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: [email protected] 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 

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