In just a year and a half, YouTube became the most visited site on the web to watch videos. The YouTube online community cornered 46% of the online video market, which has swiftly become an important medium on the web. Content remains king, and the ultimate rulers of the digital kingdom will be those offering the greatest riches in terms of a functionally-rich, interactive, consumer-driven multimedia experience.

The dissemination of video on the Internet has exploded over the past few months, virtually transforming the media sector overnight. In Part I of our three part Online Video Series, we'll take a look at the YouTube/Google (GOOG) deal that has exposed the market's growth potential.

The deal is another sign of the widening chasm between old and new media. Still reeling from the failed acquisitions of the late 1990's, traditional media is becoming less relevant. Its inability to adjust to the changing marketplace has undermined its connection with consumers. In Part II, we'll look at two traditional media companies that are ahead of the curve in navigating the digital wave, Disney (DIS) and News Corp (NWS/A). Followed by Part III, which will outline the response to this rapidly-changing media marketplace from Viacom (VIA), CBS (CBS), NBC (GE), and Time Warner (TWX).

One of the greatest virtues of the Internet is inherent in its ability to make accessible a vast digital universe spawning a new medium of exchange, communication, commerce, and entertainment. The media sector was ripe for the transformation whether traditional (i.e. old) media was ready or not.

Consider the idea of watching favorite television programs when and where you wish, rather than at the mercy of the networks' schedule with irrelevant commercials, or watching a newly released movie from the comfort of your own home without having to go to a dank movie theater where your shoes stick to the floor and the air is filled with a cacophony of ring tones.

Do You Yoogle?

As an entertainment destination, YouTube drew in people watching more than 70 mln videos served up on its site daily. The fact that the site generated 20 mln unique visitors per month is music to advertisers' ears. As we have seen in the past, the success of these network/community-driven sites is difficult to challenge competitively once they have reached critical mass. Therefore, it was only a matter of time before any one of a handful of companies (Google, MSN, Viacom or Yahoo!) would step in. In the end, it was Google that inked the deal for $1.65 bln.

Google Video ranked third with 11% market share behind MySpace.com (21.2%), MSN Video (6.8%), and Yahoo! (YHOO) Video (5.6%).

Google, while the dominant leader in text search given proprietary algorithms, has to date had little success in  multimedia search, which is dominated by home-grown communities like YouTube and MySpace. The reason for all the hoopla over these social-networking sites, in particular, is the exponential potential in terms of ad revenues. In the US, the advertising dollars these sites collect is expected to grow from $280 mln this year, to $1.9 bln by 2010, according to research firm eMarketer. Further, Google continues to face competitive challenges from MSN and Yahoo and the social-networking sites create a degree of loyalty from users, preventing them from switching to competing portals or services. 

Video and audio search - basically anything not text-related - are differentiating capabilities that the dominant Internet players have yet to corner the market in. Google's purchase of YouTube swiftly and effectively closed the gap, to the detriment of Yahoo!. Going against its historical homegrown approach demonstrates Google's imperative to enter this space. Google needs to be proactive in protecting its 51% share of the search space.

Content Monetization

While the price tag may appear steep, Google has already demonstrated its willingness to pay a premium for traffic in the past, agreeing to a 3.5-year $900 mln deal with Fox Interactive to serve adds on News Corp's MySpace.com. This deal effectively enables Google to better monetize the traffic on MySpace.com by controlling a major content conduit, according to Needham.

Sergey Brin, Google's co-founder and chief technology officer, said, "It is hard for me to imagine a better fit for our company. One of the keys to having a comprehensive search experience is to have a great search over video." But the end-game is much more then just enhancing video search capabilities. The true gem is the considerable amount of new sources of content now available for advertising. Google anticipates the purchase will transform their company into a global media powerhouse and provide new audiences for targeting advertising - its bread and butter.

Google will instantly be able to monetize YouTube's inventory, while giving them a greater footprint in consumer entertainment content. Web-based advertising depends on the relevance of the surrounding content and site traffic. John Wanamaker, the father of modern advertising, said, "Half the money I spend on advertising is wasted; the trouble is I don't know which half."  The question is whether Google can convert the opportunity into advertising dollars. CIBC estimates $1.6 bln could be a bargain as YouTube has the potential to generate $200 mln to $300 mln in ad revenues by 2007 based on the ongoing advertising rates of $20-$50 for cost-per-thousand-impressions.  

According to the Interactive Advertising Bureau (IAB) and PricewaterhouseCoopers, US online advertising revenue for the first six months of 2006 was approximately $7.9 bln - up 37% from the first half of 2005. In just the second quarter, Internet advertising grew 36% year/year and 5% quarter/quarter to $4.1 bln.

Risks/Challenges

The main challenge is copyright issues. Given the fact that YouTube does not prescreen the videos it posts, its policy is to remove any content after notification of copyright violations. Even though it's operating within the laws of the Digital Millennium Copyright Act, YouTube has been sued. Considering the company has never made money, the number of filings could certainly rise with the lure of Google's deep pockets.

While digital domination may be Google's ultimate goal, there's still a steep learning curve as well as competition in this space. There are many video content sites, including Akimbo, PodZinger, Blinx.tv, Cinemanow, Sling Media, Guba, grouper, Tivo, MobiTv, Movielink, Rewer, Truveo, and Vongo. The difficulty is identifying videos, which can be done by voice, face, and picture recognition or user tags, based on relevancy. The possibilities are endless for advertisers, who can link ads to words or faces in videos. In August, Google purchased Neven Vision, a company which specializes in face recognition in photos, which is only a short jump to videos.

The long-term potential for Google and Yahoo! to store digital video content and match it with relevant advertising based on demographics, consumer behavior and preferences is a compelling opportunity.  According to ABI Research, revenues from dynamically inserting targeted ads via video on demand or streaming video content will grow from $284 mln (roughly 2.5% of total online advertising) this year to $1.8 bln by 2011.

Check back next week for Part II, Old vs. New Media: The Emerging Battle Over the Online Video Market

--Kimberly DuBord, Briefing.com