Sony (NYSE: SNE  ) to Warner Music (NYSE: WMG  ) host official music videos, where some of the advertising revenue streams back to the copyright owners.

Premium partners also get to break those limiting 10-minute and 2-gigabyte upload restrictions, so there are plenty of full-length movies to peruse. Most may be indie flicks, but big-time names like Lions Gate Entertainment (NYSE: LGF  ) , PBS, and Time Warner (NYSE: TWX  ) subsidiary HBO all post two-hour films to YouTube.

There will be blood
And where there is content, there will be advertising. According to Google's myth-busting post, "over 70% of Ad Age Top 100 advertisers" ran ad campaigns on the site last year. Just a couple of clicks around the site reveal ongoing banner ads for 3M's (NYSE: MMM  ) Post-it Notes and satellite broadcaster Dish Network (Nasdaq: DISH  ) . There's clearly no lack of advertiser interest in Google's finest eyeball magnet.

Meanwhile, the company is figuring out how to squeeze money from this popular asset. The "oft-cited statistic" that only 3% to 5% of the YouTube site is monetized is "old and wrong." Google says that "we are now helping partners generate revenue from hundreds of millions of video views in the U.S. every week (and billions worldwide), more than any other video site has total views. Monetized views have more than tripled in the past year." And moreover, the company states unequivocally that more views is good news for the bottom line, not bad.

In other words, Google is running ads on quite enough of its videos to put a dent in the bandwidth bills. If increased traffic means more money, then the advertising revenue must outpace the variable costs like bandwidth, electricity, and license bills that keep the content flowing. It's only a matter of time before the torrential volume lets these operating profits rise above the fixed costs of staffing and facilities -- if that hasn't happened already.

The Foolish course of action
So the next time you hear someone making fun of Google paying $1.45 billion for a money pit, you can feel secure in the knowledge that it's old hat. I can think of several acquisitions that made less sense and worked out worse for the buyer than YouTube has for Google. Google has a business plan here, and I wouldn't be surprised to see Big G breaking out YouTube's revenue and operating results within the next couple of years.

When you put the best advertising platform on the Web together with the highest-traffic site anywhere, it's only a matter of time before the cash starts percolating. Now we have some evidence straight from the horse's mouth. Feel free to invest accordingly, before the rest of the market catches on.

Further Googly Foolishness:

Google is a Motley Fool Rule Breakers recommendation. 3M is a Motley Fool Inside Value pick. Try any of our Foolish newsletters today, free for 30 days.

Fool contributor Anders Bylund owns shares in Google, but he holds no other position in any of the companies discussed here. You can check out Anders' holdings or a concise bio if you like. The Motley Fool is investors writing for investors.

Read/Post Comments (1) | Recommend This Article (7)

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Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On July 28, 2009, at 11:27 PM, lazaz wrote:

    You are DEAD WRONG. They are losing a few hundred million a year, they never break out these numbers and will have a big GOODWILL WRITEDOWN within 12 month. The business model DOES NOT WORK, they need to charge members and pay professional content owners, like all new medium. What is really disturbing about your article is that its total speculation, you have no hard data. Really unprofessional.

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