A number of you have asked for my reactions to Google's acquisition of YouTube, so I thought it would be good to share the following thoughts with you.
First a confession — as news of this deal trickled out over the past week I was predisposed to disliking it because it reeked of acquisitions during the "bubble" years where bigger public companies with high-flying stock bought young companies with lots of traffic (i.e. "eyeballs") but modest revenues in a vague attempt to grow their businesses.
However, what's different here is that Google has a well-understood business model and can derive great insight about the economic value of both distributing its AdSense ads on YouTube pages and embedding Google's WebSearch on YouTube. On this basis alone, the $1.65 billion price tag can probably be justified. And even if the benefits of these tactics are not fully realized, the deal still won't have any material financial downside on Google, with its $130 billion market cap.
Making sense of the deal
As many of you know, in our Q1 report earlier this year we identified Google, along with Yahoo, AOL, MSN and Apple (a "Group of Five" companies) as being best-positioned to become next-generation, broadband-centric video distributors. I continue to believe that a competitive dynamic is taking shape for which company (ies) will be the front door to consumers' future video experiences. The traditional leaders are cable TV and satellite operators. On the strength of broadband as a robust video distribution medium, the Group of Five companies are all gearing up (though not publicly admitting to it) to compete with these incumbents sometime down the road.
I think the framework presented in the Q1 report is a useful way of assessing the value of the Google–YouTube deal and other video-related initiatives that these 5 companies (and other would-be broadband distributors) undertake. As a reminder, that framework asserts that future broadband-centric video distributors will succeed by focusing on meeting the evolving needs of three core constituencies — consumers, content providers and advertisers. The framework identifies each of these constituencies' needs, as I currently understand them.
With this framework in mind, here's how I assess the Google–YouTube deal:
Consumers' behavior with video is changing fast. Users want their programming on-demand, from myriad sources (i.e. professional, independent and fellow users) and perhaps most importantly, with opportunities to involve themselves in it (e.g. sharing, reviewing, collecting, etc.). Google Video's efforts to meet consumers' video expectations were sub-optimal, while YouTube's were market-leading. If YouTube can keep its finger on the pulse of consumers' video behaviors (and potentially improve its ability further with Google's technologies), it ties in Google much tighter to what consumers want from their new video experiences.
Content providers are still in the early stages of figuring out how to harness broadband video's different consumption and monetization models. They need strong technology partners to help shepherd them through this learning process. Following Google's deal with MTV this summer, Google stayed on message that it was a technology company aiming to help media companies exploit the Internet's potential for video distribution. YouTube clearly helps this mission, so we can all expect to hear more of this message coming out of the Googleplex. While there is no shortage of hubbub about copyright infringement on YouTube, smart content providers recognize that it's far better to learn how to leverage the user-generated phenomenon than to shut it down. Yesterday's deals with UMG, CBS and others demonstrate this. If YouTube can accelerate Google's ability to effectively migrate big media companies to the broadband video world, it will be making a huge contribution to Google's value to content providers.
Advertisers need to follow consumer behavior to stay relevant and they need to demonstrate a return on their spending. Spending is shifting from 30 second TV advertising to new advertising platforms. Broadband video advertising has been a clear beneficiary of this shift. Google's potential to marry its keyword-based ad model with broadband video represents a massive opportunity for advertisers to improve their spending effectiveness. Google's ability to monetize web content more effectively than anyone else gives it huge financial flexibility. This is what drove their ability to do the recent $900 million Fox/MySpace deal and in fact provided Google with additional flexibility to outbid all others in acquiring YouTube itself. Longer-term, if (and this is a big if) Google can also monetize video content better than anyone else, think about how attractive that makes the company to advertisers and content providers.
One of the key advantages Google/YouTube has is sheer scale. Big brands that spend heavily on TV advertising require lots of inventory and impressions from alternative ad platforms to make them sufficiently attractive to materially affect their brands' businesses. The lack of high-quality broadband video ad inventory has been a major challenge for all advertisers to date. If Google/YouTube can bring advertisers into the world of user-generated video and to YouTube's communities, it opens up a lot of new real estate. This of course is a highly delicate area for everyone involved. But with Google's financial might behind them, YouTube can follow a more patient and experimental path.
Conclusion
Net, net, what YouTube brings to Google is the potential to better meet the evolving video needs of consumers, content providers and advertisers. These are the core criteria for succeeding as a future video distributor. On yesterday's conference call, Google CEO Eric Schmidt said there are at least 20–30 ideas that the development teams came up with for how to work together. Prioritizing and executing on these is the key to this deal's success. And if Google and YouTube do succeed, they will very definitely raise the competitive bar for all other current and aspiring video distributors.
