The Deal Was Simple: You Upload, They Sell Ads. So Why Is YouTube Building a TV Network?

Google, Apple, and Amazon all want to be everything you need the moment you turn on the TV.

YouTube is building a TV network. According to a Bloomberg report last week, if the plan goes through it will become a sprawling internet entertainment hub that includes traditional broadcasters like NBC, Fox, and CBS.

The service, called UnPlugged, will cost money — $35 a month for everything from comedy clips and talk shows to TV dramas, serious news, and sports. In effect, it aims to replace traditional television outright.

Google isn't the only company trying to replace TV service completely, or the latest. Apple was reported earlier to be preparing a similar project, bundling 25 channels; those talks have already dragged on for more than a year. And Amazon has been pulling more TV networks and other online paid services into its Prime Video service.

Still, YouTube doing this is a surprise. If any video site could live on free-plus-ads, it's YouTube.

YouTube was the video site most likely to pay for itself on advertising alone

You need a VPN to reach it, but when it comes to video sites, YouTube is the one you can't get around.

Beyond its scale and influence, YouTube's cost control is the model most video sites study and copy.

When YouTube launched in 2005 it put up a line of text: "Broadcast Yourself." That slogan hasn't changed since. It is still a video-sharing site that runs on what its users upload.

YouTube now has a billion users in 76 languages — a third of everyone on the internet. That is roughly the same number as all the Apple devices in the world: every iPhone, iPad, and Mac combined.

Every minute, 12 days' worth of video is uploaded to YouTube's servers. And the scale keeps growing: in 2015, YouTube's views were up 50% on the year before.

You probably remember Gangnam Style. A few years ago the song went viral worldwide on YouTube, and the Korean singer PSY became the first artist on the site to pass a billion views.

More of the internet's stars are ordinary people sitting in front of a computer — like the gaming vlogger PewDiePie, who has 43 million subscribers and reportedly earns $24 million a year.

For a video site, the basic costs are content (rights) and infrastructure (servers, bandwidth).

Netflix, Amazon, and the Chinese video sites have to buy the rights to almost everything they stream, apart from a little original content. As their user bases grow, rights holders keep raising their prices.

YouTube has no such pressure. Its content comes entirely from users, and fierce competition pushes the best of it to the top. All YouTube has to do is hand its partners a share of the ad money.

And after Google bought it in 2006 for $1.65 billion, YouTube got the cheapest infrastructure in the world.

A video site has to move and store enormous amounts of video, and make sure users everywhere don't wait long for it to load.

Google has huge data centers it built itself; after the dot-com bubble burst in 2000, it bought up cheap fiber-optic cable and other hardware from other companies to build them. In recent years it has even designed its own servers and switches to cut costs further.

Data centers are a scale business: the bigger you are, the lower your cost per unit. And among the companies behind the world's video sites, none runs more servers than Google, except Amazon.

Scale covers advertising too. As the world's largest digital advertiser, Google holds the richest store of user data and the largest pool of advertisers. YouTube never had to build an ad system or ad technology from scratch.

But judging by its recent run of attempts at paid services, YouTube's ad revenue clearly still isn't good enough.

Google's earnings have never broken out YouTube's revenue on its own. By eMarketer's estimate, the figure was $4.28 billion in 2015 — growing fast, 2.3 times what it was in 2013.

But advertising hasn't made YouTube much money

Even so, YouTube is still not a profitable business.

According to a Wall Street Journal report, YouTube supplied 6% of Google's ad revenue in 2015 and was still losing money. By comparison, Facebook, with 1.4 billion users, clears more than $3 billion in net profit a year.

Figures from eMarketer show that YouTube's ad revenue growth has been slowing since 2014 and is expected to drop to 6.7% in 2017, far below the 46% of 2014.

Which means that even with tight cost control, YouTube's ad revenue still can't cover what it spends. Analysts think too much of what is on YouTube now is shoddy, and that the site needs more varied content to attract advertisers.

In fact, YouTube has been trying to reach break-even from every angle.

YouTube's attempts to diversify revenue

2011

Launched a movie rental service along the lines of iTunes.

2013

Launched paid channels — as little as $0.99 a month to watch one channel.

2015

Launched YouTube Red, $9.99 a month to get rid of the ads.

2017

Plans to launch the Unplugged TV subscription service.

Some of the money has also gone to YouTube's most valuable asset: its stars. YouTube is counting on them to make more professional programming.

How YouTube has backed its stars

2012

Launched YouTube Space, a studio program meant to give creators better equipment and training so they can make more high-quality video. There are now seven studios worldwide.

2014

Said it would spend millions of dollars helping the stars on its platform make content.

2016

Commissioned feature films for 10 creators, with four trailers released so far.

Paid subscriptions look like a good way to turn things around, but so far the effort hasn't shown much result. One reason: Red's subscription money and advertising are in conflict at the source.

The users who can afford $9.99 a month are exactly the high-quality audience advertisers want most — and Red walls that most valuable audience off from the ads.

Google, which is expert at optimizing ad models, certainly knows this. Its reason for pushing on with Red may be that over the long run, subscriptions are still a more effective model than advertising.

A Credit Suisse research report is optimistic: even though only 3% of users are willing to pay for YouTube Red, it says, those users will bring in $1 billion of revenue in 2016, and by 2022 that revenue will account for 4.5% of Google's total operating revenue.

If YouTube, the largest video site in the world, can't survive on advertising alone, that predicament is also a warning to Chinese video sites — build paying audiences, and at the same time grab more and more exclusive IP to tie users to the platform. Major Chinese video sites spent an estimated 10 billion yuan on content rights in 2015, and to this day not one of them is profitable.

Why are tech companies going after television's business?

The conflict between broadcasters and internet companies is changing shape.

Internet companies originally took only a small slice of the market: film and TV. Streaming companies — Netflix, Amazon Prime, Hulu — do on-demand film and drama. The difference from cable channels is that cable also carries news, entertainment, and sports.

Against the tens or even hundreds of dollars cable operators routinely charge in subscription fees, streaming is cheap.

• Netflix: $7.99–$11.99/month
• Hulu: $7.99–$11.99/month
• Amazon Prime Video as it stands: $99/year, with free two-day shipping as the main service and film and TV as an add-on.

For Netflix, building the equivalent of one HBO may be enough. For Apple and Google, that still isn't a big enough business.

Netflix's 2015 revenue was $6.78 billion — 3% of Apple's $233.7 billion over the same period, and 9% of Google's $74.54 billion. When a tech giant gets serious about video, that is not enough.

But taking the whole pay-TV market, news and sports included, is far more attractive to Apple and Google. In 2015 that industry was worth $111 billion.

A vast user base is Apple's built-in advantage. The iPhone alone sold 231 million units in 2014, and while iPad sales have fallen year after year, the installed base is still large. Add the MacBook, and Apple can give its internet TV service an outlet reaching a billion people in all.

By the same logic, YouTube also has more than a billion users, and Amazon is the world's largest e-commerce site. Both already have a huge user base under them.

Internet TV has been talked about for years. Can it finally arrive?

Internet companies want to compete with traditional pay TV on price. In the US, operators like Time Warner, Comcast, and Dish bundle channels of differing appeal and sell them to subscribers. Time Warner, for example, charges $79.99 a month for a 200-channel package that includes HBO. Every channel takes a cut of that money, and the size of the cut depends on how much it draws viewers.

YouTube Unplugged and Apple's service are priced around $40.

The biggest problem for the tech companies is content. They are all pouring money into making TV shows and films right now. Netflix and Amazon each pull in viewers with a slate of hit series.

Chinese video sites are in the same position. A third-party survey found that in 2015 they put about 2 billion yuan into original content, including 26 new original variety shows, which together drew 6.306 billion views.

Original scripted shows had already reached nearly 100 titles by 2014, more than 1,400 episodes in all. In 2015, iQiyi's The Lost Tomb alone drew 2.75 billion views.

But what audiences want isn't only drama. It's news, variety shows, sports, and children's programming.

Among YouTube's 10 "most-viewed" channels this March, kids' content and music videos dominated:

• David Gutta: music
• JustinBieberVevo: music
• jarad egg: documentary
• Ryan ToysReview: kids
• WWE: sports
• Family Fun Pack: kids
• mashamedvedtv: kids
• LittleBabyBum: kids
• T-Series: TV dramas
• need mzik: music

To fill in news, sports, and variety programming, internet companies all need to talk broadcasters into working with them.

Apple TV's streaming service has been discussed since 2009 and still hasn't launched. Apple's $40-a-month price hasn't convinced the TV content providers; in their eyes it is too low. A low price would undercut cable on one side and eat into their share of the revenue on the other. The latest news is that a CBS executive says talks with Apple have ended.

The problem Apple has run into, YouTube is almost certain to run into as well.

On building real internet television, the conflict between tech companies and the old TV industry has only just begun.

Cover image source: news.wgbh.org