YouTube just announced its plans for a paid subscription offering for its video streaming platform called Red. At least some of the Google subsidiary's 1 billion monthly visitors will express interest in removing ads from YouTube and gaining access to an on-demand streaming service at the same time. Subscriptions represent an opportunity for YouTube to start generating a profit for Alphabet (NASDAQ:GOOGL) (NASDAQ:GOOG) shareholders.

Source: YouTube

That may be why YouTube is looking to entice its most loyal viewers to subscribe by placing some of its most popular content behind the paywall. Last year, YouTube announced that it's funding new content from some of its most popular creators. And in May, it made five strategic partnerships for exclusive content with popular creators. Some of that content will only be available to Red subscribers.

Originals work
It's well known that Netflix hasinvested heavily in original content for its streaming video-on-demand service. Those originals aren't available to stream anywhere else (but you can buy them on DVD after the first window expires). Netflix has seen subscriptions steadily grow and average watch time balloon since it first started financing original content.

YouTube, too, has seen the average watch time on its platform continue growing as it makes partnerships and more of its creators become increasingly mainstream figures. Last quarter, Alphabet management told investors that watch time on YouTube was up 60% from the same time a year ago. However, management didn't give any details on what exactly is driving that growth.

With competition from numerous other tech companies such as Facebook (NASDAQ:FB), however, it's a good bet that there are two things driving that growth. First is the access YouTube has to music videos. YouTube remains the most popular free music streaming service in the world, streaming millions of music videos every day. Second is the growing collection of creators that have built an audience on YouTube.

Facebook has reportedly been in talks with music labels to gain access to music videos and the rights to stream music, but it's had trouble attracting famous YouTube creators to its video platform. Not only does Facebook not offer much in the way of revenue sharing, but it also can't match the audiences those creators have spent years establishing on YouTube.

YouTube, then, is killing two birds with one stone. It's keeping content creators from considering posting content on Facebook and convincing the service's most active viewers to pay for access to the content they want most.

Making a profit
YouTube is spending millions of dollars to produce some of this original content, and it will be available only to the few who sign up for its subscription plan. Because the plan will be a two-in-one deal with ad-free YouTube and unlimited music streaming, the record labels will take 70% off the top of any subscription revenue. Additionally, it's unclear if YouTube has to split any of the subscription revenue with creators, or if that cost is included in the upfront production costs. As the costs add up, it seems unlikely YouTube will make a profit off of these original productions.

But they can be used as a loss leader to get more people to sign up for a subscription service that appears to be profitable in general. The bigger the paid subscriber base for YouTube, the more profitable it can become as upfront content costs are spread across more viewers.

Adding exclusive content (and music streaming) to the subscription offering increases the breadth of the audience YouTube can reach, lowering the average opportunity cost of not showing those viewers pre-roll video ads. That's necessary for the subscription option to make sense for YouTube. Otherwise, it's better off just showing more ads.