$1.65B for YouTube: Why Google Did It

To many, Google’s acquisition of YouTube may seem like the product of irrational exuberance, but a quick back-of-the-envelope calculation can show why Google may have made this move. YouTube serves 100M videos per day. With a 4% clickthrough rate, this gives YouTube 1.46B possible clickthroughs per year. At $.30 per clickthrough charged to advertisers, YouTube could sell $438M worth of ads. When you consider that, from Google’s perspective, YouTube’s costs are insubstantial if Google folds them into its own massive datacenters and network infrastructure, throw in some room for 5% error, and you have approximately $1.65B of value without attaching a strategic premium to the purchase.

If there is so much value in YouTube, why sell to Google? Because, unlike Google, YouTube doesn’t currently sell ads in its videos. It hasn’t wanted to tamper with the user experience by doing anything as deleterious as placing ads before, during, or after the videos. And it probably hasn’t written the code engine to do it. But Google has no issue with selling advertising and placing ads in or around content – and it has mastered the art of targeted ad placement that is unobtrusive yet generates significant clickthrough. So, in essence, the acquisition could be seen as Google putting up $1.65B of stock to buy advertising rights to YouTube’s audience.   Google has no shortage of cash and is willing to risk some market cap in exchange for the potential to make substantial profits. Adding 65 people to its payroll is no big deal, and taking over YouTube’s infrastructure is a small job for Google’s operations team.  Google can actualize the potential of YouTube because they are the best at online advertising.

The Big Sucking Sound
The implications of the acquisition are subtle. Google's strategy to become a monopoly in the online (and some offline) advertising markets is obvious. But less obvious is the impact these types of acquisitions will have in the infrastructure space. In the past, the only options for content owners to get videos online were to deliver the videos from their own servers or sign up with a content delivery network (CDN). Even specialized video sites like iFilm were not above taking creators' money to provide the privilege of self-publishing. All the paths required a cost expenditure on the part of the content owner. Paying to deliver content is the opposite business model from TV and radio- where networks license content from the content owner and pay the creator and copyright owner a share of the revenue.

While delivery costs are still small in the greater scheme of things – 11% of a content service’s revenue on average – in this market every penny counts. Based on our mid-2006 research, three of the top seven business models in online audio/video distribution are systematically unprofitable, and our recommendations to media and technology companies looking to enter the market is almost always “don’t look for a profit in the first 2 years unless you own truly premium content with no incremental licensing costs.” Google has the potential to change this dominant dynamic and make more ventures viable.

With this acquisition, a new option is now available. Give the content to Google, let it sell ads around it, take a cut of the advertising, and let Google handle the headache of hosting the content. This model is much closer to the TV and radio broadcast model of yesteryear: content owners get paid to deliver content to the masses; they don’t pay to do it. Google and other infrastructure intensive ”destination companies” can remove and consolidate vast amounts of content into their own datacenters. CDNs, hosting providers, and media services companies may feel the pinch as the wind is taken out of their sales as Google swallows up as much content as it can and serves it from its own datacenters.

The Pendulum Swings
Over time, Google might keep trying to ingest as much content as it can and offer ads and other monetization methods around the content. It has enough resources to consume almost every type of media - books, movies, clips, music, and games - just about anything imaginable. Basic laws of economics tell us that as it becomes more dominant, it very well might increase the cut of the ad revenue it takes for each piece of content served. As its demands increase, one of three things could happen: #1 it could be sued for monopolistic behavior, #2 content owners could take their content back, build their own content sites again, and make the content merely index able by Google - harnessing Google’s search power but finding other ad mechanisms that give them a better percentage, or #3 Google can just keep raising prices and getting richer and richer.

So is there any room for new market entrants? Should all new media technology companies, operations departments at old world media outlets and hosting provider’s pack it up and go home? Absolutely not. There is no one formula for success and history has shown that, over time, no single vendor ever wins everything, especially when armies of eager minds can enter a market and chip away at a giant. The television networks, cable companies, movie studios, and record labels of the world need to examine all options in front of them to see which combination of strategies and tactics yields the best result. Technology and infrastructure companies need accurate market sizing information and effective productization developed using data and experience as inputs. And operations departments need in-depth analyses of alternative strategies for serving their company and customers. A data driven approach to market entry, competition, or survival can always improve a company’s prospects – and even enable it to win - regardless of market conditions.

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Regardless of the outcome, the world of content, advertising, and infrastructure is undergoing a radical shift, and just about all sides of this shift are driven by consumer behavior rather than the old “push” model of broadcast networks, billboards, and print ads. All we need now is a fully integrated internet television device with clickable ads changing every so often under the video, or during commercials, or even allowing us to point our remote control at items, click on them, and see more information.

But didn't we see that demo at Internet World 10 years ago?

About the Authors
Steve Lerner is the Practice Leader for Content Delivery and Hosting at RampRate Sourcing Advisors / Strategic Research http://www.ramprate.com. Steve can be reached via email at: steve@ramprate.com.

Alex Veytsel is Senior Research Analyst at RampRate Sourcing Advisors / Strategic Research http://www.ramprate.com. Alex can be reached via email at: alex@ramprate.com

About RampRate
RampRate is the authority on Information Technology Outsourcing Services, and offers procurement and lifecycle management and business planning research. RampRate's advisory experts work closely with technology-dependent businesses to ensure their IT sourcing decisions are achieved quickly and affordably for wide range of services including hosting, content delivery, streaming, telecom, messaging, desktops and bandwidth. By leveraging the company's extensive vendor portfolio and its data-driven SPY Index, RampRate is transforming the IT sourcing industry to reduce procurement costs and bring more value to both customers and vendors with significant cost and time savings. As a result, RampRate reduces the decision making time from months to weeks saving businesses on average 30+ percent. RampRate's customers include CBS, Microsoft, Sony, McGraw Hill, Goldman Sachs and iFilm and dozens market leaders. Privately held, RampRate was founded in 2001 and is based in Santa Monica, Calif. with offices in Atlanta, Boston, Chicago, Dallas, Seattle, Palo Alto and New York. For more information, visit www.ramprate.com.