Google's real YouTube strategy

A social network by stealth

One of the little discussed benefits of Google owning YouTube is that YouTube is more than a pure video streaming network. It is a social network in its own right. Accounts are needed to create, comment about and rate content, which is something that is not required for the core search service.

It is hard to envisage that at this stage YouTube is directly monetising this meta-data. Undoubtedly, however, it will be contributing to understanding of user-behaviour, and probably the data is already contributing to the optimisation of the Google advertising engine.

Google's economics are extremely difficult for competitors to replicate and represent a significant barrier to entry.

Google worldwide revenues have grown by US$11.2bn to US$21.8bn in the two years since purchasing YouTube in 2006 for an all-share cost of US$1.8bn. In the same period, operating cashflow has grown by US$4.3bn to US$7.9bn.

The amount of indirect contribution of YouTube to Google revenues is uncertain, but what is more certain is that Google can afford YouTube.

The real economics of YouTube

One of the most important disciplines of internet economics is to keep the marginal costs of delivering another page or another video stream as close as possible to zero. With YouTube,the key variables are computing and bandwidth costs. Google’s tactic is turning the majority of them into capital costs. Google is deploying more and more capital building out infrastructure, whether vast data centers or its own network - effectively keeping an ever-increasing proportion of its traffic on the Googlenet.

Another key variable costs for YouTube is the cost of the content itself. Google here attempts to minimise its risk by making any payout to third parties dependent upon success of advertising revenues achieved. This is the cornerstone of the Adsense program for publishers. Unfortunately for Google, it is not the traditional way that the video content industry works and therefore is a great source of friction between YouTube and video rights holders.

The Bandwidth Equation

A case can easily be made that Google could make its cost of delivery for video zero. Every global IP transit provider would love to be the exclusive deliverer of such a significant portion of the world’s Internet traffic, and the transit providers could make money by squeezing the downstream ISPs in their cost of delivery. Such an extreme network design would bear a heavy political cost for Google and would obviously be unpalatable, but it illustrates the power that Google has accumulated through the YouTube traffic.

Instead of focusing on IP transit, Google extensively uses peering, delivering its own traffic to the major peering points in the world, as we made clear in this post, which the people at RampRate used in their critique of Credit Suisse. Peering is not free - it involves buying expensive dark fibre linking the Google data centres to the peering exchanges, renting space in the peering exchanges, equipment to light up the fibre and a team of network engineers to manage the peering relationships. However, most of these costs are fixed. As important for Google is that peering will allow them to control the reliability of delivering their traffic.