Why Hulu is Screwed, Part 2: Bad Economics (GE, NWS)

In Part 1 of this feature, we summarized why we think NBC/NWS video joint venture Hulu is screwed.  Here, in Part 2, we take a look at one of the most important reasons: Hulu's (bad) economics.

Hulu's (Bad) Economics

In our ongoing series on the Economics of Online Video, we concluded that companies that own vast libraries of pre-existing content that can be cheaply reformatted for the Internet have a compelling advantage.  Why?  Because:

1. professional content is 100% monetizable,
2. production costs can be cheap,
3. bandwidth and other high online hosting costs can be outsourced to a video-hosting site in exchange for a minimal royalty.

At first glance, it might appear that this is exactly why Hulu is going to win--because it's all about professionally produced content! Unfortunately, while the above applies to Hulu's content contributors (NBC/NWS, et al), Hulu itself is just another middleman.  News and NBC should ultimately do well with their re-purposed video. Hulu itself, however, probably won't.  Details after jump...

Hulu is the video aggregation and distribution business, not the professional content production business.  Unless you have industry-leading scale and/or exclusive high-value content (not some--a lot), Internet video aggregation and distribution economics are poor.  (For details, please see Economics of Online Video 2: Unit P&L Analysis). 

Hulu: Estimated P&L

How poor?  We've taken a stab at a hypothetical Hulu P&L, using our basic "Economics of Online Video" model.  The detailed spreadsheet is here.  The key assumptions are:

High CPMs: We've used a range of $10-$50, with a $30 base case.  This is high relative to average video CPMs these days ($10ish).  Yes, Hulu will have high-quality, advertiser friendly video.  And, yes, there are exceptions: Some niche sites have reported the occasional $500 CPM.  But given the current industry average, $30 seems reasonable.  (And even if it's far higher, Hulu's economics are poor--it's the royalty split that kills them).

Percentage of Videos That Are Monetizable: 100% Most video sites have tons of crappy or offensive user-gen videos that big advertisers won't touch.  In those cases, the hosting sites bear the costs of serving videos that aren't monetizable.  Happily, this won't be the case for Hulu: All of its videos should be able to carry ads.

Percentage of Videos Distributed Through Other Sites: 50%. Hulu intends to distribute video through third-party sites as well as on its own site.  We've assumed a 50/50 split of own site vs. distributed.

Distribution Fees Paid to Distribution Partners: 10% of revenue. To encourage others to distribute its videos, Hulu will presumably pay modest distribution fees.  We've assumed 10% of revenue.

Royalty Payments to Content Providers: 75% of Revenue.  This is the big one.  NBC and NWS aren't going to give all that video to Hulu for free.  CBS is currently using a 90%/10% rev-share split with many of its distribution partners.  There is no reason for NBC/NWS to take any less.  To be conservative, we've assumed a 75% royalty payment.  In our model, even if it's 50%, Hulu still loses money.

SG&A: We've assumed 50% of revenue, but this assumption isn't critical. What matters here is the gross margin--the amount of revenue Hulu will have left after it has paid royalty, distribution, and serving costs.

CONCLUSION

In our model, even with a $30 CPM, Hulu's gross margin is a meager 15%.  It's hard to be profitable with this low a gross margin, and with our SG&A assumption, Hulu isn't (in fact, it's operating loss is -35% of revenue).

Importantly, these economics doing change much as bandwidth costs decline.  We've run a "future" scenario in which bandwidth costs are 50% less, and the company still has a hard time making money.  Thus, even if Hulu implements a low-cost P2P distribution platform, the economics are tough.  Unless the content contributors are willing to settle for a very low royalty, it's just hard to be a middleman.

Feedback/thoughts appreciated, including from Hulu: hblodget@alleyinsider.com. We'll refine the model with more information as we get it.

See Also:
Why Hulu is Screwed, Part 1
VC Firm Goes Insane: Dumps $100 Million in Hulu