Internet Outsider: Economics of Online Video 1: One Tough Business

September 11, 2007

Economics of Online Video 1: One Tough Business

From Silicon Alley Insider: Streaming video is all the rage, with start-ups popping up like mushrooms, incumbents like Yahoo (YHOO) cramming video into every corner of their sites, and analysts locked in fierce debate about how much revenue the industry behemoths like YouTube (GOOG) might eventually generate. Revenue is an improvement on the industry's experience to date, but it's time for a detailed look at streaming economics. Specifically, what's the bottom line? Can streaming video make money? Can YouTube?

(Note: we are analyzing video streaming here, not video downloads. See Peter Kafka's analysis of the NBC/iTunes economics for a primer on the cost structure of the latter.)

After performing a detailed analysis of streaming video's cost structure, we remain convinced that it is one tough business. Individual business models differ radically, of course, but in general:

Costs are high
Costs are variable (meaning that they rise in proportion to usage)
Profit margins at scale will at best be fair-to-middling (10%-20%, not the 30%-40% text-based Internet media enjoys).

In general, therefore, we believe that observers are vastly overestimating the amount of money that will be made in streaming video, at least over the next several years. What are the specific ramifications of these conclusions?

Most dedicated streaming video start-ups will never make money and will disappear (either via bankruptcy or fire-sale). Thus, streaming video entrepreneurs should raise as much cash as possible, now, while investors are still throwing it at them. (Investors, meanwhile, should stop throwing it--immediately). Also, all companies competing with YouTube in the "generalist" broadcast-yourself market should re-focus or sell themselves immediately (which is what we hear many are trying to do).
The widespread adoption of streaming video may permanently reduce profit margins in the Internet media sector. If YouTube gets as big as some flag-waving Google bulls hope, Google's profit margins will never be the same. Is that the end of the world? No. But it could be the end of a steady upward march in Google's stock price, at least until margins stabilize at a new "adjusted for video" level.

The companies in the best position to benefit from the boom in online video are those with 1) enormous scale, 2) minimal production costs, and 3) business models built around something other than storing and streaming video. Such companies include firms that already produce countless hours of the stuff--TV networks, movie studios, etc., as well as video ad sales networks, video search firms (including YouTube), and new era production firms with absolutely rock-bottom production costs (Rosie in her bedroom with no make-up, a handheld video cam, and an incandescent light bulb).

As for the companies that actually store and serve video (YouTube, Heavy.com, blip.tv, Rocketboom, etc.), if they wish to survive the shakeout, they will need: 1) massive, industry-leading scale, 2) low content acquisition/production/revenue-sharing costs, and/or 3) a highly valuable, targetable, and defensible niche.

Next up: A detailed look at video-unit-economics. Please share thoughts/insights in comments or email (hblodget@alleyinsider.com). We will refine as we get additional input.

Posted by Henry Blodget on September 11, 2007 at 08:12 AM | Permalink