Ecosystem economics – Sticky wicket

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YouTube contributes no profit but a lot of value to Google.

  • Even though YouTube managed to earn around $4bn in revenues in 2014A, the inherent nature of video economics continue to prevent it from turning a real profit in its own right.
  • I suspect that the main reason for this is that most of the data that it gathers is monetised elsewhere within the Google ecosystem.
  • As a result, YouTube is an excellent example of how important it is to look at the overall economics of an ecosystem rather than its individual pieces.
  • I believe that YouTube is unprofitable for the following reasons.
    • First, Although it has billions of visitors, it is estimated by data analytics company, Pivotal, that 9% of users consume 83% of the videos viewed.
    • This has a substantial and negative effect on the advertising opportunity that exists for marketers on the platform.
    • Second, A large proportion of the videos are viewed from embedded players rather than on the site itself.
    • This reduces the opportunity for profiling of the user as well as the opportunity to advertise to that user.
    • Third, The real money in TV, movies and video is not made in the long tail.
    • In TV and video there is a small amount of content that appeals to almost everybody and then a long tail of categories and genres that appeal to special interest groups.
    • YouTube is the long tail whereas Netflix is the small amount that everyone watches.
    • Fourth, The popular content is many times more expensive to acquire but it is only here where the benefits of scale can lead to sustainable profitability.
    • The cost to support video streaming is much higher than it is for audio or a webpage.
    • A video requires much more storage space and transmission capacity than audio or a simple webpage.
    • This means that that in order to have comparable economics, advertising revenues per video have to much higher than for a piece or audio content or a webpage.
    • This is exactly the problem that made video calling over 3G completely pointless for mobile operators as they would have needed to charge 10x the price of a voice call for a video call in order to earn the same return.
    • Advertising revenues from video have been the fastest growing in recent years but I think they are still far below the levels needed to match the economics of audio or a webpage.
  • Given these limitations, I think it extremely unlikely that Google will turn YouTube into a meaningful profit centre anytime soon.
  • If YouTube is making no money, one has to ask why Google bothers holding onto it?
  • The answer to this is simply that video is a very important part of the ecosystem and I suspect that Google’s overall revenues would fall by much more than $4bn if YouTube was to be sold or closed.
  • This is because YouTube is an integral part of the overall Google ecosystem where I continue to believe that the whole is much greater than the sum of the parts. (see here).
  • Consequently, while YouTube does not turn a profit in its own right, I believe that it enhances Google’s ecosystem to a point where the overall return on investment is nicely positive.
  • This makes YouTube a very valuable asset despite the fact that it earns no money in its own right.
  • RFM forecasts that Google’s revenues from its ecosystem will grow nicely again during 2015E, albeit more slowly than it did in 2014A.
  • Google after Microsoft, is my second choice in the digital and mobile ecosystem.

RICHARD WINDSOR

Richard is founder, owner of research company, Radio Free Mobile. He has 16 years of experience working in sell side equity research. During his 11 year tenure at Nomura Securities, he focused on the equity coverage of the Global Technology sector.