Analyzing YouTube's Revenue Potential

From Silicon Alley Insider: So, Google's YouTube will finally sell video ads.  How much revenue will they generate?  Most likely, not enough to materially affect Google's overall revenue for at least a year or two.  Over the long haul, the contribution could be very material, at least on the top line.

Let's run the numbers. 

Emily Steel's WSJ and Miguel Helft's Times articles included several key data points:

• YouTube is testing overlay ads that run along the bottom of videos.  If viewers click on these ads, the videos they are watching will pause, and the ad will launch.
• YouTube will only run ads on videos from signed content partners (for now).
• In tests, approximately 75% of viewers presented with an ad chose to watch the whole ad.
• Google plans to begin by charging a $20 CPM.

Combining this information with Comscore's finding that YouTube streamed 1.7 billion videos in May, we can construct a basic range of revenue estimates.  What is important here, moreover, is not how much revenue YouTube can generate today, but how much it can generate in, say, five to ten years, when video is many times more popular, other ad formats are in use, and the company has many more content partners. So, we'll also run a range of estimates based on possible traffic in five years.

ASSUMPTIONS

For our initial scenarios, we make the following assumptions:

• Google streams 2 billion videos a month (up modestly from the May numbers)
• A sub-set of this group are from content partners and will eventually have ads (we'll run a range of 10%-50%)
• A sub-set of this group will have ads that are actually watched (we'll run a range of 33%-75%.  In tests, 75% of videos were watched, but this was likely heavily influenced by the curiosity factor.  In the early banner ad days, banner click-through percentages were high, too).
• The ads will be highly targeted, full-motion video, and should therefore command a high CPM (we'll run a range of $10-$50).

RESULTS

We ran five scenarios, from Conservative to Aggressive (please see this page for details). In the Conservative scenario, YouTube generates about $8 million in revenue, less than 1/10th of one percent of Google's overall revenue ($16 billion).  In the Aggressive scenario, the company generates about $450 million of revenue--enough to make a meaningful contribution, but barely.

FIVE YEARS FROM NOW

We also ran scenarios using a far higher number of monthly streams (range: 10 billion to 50 billion), a greater percentage of ad penetration within videos (range: 50% to 70%), and a similar percentage of ads watched as in the above scenarios (range: 33% to 60%).  Here, the revenue is far more meaningful.  In the Conservative scenario, YouTube generates $200 million of revenue: nice, but nothing to write home about.  In the Aggressive scenario, however, the company generates $13 billion of revenue--closing in on Google's current revenue today.

BOTTOM LINE

In short, YouTube's revenue won't likely be material to Google for at least a year or two and possibly more.  The impact on the bottom line, moreover, will probably be even less pronounced: Serving a video ad, even for Google, is far more expensive than serving a text link.  At a $20 CPM, the gross margin on such ads will likely be well below Google's current margins.

After the jump: More details from the WSJ story
In this spreadsheet: Detailed assumptions and results.

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