YouTube is pulling the plug on high-end original content. In 2015, YouTube Red was launched to compete with premium video-streaming titans Netflix, Amazon, and Hulu. YouTube's strategy relied heavily on the production of originals shows, which came with a hefty, multibillion-dollar price tag.
From the start, YouTube Red was an uphill battle. In the past year, Disney, Apple, and AT&T have announced initiatives in the video-streaming market and have ratcheted up the competition. In response, YouTube has abandoned the new arms race for Hollywood nods, and doubled down on its lucrative content platform.
This move makes sense from a business perspective. YouTube's video dominance and financial success rests on the strength of its platform business model. YouTube monetizes its user-generated content platform with ads to great success, because advertisers cannot ignore its two billion monthly active users.
In 2018, YouTube generated more than $15 billion in ad sales without any Hollywood nods or critically acclaimed shows. Similarly, Netflix earned $15.8 billion in 2018, but also spent $8 billion that same year on original content. Netflix burned $3 billion in cash last year. In contrast, while Google doesn't break out numbers for YouTube, most recent analyst estimates suggests YouTube's core business is strong and profitable.
The difficult economics of subscription streaming
YouTube had briefly flirted with the idea that paid subscriptions could make up for the cost of premium content. But given the entrance of media juggernauts like Disney and AT&T, the race to claim the lion's share of the market looked pricey and unwinnable.
With several new entrants, staying in the race will only get more expensive, as competition leads to higher content costs and high customer-acquisition costs.
In addition, video-streaming subscription models face another challenge: churn. Subscription services can lose between 7 and 23.4 percent of subscribers in a single month, a metric they call churn rate. According to an analysis by The Information, the median churn rate for on-demand video-streaming is 8.9 percent. As The Information puts it, "The median number for video services means, in very simple terms, that they have to replace the equivalent of their entire subscriber base every 11 months just to stay even."
Thus, subscription services not only incur high content creation costs, but also rack up a large customer-acquisition bill. According to The Information, "the cost to acquire a new customer ... ranged from $40 to $200. Given that many services are only charging $5-$10 a month, services losing 10-15% of their subscribers every month quickly run into financial pressures."
As the competition heats up, competitors will routinely poach each other's customers in a moderately sized -- but growing -- market. Users routinely subscribe for new shows and then unsubscribe between offerings. To combat this behavior, video-streaming services will need to continuously offer high-quality shows. This means ramping up content spend significantly, as Netflix has been doing, and keep prices relatively low.
Lastly, economies of scale in content production appear to be limited. Per Barclays Research, in 2017, both Disney and NBCUniversal spent about 55 percent of revenue on programming costs, as did Netflix. This compares to around 35 percent for HBO or 44 percent for CBS, which had much lower revenue than their two traditional competitors. In other words, as content-production companies get bigger, content spend per dollar of revenue actually increases. Netflix hasn't solved this problem and is unlikely to anytime soon.
While Netflix has innovated on the distribution side by going digital, it has changed very little in terms of the economics of content production. In fact, it's doing even worse on that measure than most traditional content businesses. Compared with these traditional media companies, Netflix achieves substantially less revenue per dollar spent on programming.
This dynamic suggests that programming costs will inevitably go even higher as more competitors pile into the video-streaming market, but revenue won't rise equally.
Given these unfavorable economics, YouTube wisely bowed out of the fight and has instead focused on boosting its content platform, where its strong network effects and user-generated content gives it a defensible advantage.
YouTube doubles down on its content platform
While YouTube is bowing out of its subscription content offering, it still has a host of premium shows, like Kevin Hart's What the Fit and Charlie Sanders and Jordan Peele's Weird City. In the coming months, these shows will transition out from under the paywall and be available for free on YouTube
We wouldn't be surprised if YouTube continues to partner with talent like Hart, Sanders, and Peele to produce lower-budget premium content that attracts different demographics to the content platform. YouTube can act as a market maker in new content categories by providing the initial quality content to attract consumer eyeballs, before it then goes after content creators in those categories. These premium offerings effectively act as anchor tenants that bring in more consumers and creators.
YouTube is also doubling down in its core niche markets on its content platform. Tech journalist Vlad Savov recently made the case that Google's announcement of Stadia, its video-game-streaming service, is more about defending YouTube's status as the gaming video king than it is about entering the game industry. Writes Savov, "It's telling that when Google wanted to show someone excited for Stadia it brought out a YouTuber, MatPat. His time on stage was spent talking about how Stadia builds a greater connection and interaction between YouTube creators and their audience." Savov goes on to point out the screen capture button on the Stadia controller that makes sharing live gameplay to YouTube easier than ever.
YouTube doesn't want to be Netflix -- should you?
Taken together, all of YouTube's recent moves suggest that Google sees its content platform as a substantially stronger business than what's achievable in the subscription streaming market.
Do you really want to be Netflix? It's clear that Google doesn't. And for any of the large players contemplating launching their own Netflix competitor, this should be seen as a warning. The economics of subscription streaming as a standalone business were too tough for Google, despite its considerable financial muscle, to take on. Meanwhile, the economics of user-generated content platforms look much more favorable and defensible, bolstered by a network of unique content that doesn't come with substantial upfront costs.
Rather than emulating Netflix, traditional media companies should be looking at how to bridge the best of both worlds, combining the strengths of their traditional content production business with the scale and distribution of a content platform. Finding a way to embrace user-generated content could put them in a much better position to not only take on subscription services like Netflix, but to also recapture more of the traditional TV ad dollars as they continue to move online.