Why YouTube is ready for prime time

By Jon Markman

Student rebels in the 1960s used to say, borrowing from a song by Gil Scott-Heron, that the revolution would not be televised. Boy were they wrong. It's not only televised, but video-journaled, blogged, sampled, derided, defended and turned into parody -- sometimes all within the space of a few hours.

Destination No. 1 for whatever cultural kink catches the attention of Generation X, Y and Z these days is YouTube.com, a Web outfit in Northern California whose founders only turned on the lights 12 months ago. Despite its youth, YouTube already has become the fastest-growing media company in the world -- outpacing even MySpace.com. It serves more than 100 million video clips a day, and something like 70,000 new videos are added every 24 hours.

Watching are 20 million people a month with nothing better to do than view a video of a cat chasing the light of a laser pen around a room. A video of a Russian ninja jumping off buildings was popular for awhile. And the sweet, strange video journals of a LonelyGirl15 on the site recently became a mass-media touchstone, drawing nearly a million clicks per film as viewers became drawn into her world of home-schooling, dating and parent conflict. Or not, as the case may be -- since she was later revealed as an actress experimenting with creating fictional non-fiction journals.

With attention like this, you know what happens next. No one is satisfied with making anything merely popular or artistic anymore. You've got to make money from it. And in this case, the numbers thrown around are as crazy as anything we heard about in the early days of Yahoo! (YHOO, news, msgs), Amazon.com (AMZN, news, msgs) and eBay (EBAY, news, msgs).

Losing money for fun and profit

Although shares of these three horsemen of the Internet are pretty much on the skids now, they are still up 1,300% to 3,000% since they first sold shares to the public seven to 10 years ago. At the time, except for eBay, no one was quite sure how any of these money-losing operations was ever going to turn a profit. And skeptics were all quite sure that larger media and software companies would eat their lunch and spit out the bones. But incessant innovation, compelling content, clever management and a lot of good luck helped them all prove the naysayers wrong and make their early supporters rich.

So now the inevitable question arises: Will YouTube.com hit the public market anytime soon, and if so, what's a company that flamboyantly loses $20 million a year worth these days?

The short answer is maybe a lot -- or next to nothing. It depends on how well the company navigates a looming legal confrontation with copyright owners. In the most lucrative scenario, YouTube would toss minor equity stakes to major corporate owners of songs and shows its users borrow for spoofs and karaoke performances. Then, judging from the $580 million that media conglomerate News Corp. (NWS, news, msgs) paid for MySpace.com, it could be worth $500 million to $1 billion in an IPO, which is not bad for a year-old company with few barriers to entry and competitors galore. In the worst-case scenario, it would be sued into oblivion, like the early version of Napster.

For the long answer, I turned to Paul Kedrosky, a Web media expert and venture capitalist in San Diego. He argued that we first need to understand what makes YouTube unique, and worth investment underwriters' attention more than a dozen rivals with names like Revver and Clipstation.

As with most things, there's a lot to be said for great timing. YouTube was the first Web site to make the sharing of homemade videos easy and fast -- and it came along at the exact moment when residential broadband and cheap digital video cameras hit the mainstream and intersected with the rise of a phenomenon known as online social networking. YouTube's genius is fourfold: It marries smart engineering with simplicity, immediacy and community.

• Until a year ago, if you shot a one-minute video on vacation with your digital camera and wished to share it with friends and family, it was a pain. You needed to save it to a DVD and send it through the mail.

• YouTube's founders, who were previously early-stage developers at the pioneering online financial services firm PayPal, figured out how to let you easily upload your video in its native MPEG format and then quickly convert it into a widely accepted, highly compressed, fast-loading format known as Flash Movie. (It takes minutes to load and share your video, versus the two- to three-day process involved with doing the same at Google's (GOOG, news, msgs) video site.)

• YouTube engineers then figured out how to let you embed the Flash movies into blogs so that they could be easily shared with a single click.

• They made the clever marketing decision to allow people to watch the movies without going through a cumbersome registration process.

• And they decided to let the growing community be self-policing, allowing self-appointed nags to flag, segregate and dispose of pornography and other objectionable content.

Pretty soon, as the YouTube community grew virally through word of mouth, artists and exhibitionists figured out that they had a fast-growing audience for personal and semi-professional video journals and stories. Before long, the dumb but amusing karaoke klutzes that started the ball rolling for YouTube were surrounded and supplanted by content that was fairly compelling, as long as your standards were blunted by years of bad commercial TV. And if you want, you can also see my one-minute vacation video, or dozens of card tricks, or instructions and examples on wakeboarding tricks.

Tale of the tail

YouTube has become a shining example of what former Wired editor Chris Anderson calls "the long tail." His theory is basically that until broadband came along, mass-media organizations like the broadcast networks would make money by creating a small amount of high-quality content that would appeal to 75% of advertisers' potential audience. The "long tail" is the tens of thousands of pieces of content that have a very small potential audience, but can make an equivalent pile of money for a producer because there is virtually no cost to providing it.

Kedrosky believes that YouTube can become profitable very quickly simply by inserting 5- to 15-second ad snippets before and after those millions of videos. Calculating that they provide 8 million to 12 million streams of video a day, he figures they could earn up to $20 million in annual videos in a heartbeat. Since the only material cost at YouTube is its astounding 200 terabytes of traffic a day -- the company staff is said to be fewer than 30 people -- that much money would erase the operating deficit and lay the groundwork for substantial profitability.

Mainstream ads are probably not the focus, however. It's probably more attractive to potential buyers as a means of wholesaling videos to young consumers who have become accustomed to the notion of paying a buck or two, through iTunes and the like, for episodes of commercial TV fiction, news, sports shows and movies.

Kedrosky thinks the key is that people increasingly don't want to watch an entire show twice. They want to watch a good show once, and then will pay to keep the good bits. "That's where YouTube comes in," he says. "People don't want to watch the full 'Daily Show with Jon Stewart.' They just want to watch the best parts. This is what I call GBOD, or 'good bits on demand.' There is no prime time anymore. People will get the parts of the shows they want when they want it."

CBS, NBC and Fox are already paying YouTube and Google to post pieces of their programming as promotions. CBS, in fact, has posted entire episodes of its hit comedy, "The New Adventures of Old Christine" and "Smith," and Warner Music this week agreed to allow YouTube to post its music videos on an ad revenue-sharing basis.

Television producers are putting increasing focus on the four-minute segment of all their shows that they think people will buy and share. Since that's how people already think about shows -- relaying to friends their favorite parts of a show -- producers will find success by using YouTube and Google Video to intersect with their audience in a natural way. "This audience was always there," Kedrosky said. "It's not being invented on the fly."

Too big to topple

At present, YouTube is pretty disorganized and poorly marketed. As it preps for an initial public offering over the next six to nine months, expect it to get an attractive makeover -- much as Amazon.com went through in about 1998. Since the company just hired a veteran chief financial officer from Yahoo!, I think it will go public by the summer of 2007. It needs to go soon, while there is still a lot of hope and expectation on the part of speculators about the democratization of video. By not affiliating with any one network, YouTube can remain the Switzerland of video, attracting attention and eyeballs from networks and the public alike.

Sure, it could be replicated. But so could Starbucks (SBUX, news, msgs) in its early stages. So could Google. But they weren't after they had gathered a fanatical audience. Kedrosky points out that the luck and beauty of YouTube at present is that "everyone goes there because everyone goes there." He adds: "Once you reach a tipping point, the size of your community becomes its own barrier to entry."

Unless the deal is really crazy, I think this is one Web 2.0 success story that will fly as a public company as long as it doesn't go too mainstream to satisfy Hollywood first. Watch for it.

Fine Print

To see a typical video log at YouTube, visit LonelyGirl15's area there and click the big arrow in the middle of the page. … To see a typical karaoke performance, check out this version of "Hey" by The Pixies. … NBC used YouTube to promote its fall lineup. See Part 1 of the promotion. … Over at Google Video, full-length shows debunking what authors consider to be myths about the 9/11 attacks are popular. Check out this one. It's pretty well done, and interesting. … Google is also home to high-quality video out of trade conferences. Check out this video of motivational speaker Anthony Robbins at the TED Conference this year. … Paul Kedrosky writes a great blog himself called Infectious Greed. … Gil Scott-Heron was a jazz/funk artist in the 1960s who is considered one of the godfathers of rap. His "The Revolution Will Not be Televised" was called a "spoken song" at the time. It's a great time capsule of political interests at the time, but still sounds amazingly up to date with its critique of the media. Here are the lyrics. You can buy or download the music at Amazon.com.

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Jon D. Markman is editor of the independent investment newsletters Strategic Advantage and Trader's Advantage. While he cannot provide personalized investment advice or recommendations, he welcomes column critiques and comments at jon.markman@gmail.com; put COMMENT in the subject line. At the time of publication, Jon Markman owned shares of Starbucks.