In 2015, Alphabet's (NASDAQ:GOOG) (NASDAQ:GOOGL) Google launched YouTube Red, a paid ad-free subscription service aimed at challenging Netflix (NASDAQ:NFLX). However, YouTube Red never gained much ground against its entrenched rival.
In a recent interview with IndieWire, Susanne Daniels, YouTube's chief of original content, admitted that Netflix was "too far ahead" and that YouTube Red's development remained "in an early stage."
The numbers clearly support that bleak view. YouTube claims to have over one billion users worldwide, but YouTube Red had just 1.5 million paid subscribers in 2016 according to The Verge. Last year, Billboard claimed that YouTube Red and Google Play Music had a combined subscriber base of 7 million. For comparison, Netflix finished 2016 with 89.1 million paid subscribers, and that figure hit 118.9 million in the first quarter of 2018.
YouTube's failure to convert its free users to paid ones is a frustrating one, and probably can't be solved easily for three simple reasons.
1. YouTube's dependence on social media celebrities
YouTube believed that giving its most popular YouTubers original programs, then offering that content as YouTube Red "exclusives", could convince free viewers to pay $10 per month. YouTube also produced its own original films, like The Thinning, which starred top YouTubers like Logan Paul.
That strategy backfired when some top YouTubers tarnished their own reputations with increasingly outrageous videos aimed at growing their followings. Logan Paul mocked a dead body in Japan's infamous "suicide forest", Sam Pepper faked a kidnapping and a murder, PewDiePie made numerous racist jokes, and GloZell Green filmed herself eating Tide Pods -- which caused other attention-seeking YouTubers to do the same.
YouTube disciplined some of those troublesome YouTubers by suspending their YouTube Red projects and dropping some from its Google Preferred ad platform. Nonetheless, these problems highlight YouTube Red's toxic dependence on social media celebrities, and why it remains well behind Netflix in terms of quality original content.
2. A lack of investment in A-list projects
YouTube then started chasing Netflix with original scripted shows like the sci-fi series Lifeline, the dance drama Step Up: High Water, and the Karate Kid sequel series Cobra Kai.
However, the vast majority of its programs still star YouTube celebrities instead of Hollywood talent. That makes YouTube Red look amateurish compared to Netflix's expanding lineup of original programs, which feature a wide range of established Hollywood writers, directors, and actors.
YouTube also seems to be investing more money in original content for free YouTube users than YouTube Red subscribers. For example, YouTube recently added seven new series -- including shows from Kevin Hart, Ellen DeGeneres and Demi Lovato -- to its free site.
That decision seems odd, until you consider that YouTube Red users probably account for less than 1% of YouTube's worldwide user base. Therefore, free YouTube Originals probably generate a higher ROI through ads than YouTube Red subscriptions.
Therein lies the problem: YouTube needs to invest more heavily in YouTube Red's original content to attract viewers, but that money would be better spent on launching new original content for ad-supported users. Meanwhile, Netflix plans to invest $8 billion in original content this year.
3. The confusing YouTube ecosystem
To make matters worse, Google keeps shuffling the pieces of the YouTube ecosystem. Many users are still confused about how YouTube Music, Google Play Music, YouTube Red, and the upcoming YouTube Remix even fit together.
Back in 2011, Google launched Google Play Music, a free service that lets users store their own digital tracks in the cloud and buy digital songs. Google eventually added curated streaming radio stations to the platform, then launched a $10 per month subscription that gave users on-demand ad-free streams, unlimited skips, and offline music playback.
In 2015 Google launched YouTube Music, a free ad-supported app that plays the audio streams of music videos on YouTube. It then bundled a premium ad-free version of YouTube Music with YouTube Red subscriptions for $10 per month.
Recent rumors now suggest that YouTube will bundle together Google Play Music, YouTube Music, and YouTube Red into a single platform -- which will presumably also cost $10 per month. That sounds like a great way to challenge Netflix and Spotify simultaneously, but I suspect that YouTube will botch that launch and confuse users of all three services.
The bottom line
Daniels believes that YouTube Red can eventually "compete with Hulu and Amazon and certainly Apple." However, YouTube's aforementioned problems could prevent it from beating those rivals at capturing paid subscribers -- even though it remains the largest video streaming site in the world.
John Mackey, CEO of Whole Foods Market, an Amazon subsidiary, is a member of The Motley Fool's board of directors. Suzanne Frey, an executive at Alphabet, is a member of The Motley Fool's board of directors. Leo Sun owns shares of Amazon and Apple. The Motley Fool owns shares of and recommends Alphabet (A shares), Alphabet (C shares), Amazon, Apple, and Netflix. The Motley Fool has the following options: long January 2020 $150 calls on Apple and short January 2020 $155 calls on Apple. The Motley Fool has a disclosure policy.