The Microsoft Story

Let me start with my take on Scoble’s post that Microsoft should have bought YouTube rather than take the build-it-yourself route. Scoble is saying we should pay 1.65 billion odd dollars for the community, not for the service. Some others are saying Microsoft failed to close the deal. But the truth is that Microsoft didn’t really lose out on this deal–it just didn’t make business sense at those prices. Steve Berkowitz (Senior VP, Online services) recently sent a mail to employees outlining our position:

…MSN has a huge global audience of 465M users per month that we can tap into and focus on Soapbox to contribute and share videos. We have a far better strategy around integrating Soapbox across MSN, Windows Live and Microsoft services like Windows Mobile, Xbox and Zune, that we couldn’t have matched with an acquisition.

We don’t need to buy any community, we already have a really large one we can tap into.

Consider how we leveraged the Hotmail community. What we get from Hotmail is far greater than one could attribute to the dollars generated. Hotmail could be attributed as the primary grower of the MSN network. We delivered the Hotmail Notifier that sat in the system tray and evolved into a messaging application and drove Hotmail users to what eventually became MSN Messenger. Messenger drove traffic to MSN Spaces with the gleam feature which helped us dominate the blog market share overnight. Messenger now has built in search that drives traffic to MSN Search and the default install of Messenger is also driving traffic to the IE toolbar, Live Sign-in Assistant etc. All those users originally came from Hotmail–users who wanted to connect.

Microsoft has plenty of users. Building a video service is very easy.

The Value of YouTube to Google

I would’ve considered the $1.65bn price tag to be exorbitant and reminiscent of the dot com era. But Google found it justifiable.

However, what YouTube means to Google is much more than what it means to Microsoft or Yahoo. The simple reason is that Google has a better ad infrastructure at present which will allow it to better monetize YouTube. They can recover their costs much faster than anyone else out there and so they can afford to pay more. There’s also the competitive aspect. Google would rather not see YouTube go to anyone else. YouTube is a big driver for Google’s ad traffic and losing it to someone else like Microsoft might mean the loss of all those ad dollars.

Further, Google does not have a large registered user base. Google Search is their primary traffic driver and it’s a hit-and-run type of deal. Google could potentially convert YouTube users into registered Google users or channel them to other Google services much like Microsoft did with Hotmail. The reason they will have more success with getting these users to register versus search users is that these users are lurkers. They hang around YouTube spending idle minutes entertaining themselves. Search users on the other hand are task driven–they want to find whatever it is they are looking for and be on with it. This makes YouTube all the more lucrative for Google.

YouTube’s Legal Hurdles

The most intriguing aspect regarding this whole ordeal will be the reaction of MPAA and RIAA to YouTube which is basking in the glory of copyright infringing videos. This will be similar to Napster albeit Napster’s traffic was almost entirely composed of copyrighted material while YouTube thrives on plenty of legitimate content. Further, if YouTube falls under the “safe harbors” of the Digital Millennium Copyright Act of 1998, the burden of finding copyright material will lie with the copyright holders who will be required to provide a list of copyrighted material to Google to take down. Napster failed here for technical reasons as they could not satisfactorily comply with or facilitate the major copyright holders to weed out infringing materials.

YouTube’s story is different as theirs is a much more tractable problem. One idea might be for Google to provide administrative accounts to the large media companies (and complying primarily with the major copyright holders is the key here) to remove infringing content themselves or possibly build a “community moderation” system. The latter will probably not work due to conflict of interest–the community finds value in free copyrighted content but the design could be modified to reward the community of moderators. YouTube could also hire auditors working around the clock to comply with the smaller players though Google is a strong believer of autonomous, scalable systems so its unlikely they will take this route in the longer term.

YouTube also differs from Napster in that their architecture is considerably different. Napster’s P2P network meant there were millions of infringers floating millions of copies of any particular song with hundreds of variations. YouTube has a very limited number of duplicates and uploading the same videos under different guises doesn’t make sense as the user will not be able to find or share it without the copyright owners being able to do the same. Further YouTube controls the content format which means that copyrighted content cannot be wrapped inside an encrypted layer which is how Napster users were able to share banned songs.

Finally, since the big copyright holders are the ones with which Google will primarily be concerned it will mean that YouTube can do traffic profiling to find videos with massive infringement. It doesn’t make sense to go after a copyright video that’s being viewed by < 1K users when there are videos out there being viewed by 50K+ users. For all these reasons and more, Google/YouTube should be able to pull this off. The problem is easily surmountable.

In Summary

Google will weed out the copyrighted content and the problem is not hard to solve. They will get their moneys worth through direct monetization via AdSense and also by channeling these users to other Google services. It did not make sense for Microsoft to pay a similar amount for YouTube’s users since it already has a large registered user base from which it can carve out a community of video watchers and it could not have monetized as much from these users. Microsoft will continue to build upon its ground-up service, SoapBox which will be woven with other technologies like Zune, Spaces, Messenger and Mobile.

The legal hurdles should continue to hit the press in the coming weeks/months possibly wavering Google’s stock up and down. Bloggers at the same time will continue to feed the frenzy calling Google crazy and brilliant.