THE SHAPE OF THINGS TO COME

October 15, 2006  

Google just paid $1.65 billion for YouTube.com, a video-sharing website started in a garage in February 2005 by Chad Hurley and Steve Chen, two geeks in their twenties working for eBay’s PayPal.  They just wanted to share videos with their friends but discovered there was no easy way to do it, so they developed a website to do it themselves.  Hurley and Chen, who owned a 40-percent stake in the video-sharing phenomenon, will share approximately $670 million.  Google’s purchase of YouTube is reminiscent of the dot-com boom of the 1990s when potential was valued over performance.  And it’s another confirmation of the belief that the Internet is destined to gobble up the television and the motion picture industries. 

YouTube, for anyone not be familiar with it, currently gets 100 million (yes that’s one hundred million) hits a day from people who click on the website to watch free videos from the banal to the sublime.  They load quickly and play in a slightly larger format than other web videos.  The site is well laid out and easy to use.  But whatever the two wiz-kids spent developing and maintaining the site, it cost them nowhere near $1.65 billion, nor did their earnings from advertising even begin to approach that amount.

So why would YouTube be worth so much money?  As one article recently noted, for that price you can buy a nuclear aircraft carrier and have $200 million left over to fuel and man it.  And beyond the capital Google ventured up front, the company could face considerable expenses defending itself against copyright infringement lawsuits.  Since anyone can upload videos to YouTube, there is no way of knowing if they’re uploading copyrighted material.  So what does Google know about the future that motivated it to take this kind of risk?

Companies and investors who dominate emerging markets tend to dominate those markets and reap the greatest profits when those markets mature.  Just think of Bill Gates and Microsoft.  No one at Google has shared their vision of the future with me, but I suspect that the market Google is positioning itself to dominate is a much bigger than the one it currently dominates.  Google already is the leading search engine, and with its purchase of YouTube it now dominates Internet video sharing.  Its revenues from YouTube eventually can recover Google’s investment and add to its profits, but I don’t think that’s what motivated it to buy YouTube.

Predicting the “shape of things to come” is fraught with danger, but I don’t think predicting the future in this case requires much guesswork.  Consider what’s already happened.

When motion pictures and television began they were separate and distinct media.  It didn’t take long, however, following the advent of television, before motion pictures were broadcast into everyone’s home as just another form of television programming.

The first Sony Betamax videotape players and recorders came along in the mid-‘70s and video rental stores popped up all over the country.  You could buy or rent recent movies to watch on your television at home.  Then Beta lost out to VHS.  VHS lost out to DVDs and TiVo digital recorders. 

DVDs sell well at places like Best Buy and Circuit City, but DVD rental stores like Blockbuster are struggling to maintain their profits.  Many video-rental stores have closed already.  The cost of renting a movie has risen steadily and cable television movie channels and their On-Demand services have eliminated the need to drive to the local shopping center to rent a movie.  But while two hundred cable television channels may provide a broad selection of television programming, cable or satellite are not the most efficient means of providing the broadest selection of motion picture choices or they would have consumed the DVD market already.

Netflix, the through-the-mail DVD rental service, also does well because you don’t encounter the “all-our-copies-are-out” problem and you can select from thousands of movies.  High Definition (HD) DVDs are just coming out, but they, like their predecessors, are just a temporary fix. 

With the spreading popularity and affordability of high-speed internet and media devices like Apple’s iPod, people now can download movies, television programs, and other video entertainment and play it on their computer, their TV, or their portable device at their convenience cheaper than they can buy or rent them.  If you’ve purchased, or are about to purchase, a HD flat panel television, look on the back.  Most of them have the standard computer monitor cable receptacle.  All you have to do is plug in your PC.  Most people aren’t using their HD sets for this purpose yet because the quality of video currently available over the Internet won’t fill such a large screen with a high-resolution picture.  And it’s still easier and faster to buy or rent the DVD or watch On Demand services than it is to download the movie on your computer.

Before long, however, that won't be the case.  The proliferation of high-speed broad band Internet, faster computer chips, and larger capacity hard drives will make downloading and watching a movie on a large-format HD monitor just as convenient as renting or buying it on DVD.  And your choices will be virtually limitless.  Like televisions today, there will be one or more HD monitors with integrated hard drives connected to the Internet in every home for access to movies, interactive television, Internet radio, browsing and shopping.

Once the technology develops to this stage--it’s not that far off--and it is available at an affordable price, it will transform the Internet, television, and motion picture industries.  With today’s wide-screen HD televisions and home audio systems it’s already possible to create a movie-viewing experience that rivals what you get in a theater.  All that keeps most people from staying home is the fact that you can’t see new releases when they first come out unless you buy a poor-quality pirated DVD or go to the theater. 

Theater owners will resist it, but when the demand for initial release of motion pictures directly to Internet movie services gets great enough, and the potential profits large enough, the motion picture industry will happily part company with theater owners.   People will prefer to watch and listen to newly released movies, downloaded from the Internet, on their HD home-theater systems.  Yes, experiencing the audience reaction in a movie theater enhances enjoyment of the movie, so movie theaters won’t go extinct overnight.  But in time, when we have almost immediate access to every movie or television program ever made that still exists from the comfort of your living room, movie theaters will go the way of the drive in.  It’s no coincidence that most broadband Internet in this country is provided by cable and satellite television services.

There is no guarantee that Google won’t regret purchasing YouTube.  There may be several more cycles of boom and bust before the future I’ve described arrives.  But have no doubt, it will arrive.