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Tue 8 Jun 2010 03:47 PM

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Show me the money

Five years ago YouTube was just another start-up but all that changed when Google paid $1.65bn for it. So why is the internet sensation still failing to make a profit?

Show me the money
Video queen: Lady Gaga’s video for Bad Romance is currently the most viewed YouTube video in the world.
Show me the money
Turnaround: Google’s CEO Eric Schmidt hinted that YouTube might post its first profit in Q4 this year.
Show me the money
Cash cow: In January analyst Douglas Anmuth released a report predicting YouTube’s revenue would increase 55 percent to $700m in 2010.

Five years ago YouTube was just another start-up but all that changed when Google paid $1.65bn for it. So why is the internet sensation still failing to make a profit?

Five years ago last month, three slightly geeky looking friends rented a room above a pizza parlour and launched their own website. One year later, Chad Hurley, Steve Chen and Jawed Karim became overnight millionaires when they sold YouTube to the internet search giant, Google.

Today their website is responsible for streaming more than two billion videos a day as well as making internet stars of thousands of ordinary people. Last month, 12-year-old Greyson Chance was invited onto one of America's most popular talkshows, The Ellen DeGeneres Show, after his YouTube rendition of Lady Gaga's ‘Paparazzi' was viewed by more than eight million people. Days later the mysterious Lady Gaga helped Chance land a record deal.

Chance isn't alone in his internet stardom. The world's second most watched video clip features a young baby called Charlie biting his older brother's finger. The 56-second clip, entitled Charlie Bit My Finger Again!, was loaded onto the site by the boy's father for their godfather, who lives in America, to watch. When the clip went viral, it become an internet sensation, pulling in 189 million viewers from across the world.

The video website might be a global phenomenon but it hasn't had the same impact on Google's bank balance. Its 2006 acquisition of the website was one of the most controversial ever made, not least because it paid a staggering $1.65bn. So, why five years later is YouTube still failing to make a profit?

In an interview with the newspaper US Today, Hurley, who is currently the company's CEO, remained tight lipped about the firm's financials, claiming it "may have turned the corner, it might not have turned the corner." Days later, Google's CEO Eric Schmidt told the UK's Financial Times it could post its first profit in the fourth quarter of this year.For years, opinion as to whether or not the website can ever make any money has been divided. Just two years ago, Schmidt himself admitted he hadn't worked out the best way of monetising the site, saying it would be his top priority for 2008. The following year, the financial advisor Credit Suisse estimated the video website would make $470m of losses in 2009.

One of the biggest reasons sceptics believe YouTube will continue to bleed Google dry is its business model. For the last five years YouTube users have been able to watch videos for free. Now, like many publishing houses across the world, the website's executives are desperately trying to figure out ways to make money through content.

But if there's one thing that Google is good at, its making money. In the six years since it first listed its shares on the Nasdaq, the internet search giant has only ever posted one quarterly loss and that was in January 2010. The following quarter it beat all analysts' expectations to record a 23 percent increase in revenues to $6.77bn, a huge $6.47bn of which came from advertising.

Barclays analyst Douglas Anmuth believes Google's two biggest strengths are its ability to make billions in advertising together with  its sheer size - it is the one of the world's most popular search engines. In January, he released a report predicting YouTube's revenue would increase a staggering 55 percent to $700m this year.

"With YouTube monetising more than one billion video views every week, and with strong sell-out rates on its home page from larger advertisers - we note 90 percent of the top 50 Ad Age have advertised on YouTube - we believe the site can profitably take share of the branded display and video market," he writes in his research note.

Anmouth also notes that the video networking site's biggest competitor is Hulu, which YouTube leaves trailing behind in terms of number of followers. "In November the total number of YouTube's videos viewed grew 139 percent to 12.2 billion and unique visitors grew 32 percent year-on-year to 129 million. As a comparison, Hulu, the second most popular site by videos viewed according to comScore, recorded 923 million videos viewed," he adds.

Google is making the most of its ability to print money. In the fourth quarter of 2009, Patrick Pichette, Google's chief operating officer, claimed that advertising space on its home page had nearly sold out. The reason for the turnaround?  As Schmidt told the Financial Times: "We've figured it out. Nowadays, just about every advertising campaign involves YouTube as part of the solution. That's a big deal."There are several other reasons behind the more optimistic headlines that surrounded YouTube's fifth birthday in May. Most notable is the appointment of ex-Facebook executive, Ben Ling, who joined the firm in August 2008. Ling helped develop Facebook's platform before he was given the mammoth task of coming up with a solution to help monetise YouTube.

Industry experts have credited Ling for helping monetise around one billion YouTube videos per year, which tripled the website's advertising revenue in 2009. He is also responsible for persuading 92 percent of Ad Age's top 100 advertisers to choose YouTube. How did he do it? Ling redesigned the website to make it easier on the eye and turned it into a platform for premium and semi-premium content-makers.

Other changes that are likely to help turn a profit are the tie-ups the website has in place with several Hollywood studios. Last year, YouTube signed deals with Sony Pictures, CBS, Metro-Goldwyn-Mayer, Lionsgate, Starz, and the BBC, to acquire thousands of TV episodes and hundreds of films. Today, YouTube viewers - depending on their location - can watch thousands of televisions shows, rent full length films and stream all 60 cricket matches from the Indian Premier League for free.

It is this subscription content that YouTube hopes will finally bring the viewers from the office into the home. Hurley says the deals already signed are just the beginning. "We want to showcase videos beyond just with advertising... potentially with subscriptions. Different types of content will require different types of models. We believe people will pay to watch. Maybe the experience isn't there today but as we extend into the living room we hope to have success similar to iTunes and Netflox," he told USA Today. "We see opportunities for other types of content," he continues. "For us, it's like the beginning. We don't know how many people will use the site on televisions, but if we give them the right tools, payments will flow."

Although Google has spent billions of dollars on YouTube and it clearly sees its potential, it still needs to iron out several creases before it has any hope of transforming it into the cash cow it hoped it would become several years ago.

The website is locked in an ongoing dispute with Viacom over copyright issues and YouTube's lack of ability to control content, which allows thousands of unauthorised content to be uploaded onto the site, are likely to be its biggest obstacles. A move out of the red though would certainly be a corner turned.

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