In my last post I pointed out that many of the media commentators who have criticized the YouTube video network companies as not having strong businesses were mistaken.
The main thrust of the post is that with YouTube taking a 45% of revenue and talent taking 70% of the remaining revenue, YouTube Networks didn't have sustainable businesses unless they invested heavily in technology as a tool to increase margin and provide defensibility.
This post looks at how the best in industry are moving well beyond the 16.5% margin range to more sustainable 50-60% margin businesses. The best “MCNs” are in fact building strong technology businesses with rapid growth and strong, defensible a**ets.
[To be clear before I start (since people now starting to misquote me) ... I DO believe in building most of your business on YouTube. I hope that was clear in my previous post and this one. I don't believe you can simply migrate audiences en ma**e. My point is that if you don't start to build online video a**ets in multiple locations you have platform dependence, which is never smart. Nor is it smart to have talent dependence.]
So why is online video such an attractive market to build a startup?
As I point out frequently, people want to consume video. As humans we are storytellers and our preferred form of story is visual. We like sight, sound & motion.
When I tell audiences that Americans consume 6 hours of video per day people seldom believe me (thus I publish the data). Europe is roughly the same as the US. These markets represent about $600 billion of total spend between them, leaving tons of opportunities for startups to disrupt and grow large.
People aren't going to fundamentally change their media consumption patterns just as consumers don't fundamentally change their diets.
And if you accept that premise then you have to accept that the future of the Internet will be dominated by video. Much of it already is.
But wait!
Content is a “hits-driven” business that makes it unattractive to investors – remember? Not so fast.
Traditional video had very high costs of distribution due to limited time slots of broadcast TV (we only had enough spectrum to support 3-4 channels). The number of channels grew with cable & satellite TV but we still have limitations that makes distributing content high.
As a result it only makes sense to produce the highest quality video and to market it like hell to consumers since if it doesn't capture an audience when it runs then losses are incurred. Much of network television can cost $100,000 / minute to produce.
Film is no different since you've historically been limited to movie theaters which have physical limitations, too. But distribution is now unlimited. Infinity. Evergreen. Time independent. And global.
This has allowed the largest online video content producers like Maker Studios (where I am a large investor) to produce videos for 99% cheaper than traditional TV.
That is the definition of Disruptive Technology.
Traditional studios have suffered from The Innovator's Dilemma.
So what happens when production is reduced by 99% and distribution bends to infinity?
+ Content goes global (of Maker Studios 4.4 billion video views / months 55% are international)
+ Content can go viral – the highest quality stuff is shared
+ Producers can cost-effectively test formats and build fans as they go
+ Content isn't required to fit into pre-defined time slots. In fact, it may be preferable that it does not.
And importantly for the first time in history content producers have direct relationships with their audiences.
How?
For every fan who watches your show you have the ability to ask them to subscribe. You can ask them to come and watch your videos at your owned & operated websites (O&O) where you can make higher margins as well as ask directly for more meaningful customer information such as Facebook connections, Twitter oAuths, email addresses and the like.
And with mobile you even have the ability to message your users when new content is released which leads to much higher consumptions rates.
So content distribution in the future looks more like an eCommerce business than a traditional media one.
And ironically many consumer mobile apps are more of hits-driven businesses than video is today. Video production & distribution is becoming much more programatic.
So how can you build a more valuable and sustainable business?
1. You need to focus on Margin Expansion
16.5% margin isn't sustainable for a large, growing business. It's why many talent agencies or ad networks struggle to get scale advantages. As a YouTube network you simple MUST move some of your traffic to distribution sources outside of YouTube. I'm not advocating turning off YouTube. That would be like selling physical consumer products and deciding not to sell at Walmart.
But you must work hard to develop alternate distribution at websites like Yahoo!, MSN & AOL. You must find ways to get some distribution through other online partners like Hulu or package up shows for distribution on Roku or Xbox. This type of “affiliate” traffic might represent 20% of your overall traffic.
You also need to develop an O&O (your own websites) strategy. I don't personally believe each individual artist needs to have their own website or mobile app. Consumers would struggle to find these content producers at a scale that makes sense. But one strategy we're employed at Maker is to build related types of content into “networks” that are branded and can attract loyal audiences.
Think of the Internet, short-formate equivalent of Discovery, NatGeo, E! or ESPN. The talent benefits as well by being clustered as newer acts can be discovered by fans who are searching for more familiar content. A laudable goal over time should be to get O&O to 20%.
And the important thing about O&O traffic is that these are your most loyal fans making it easier to package up ads at higher rates (10x YouTube) and sell other products like subscriptions, merchandise, music and the like. The next part of the margin mix online video companies must get control of is talent margins. I'm not saying networks shouldn't be talent friendly – of course they should. But a market in which every network competes to sign up the largest talent by throwing rev share deals at them is also stupid.
So the goal should be to have some formats that require talent who have become large in their own right and can demand rev shares of 70-90%. But these can be no more than 50% of your overall traffic in the long-run if you want to build a profitable online video business. Your “anchor talent” helps attract audiences that in turn want to discover new artists.
You need to roll up videos into aggregated channels, “networks,” that are 30% of your views in the long-run. The benefit of networks is that you can hand curate the videos that run in the network providing higher-quality, better control and more brand-safe content for advertisers. This helps get CPM rates higher – even within YouTube.
In a network you can have a mix of content from some “celebrity” content to attract audience to shows that you product customer for the network to make it unique. You might fill the balance with interesting curated content from great producers who are not yet famous.
Finally, if you want to build a successful online video company you must have some formats that are independent of talent altogether. The most obvious example is “American Idol” where the singers who start out unknown and emerge as stars. Where talent shows up unknown you don't have huge revenue splits and you benefit them by helping them build audience / fame.
Other examples are blooper videos, game shows, some cooking shows, reality TV, etc. Ultimately your goal must be to build a more sustainable margin business. But you don't need to abandon YouTube or ditch your famous talent to be successful.
2. Technology is Critical
As I argued in this widely read piece, Hollywood content producers who don't understand and develop technology prowess for the online & mobile media will fail to succeed in the future. Technology is everything to your online video success. I meet way too many Hollywood producers who tell me, “I just signed X, Y, Z talent and we're putting a bunch of videos on YouTube. We're going to k**.”
Good f**ing luck.
Online works differently than distributing on broadcast TV.
The best companies look at data to know what time to post. They understand that posting video is as much about activating your fan base to share socially as it is about marketing & promotion. The best companies A/B test everything including headlines, thumbnails, video length, etc. and understand that each distribution source (iTunes, YouTube, Facebook, Instagram) performs differently. In fact, entire businesses like UpWorthy are built by people who understand this precisely and don't even produce any content.
And while Maker Studios has almost 50 engineers now, it isn't the only MCN with tech chops. FullScreen has long been investing in technology to support content producers. As have BigFrame and Machinima. I would argue that the strongest visionaries have been TasteMade, who were originally running video at Demand Media. I'm studying TasteMade to form my own views of the future.
They have gone one step further than anybody in the industry by not only having distribution tools but they've also built really clever tools for higher quality capture and production of some videos using your mobile phones.
So you either need to invest millions or partner with a “tools company” designed to help you promote and distribute video.
One of the best I have seen in the market is Epoxy.TV. And while I'm an investor so I may seem biased, I'm an investor there for a reason. The team from Epoxy spun out of Robert Downey Jr.'s digital studio. It's a team of Stanford engineers with direct video distribution sk**s. They don't aim to be a content producer at all so the unbiased tool set gives comfort to those that want to use them.
Epoxy's tools are designed to help video producers distribute content across the social internet, driving consumption increases through Facebook & Twitter. It helps producers track fans and activate audiences. And the company is now working on tools to also help producers figure out how to compete in a world where video is moving toward even shorter formats designed to be socially shared.
So to win at online video you must either invest in tech or borrow tech from a tools co.
3. You Must Produce Your Own Videos
Many of the online video companies started by aggregating content from other people. That does work to gain scale quickly but if you don't produce content and you don't have an end destination where customers consume video then you are nothing more than a video broker. And while brokers & agencies have value they're not worth anywhere near what scalable tech companies are worth.
To build a successful online network you must have some hit shows and then you can aggregate the rest. Think of the television model where networks have hit shows like Mad Men or Breaking Bad to attract audiences to the network and drive revenues through carriage fees and ad rates. But the networks also fill the airwaves with shows that they didn't produce themselves, which may actually have higher overall margins due to no production costs. But if you didn't produce your own shows that attract audiences you have no leverage in the first place.
And production is where Hollywood beats Silicon Valley. To produce content that people want to watch takes unique sk**s:
Writing
Make-Up
Costumes
Set design
Lighting
Sound
Post-Production
Acting
Music
etc.
You simply can't replicate the world-cla** sk**s of LA through technology. And production matters.
4. Build Direct Relationships with Customers
The most important currency of online businesses is customer information. It's what allows you to continue to market your products cost effectively to customers. In the old days this was email addresses. But increasingly other a**ets are as valuable if not more so. For example, if you get a Facebook Connect integration you not only get the ability for your viewers to socially share video but you also get access to their email address, demographic data and social graph.
If you can get customers to download your mobile apps you have the right to push videos to them.
5. Build a Global Business
I know it should go without saying that in 2013 you should be thinking about building a global business.
Yet many of the startups I see are very US centric. In the video space with no distribution limitation it's not acceptable to write off the majority of your customer base as “remnant inventory” as most startup video companies do.
The future battle grounds will truly be global, which is why I believe the winners will be billion dollar businesses. We already know that audiences are consuming global content in large numbers.
When you look at global tech businesses like WhatsApp and the immense value they're creating you can see the scope to build bigger, better businesses on video. It's no accident that we recruited Ynon Kreiz, an Israeli who lived in London, to run Maker. His last company was built in Europe and sold for several billion dollars.
6. Build Non-Ad-Based Revenue
Finally, to build successful online video businesses you need to think much larger than just ad revenues. Licensing merchandise is an obvious area where you could learn from traditional video companies. Star Wars, for example, made 70% of their total revenues outside of the first-run movie business. And Angry Birds has built a franchise by extending beyond video games.
We encourage online video company to consider all forms of alternate revenue streams including: packaging shows that can be output on traditional TV (see Awesomeness TV as an example), support music sales that become popular through your videos, do licensing deals and you even have the opportunity to drive eCommerce sales for other companies.
There are many opportunities to expand margins beyond the traditional brokerage business of YouTube networks. The biggest and best MCNs have understood this for years and are building much more sustainable businesses than people on the outside understand.