In this segment from Market Foolery, Chris Hill welcomes Motley Fool analysts Jason Moser and Taylor Muckerman to the show as they consider the problems that come with being the largest site in the world for user-generated video. YouTube is algorithmically dependent, but Alphabet (NASDAQ:GOOG) (NASDAQ:GOOGL) has yet to come up with the internal controls that can prevent ads from major partners popping up next to videos with objectionable or offensive content. Keep in mind these are some of the world's biggest companies -- who have begun pulling advertising dollars -- so the question is not a matter of if this problem can be fixed, but how much Google will spend to fix it and how quickly.
A full transcript follows the video.
This video was recorded on March 27, 2017.
Chris Hill: We have to start with a story that's been brewing for a little while. I'll be honest. This is a story, I saw a headline on this a week or two ago, and it registered like, huh, that's interesting, and it continues to balloon. This is the fact that a week ago, Google formally apologized for running customer's ads alongside objectionable videos. We've talked before about YouTube and how important it is in the world of search, and how it's one of the most popular places to search. And you see these stories about, if YouTube was a stand-alone company, it'd be worth somewhere in the neighborhood of $75 billion. Google makes this apology a week ago, and here we are a week later, and I guess, among other things, Jason, probably a reminder that YouTube is a really big place with lots of videos, and therefore it's hard even for the owners to monitor it. The Wall Street Journal had this big story about how Coca-Cola, Microsoft, Amazon, Procter & Gamble, these mainstream brands, are still seeing their ads alongside videos with racist content, anti-Semitic, all of this stuff where the advertisers, rightfully so, say, "I don't want my ads next to that."
Jason Moser: Yeah. We're going to hit a point here, sooner or later, it's going to be like you do with your kids, they can say sorry only so many times before you're like, "I get that you're sorry. Just don't do it again. I'm not looking for sorry anymore." So, I think with Google and YouTube, this is obviously something that's a big deal. It's not something that immediately impacts their bottom line. When we talk about the bread and butter for Google's money-making machine, it's search advertising. But, there's a good percentage, close to 20% of that money, comes through advertising with third-party customers. So, when ads go next to objectionable content, of course, those parties are going to express concern, they want to know what's going on, why is this happening, and what are you going to do to make it stop? Because there is no middle ground here. It's just, flat-out, "This is unacceptable, don't let it happen anymore." This is sort of one of those things with this age of automation, as we go more toward automating everything, particularly on the consumer-facing side, I think it's really difficult to ever fall back on the old, "Well, the algorithm did it, it wasn't our fault." Because, ultimately, someone built the algorithm.
I think what Google needs to figure out here is, what is happening to make this happen, and how do they fix it? And whether it is through technology, whether it's through humanizing it a little bit more, and actually bringing on more people to add a human touch to these customer relationships, they need to do something with this before this gets out of hand.
We've talked about this a lot, especially in MDP, we own shares of Alphabet, and we own shares of Facebook (NASDAQ:FB): We own a far larger position in Facebook, and part of the reason for that is, when you look at the direction things are headed in social, and in internet behavior, there's no question that Facebook is becoming a place, not just Facebook, but its properties, whether it's WhatsApp or Instagram or whatever properties they buy in the future, that's a place where eyeballs go to hang out for a while. Google is more utilitarian in nature, right? You need some information, you find it on Google, and you go to your next place. Facebook is catching up very quickly. They've expressed some concerns that perhaps the last decade was the Google decade, and perhaps this next decade is the Facebook decade. If that is the case, and the numbers certainly point toward that, the argument could at least be made there, Google has got to figure out something yesterday as to how to address this and fix it, because blaming it on the technology is not going to fly.
Taylor Muckerman: I'm pretty confident that they're going to figure out a way to fix it. Especially when you're talking about Facebook, they had the whole issue around the election with fake news on their site. And you had a group of college kids come out and make an algorithm that was able to identify fake news on the site, and they've been able -- not using their algorithm, but, Facebook has been able to address that. I'm confident that Google will. You talk about big headlines about this, but I'm waiting for the headline to come out that says, right now, people think that less than 1% of Google's revenue is at risk because of this. It's a $90 billion revenue company, I've seen headlines that say $750 million might come off of YouTube's revenue in 2017 because of this. Bigger fraction of YouTube's revenue, but you're not just an investor in YouTube when you buy a stock in Alphabet. So, I'm still confident that they'll figure it out. And between the two of them, Facebook and Google, they're pretty much the only two that are growing in the digital ad space. So, I find it hard to believe that advertisers are going to completely move away from Google. Right now, Facebook is really the only alternative, and that space would become far too crowded too quickly if there was a mass exodus from Google. I'm fairly confident that, because you said 20% of their revenue comes from that search advertising, they're going to figure this out.
Hill: It is a small amount of money, and yet, when you look at the headline of Pepsi, Starbucks, General Motors, Wal-Mart have pulled some of their ad spend with YouTube. Those are big-name companies. I think, if you're Facebook, you're not throwing a parade over this, but I think if you're selling video advertising for Facebook, you're on the phone to different media agencies, and I also think television networks. If you're a broadcast network or cable network, to use your phrase, Jason, you're putting the human touch to work, and you're calling these companies and saying, "Listen, don't take a risk with the programmatic algorithm approach to YouTube. You know what you're going to get with our networks, and you're going to get something that associates well with your brand."
Muckerman: With some of those companies you mentioned, those are companies that can afford to pull back for a week or two on advertising and make a statement. That's almost advertising in itself. They're still advertising using Google's name, just not using Google's platform. So, I think they'll come back eventually. Probably not too far down the line. Those brands are brands already. You're probably looking at the smaller players, questioning whether or not they can afford to back off of Google's platform a little bit more than Coke or Pepsi.
Moser: Yeah, and I think it's also worth noting, for the longest time, YouTube has been synonymous with online video. That's what got this ball rolling. And they've enjoyed such a phenomenal competitive position for so long. What an acquisition Google made for ... what did they buy it for?
Hill: $1.6 billion.
Muckerman: Pennies on the current dollar.
Hill: And the reason I remember it was $1.6 billion is because I was one of the people saying, "Boy, they sure did pay a lot of money for that."
Moser: So, I think you fast forward today and you see how this competitive environment has changed, Google and YouTube are not the only players in the online video space. And you see all sorts of companies, from Facebook and Twitter to Verizon and AT&T developing their online video offerings. To your point, I think it's very easy to see these customers pulling back for a week, a month, and saying, "Hey, let's reasses what's going on here." Google and YouTube are too big to say, "We don't want to be a part of your environment." That's just foregoing a tremendous reach that anybody in their right mind would want to be a part of. But, what it could do is, it could result in some pricing competition. It can certainly make Google have to get in there and compete a bit more on pricing, lose a bit, perhaps, of that pricing power, particularly as we ship to mobile, and we know those mobile advertisements are not nearly as lucrative as the desktops were, from a real estate perspective. But, these are smart people running a very, very big company. The solution to this really is as simple as, listen to your customers and give them what they want. So, from that perspective, I don't see any reason why they can't fix it. I guess it's going to be interesting to see how they fix it, and how quickly they go about fixing it, because they don't enjoy that same competitive position that they enjoyed, perhaps, five years ago.
Suzanne Frey, an executive at Alphabet, is a member of The Motley Fool's board of directors. Teresa Kersten is an employee of LinkedIn and is a member of The Motley Fool's board of directors. LinkedIn is owned by Microsoft. Chris Hill owns shares of Amazon, Coca-Cola, and Starbucks. Jason Moser owns shares of Starbucks and Twitter. Taylor Muckerman owns shares of Alphabet (C shares), Amazon, Starbucks, and Twitter. The Motley Fool owns shares of and recommends Alphabet (A shares), Alphabet (C shares), Amazon, Facebook, PepsiCo, Starbucks, Twitter, and Verizon Communications. The Motley Fool has a disclosure policy.