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Hulu Profitable? Please

hulu.jpegThe analyst who predicted that Hulu will have more revenue than YouTube next year is making more headlines, this time over at AllThingsD. ATD writer Peter Kafka spoke with the analyst, Arash Amel, and says Arash thinks that Hulu is already profitable.

We'll believe it when we see it.

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It has been a while since we analyzed Hulu's profit potential, but when we looked at this issue a year ago, profitability seemed a pretty formidable goal. Based on Peter's write-up, it also appears that Arash is not referring to operating profit, but gross profit, which is what a company has left after deducting the costs directly involved in providing its products/services but before deducting all of its operating expenses. Producing a gross profit isn't much to write home about. It is actual profit--profit after all expenses--that matters.

Here's how Peter says Screen Digest analyst Arash breaks down Hulu's numbers:

Hulu:

2008 gross revenue for US: $70 million

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Net margin (factors in infrastructure costs and payments to affiliates and content owners): 15 percent to 18 percent

Net revenue: $10.5 million to $12.6 million

So that's about $11-12 million of gross profit, which is about what we would have expected on $70 million of gross sales.  That equates to a 17% gross profit margin. That is about what we estimated a year ago (lower, in fact).

A 17% gross margin is, in a word, low. (Amazon.com, a famously unprofitable company for many, many years, has a much higher gross margin).  Gross profit does not include the costs of selling advertising (10% of sales), marketing, product development (Hulu's platform), or management or administration salaries.  So, again, it seems highly unlikely--to say the least--that Hulu is actually making money.

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Perhaps Hulu is losing less money than YouTube. Hulu has fewer than 1/10th as many users as YouTube and serves an even smaller fraction of streams, so that is entirely possible. But by that measure, most companies are more successful than YouTube.

Below: Our series of analyses taking a stab at Hulu's P&L, which we wrote in October of 2007. Some of the cost or revenue-split assumptions may be out of date.  If so, please send current details and we'll update the: hblodget@alleyinsider.com


Hulu's Lousy Economics: The Details (October, 2007)

Hulu's product is cool, but we believe its business model is lousy.  A month ago, we created a basic estimated unit P&L for Hulu, which illustrated why (See below).  Today, we have updated this P&L with more refined revenue splits.  Our conclusion remains the same: Hulu is going to have a devil of a time making money.

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Specifically, our recent research suggests that Hulu's revenue splits are:

  • 70% to content provider (TV network)
  • 20%-30% to Hulu, depending on whether the video is viewed on Hulu.com or a third-party distributor.
  • 10% to third-party distributor, if any (AOL, MySpace, etc.)

We've described the assumptions underlying our unit P&L in detail after the jump.  But here's the conclusion:

CONCLUSION

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In our model, even with a $30 CPM, Hulu's gross margin is a meager 20%.  It's hard to be profitable with this low a gross margin, and with our SG&A assumption, Hulu isn't (in fact, its operating loss is -30% of revenue).

Importantly, these economics don't change much as bandwidth costs decline (especially if Hulu runs high-resolution video).  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 video middleman.

Feedback: hblodget@alleyinsider.com. We'll refine the model with more information as we get it.

See Also:
Everyone Loves Hulu...But It's Still Screwed
Why Hulu is Screwed, Part 1
VC Firm Goes Insane: Dumps $100 Million in Hulu 

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---JUMP---

Hulu: Estimated P&L

Here are the assumptions underlying our updated 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, 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).

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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: 70% 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.  Our research suggests that NBC/NWS will take a 70% royalty payment.  In our model, even if it's 50%, Hulu still loses money.

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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.


Why Hulu Is Screwed: Bad Economics (SEPTEMBER 2007)

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

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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...

---JUMP---

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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).

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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.

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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.

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


Economics of Online Video: Unit Cost Analysis (SEPTEMBER 2007)

After performing a detailed analysis of the economics of streaming video, we continue to believe it is a very tough business--with high capital costs and low profit margins.  In the first installment of this series, we explored the ramifications of this.  In the second, we take a closer look at unit costs.

Streaming video has a similar cost structure to many text- and graphics-based Internet businesses, with three significant additional costs: bandwidth, storage, and transcoding.  Each of these items increases the costs associated with video streaming relative to that of static content--without a reliable offset in terms of additional revenue.  In contrast to most text-based Internet content, moreover, these video-related costs are variable, meaning that they rise in direct proportion to video usage (not revenue--usage).  This means that the industry will not suddenly become wildly profitable as revenue increases.  On the contrary: It will likely continue to struggle to eke out a profit for many years.

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In addition to the three major video-serving costs, which we detail below, there are two other critical inputs into most streaming video business models:

  1. The percentage of videos that are monetizable. Low for video dumps like YouTube; high for network sites and professional "show" hosters like blip.tv.  Because video streamers incur the same costs for monetizable videos as non-monetizable ones, this assumption is critical.
  2. Content production/licensing costs. Relatively low for TV networks, which can repurpose content, and high for the more plush online show production* (costs of shooting, editing, studio, etc.) and YouTube (royalties).

Most companies that store and serve video lie somewhere along a continuum of, say, 20%-100% on these two expense items, with the specific inputs having a huge impact on the potential profitability of each model.  To illustrate the importance of these costs, we have modeled:

  1. A base "streaming video" model that lays out the basic cost structure
  2. A "TV Network" version, which adjusts for low royalties and a high percentage of monetizability.
  3. A "YouTube" version, with huge scale, high royalties, and a low % of monetizable content.
  4. A "niche network" version (e.g., blip.tv), with medium royalties, high targeting, and a high percentage of monetizable content.
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We are grateful to Mike Hudack of blip.tv, Dwight Merriman of ShopWiki (an SAI investor), and others for help with this preliminary cost analysis.  Please weigh in in the comments or via email (hblodget@alleyinsider.com), and we'll refine as we get more info.  Details after the jump. 

*We're not suggesting that online video production costs a lot relative to TV, movies, etc.  Relative to those, they're dirt cheap.  The expensive ones still cost a lot relative to the revenue they can produce, however.)

---JUMP---

Here are the key considerations for the potential profitability (and value) of streaming video:

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Revenue. Online video monetization should continue to improve, and, ultimately, online video should be as accepted and important an ad medium as, say, paid search.  Recent data suggests that "run of site" video CPMs range from about $5-$20, with targeted sponsorships ranging from $15 to, on occasion, $300-$500.  The high end sponsorships appear to be a bizarre outlier, and as with most other forms of online advertising, we expect that CPMs will drop as the thrill and novelty wears off.  So we are not expecting soaring CPMs to bail out the industry's high cost structure.  In our modeling, we've used a CPM range of $5-$25, with a "base case" of $15.

Percentage of Content That is Monetizable.  We have no doubt that, contrary to popular perception, dancing cat videos will eventually generate some revenue.  Blow-job videos and pirated TV content, however, probably won't--at least not on sites like YouTube.  Regardless, the percentage of videos that are monetizable at, say, YouTube, is far below that at, say, blip.tv (a niche network featuring professional "shows") and TV networks.  This assumption is critical, because if the streamer only monetizes, say, half of its videos, the "effective CPM" will be cut in half.  Our base assumptions are as follows:

YouTube:       30% monetizable.
blip.tv:            80% monetizable.
TV network:   100% monetizable.

Content production / royalty costs.  Assuming you're playing by the rules, you either have to pay to develop video content yourself or pay someone else for theirs.   In the text-based world, Google pays about 80% of revenue out in royalties ("rev share").  If the video royalties are anywhere near this level, YouTube's profitability is going to be minimal (if that).  We expect Google will adapt to the high-cost-structure reality by vastly reducing the revenue share it pays to video producers (which won't sit well with them).  In the meantime, however, we've modeled a high cost here:

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YouTube:        70% payout
blip.tv:             50% payout
TV network:    20% payout

Bandwidth.  Video streaming eats bandwidth.  Bandwidth costs are declining rapidly, of course--which is the great business-model hope of many video streamers--but, importantly, these cost declines are often offset by increases in average video file size, as resolution increases.  For the purposes of this analysis, we have optimistically assumed that the costs of bandwidth, storage, and transcoding (see below) will continue to decline rapidly and that increases in average video resolution will not eat all these benefits.  Specifically, we use a range of $0.05 to $0.15 per gigabyte and a 20mg average file size, which produces a $1.00-$3.00 current per stream CPM.  We have assumed that in the "future," bandwidth, storage, and transcoding costs will decline by 75% versus today.   If file sizes increase rapidly, this could easily prove too optimistic.  A low-cost P2P solution, meanwhile, is likely years away.

Storage and Transcoding.   To estimate storage and transcoding costs, we have estimated capital equipment costs and then converted them into per-stream costs.  These costs should decline rapidly, too, but not if video file sizes continue to increase. 

Please see the model links above for more details.


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