How will YouTube make money?

AD STRATEGY KEY TO TURNING MILLIONS OF CLICKS INTO CASH

By John Boudreau

Mercury News

Every day, more than 80 million videos are viewed on YouTube, the Internet's latest instant phenomenon that is an online diary for the digital generation.

That's some 2.4 billion clicked-on videos every month -- postings that range from a teenager bemoaning her parents who won't let her go hiking with her boyfriend to U.S. soldiers capturing scenes of combat in Iraq.

But can YouTube make money from these millions of mouse clicks? Is there a business plan that ensures the 1 1/2-year-old San Mateo start-up is not just another Silicon Valley one-click wonder?

The answer is critical to numerous start-ups jostling to position themselves at this new Internet intersection of social networking and entertainment driven by the ever-changing online behavior of young people.

Those that survive will have to find the right balance between the free expression of users, prevention of the illegal proliferation of copyrighted content and appeal to advertisers -- while not alienating users like Allen Jiang, who can vaporize in an Internet minute.

Despite becoming a cultural force, the young company is just beginning to unveil a strategy to make money off a growing audience accustomed to getting what it wants online for free. That's why subscriptions, pay-per-view videos or pay-to-upload videos are not part of YouTube's business plan.

But advertising? It'll have to be done just right.

Jiang, who just graduated from Mission San Jose High School in Fremont and is a regular visitor to YouTube, summed up the challenge: The wrong mix of ads could cause many users to unplug. ``There could be another YouTube-like site,'' he said, ``and everyone turns to that one.''

YouTube is backed with $11.5 million from Sequoia Capital, the venture capital firm that also supported Google, another Silicon Valley company whose technology wowed the online masses but initially prompted questions about how it would make money.

The privately owned company does not disclose how much money it is currently spending on the site.

But it plans to figure out a way to cash in on its stardom and is not looking to be bought, said Julie Supan, YouTube's senior director of marketing. ``Right now, YouTube is not for sale,'' she said, adding, ``the path to profitability is in sight.''

In recent months, YouTube has experimented with Yahoo and Google text-based ads, and last week it launched a banner ad campaign for Disney's ``Pirates of the Caribbean: Dead Man's Chest,'' which set a U.S. box office record this past weekend. YouTube would not disclose the deal's financial details.

``We want to get it right,'' Supan said. ``It's not just a matter of whether or not the advertiser will find value. It's also whether the users find value in it.''

Don't expect YouTube to embed commercials at the start or end of videos, she said. ``We don't think those things will be in line with our community.

``Over time, YouTube will have created a new model, just as Google created a new model for Web-based ads,'' Supan said.

YouTube's quick popularity -- it had 19.6 million visitors in June, according to Nielsen Media Research -- has brought the kind of media attention most start-ups can only dream about. Company founders have been on the ``Today Show,'' ``Nightline,'' CNN and are booked for an August appearance on the ``Charlie Rose'' show.

But with fame comes pressure. The cost of running a site that streams millions of videos a day is adding up -- the monthly bandwidth bill alone is at least $300,000 to $400,000, industry insiders say.

Advertisers and Hollywood executives are exploring numerous deals with YouTube, which can draw more viewers than some network TV shows. NBC, which just a few months ago demanded YouTube pull clips of ``Saturday Night Live,'' is now promoting its fall shows on the Web site. (Entertainment executives credit YouTube for responding immediately to requests to remove illegal videos.)

``There is an incredible upside as long as we don't screw it up,'' said John Cate, an ad executive at Carat Fusion. Cate, whose clients include Adidas and Hyundai, has been meeting with YouTube executives in recent weeks to create advertising campaigns designed particularly for the Web site, though he would not provide details. His firm launched an Adidas campaign on MySpace in which people post their own video commercials for the athletic shoes manufacturer.

YouTube's work-in-progress business plan has raised concerns among some industry observers who believe the Web site could go the way of Napster. The former Redwood City file-sharing company became an Internet star by allowing people to exchange copyrighted music, but became less popular as a legal site.

``The truly difficult task for YouTube is to change the entire culture of the viewers that propelled it to overnight success,'' IDC analyst Joshua Martin wrote in a recent report. Eventually, he added, people will accept advertising-supported video online, ``but not likely quickly enough for YouTube to reinvent itself.''

In an interview, Martin said his report was designed to counter what he sees as frenzied media coverage of YouTube and other online video sites. ``Sometimes a little cold water needs to be thrown on a situation,'' he said.

Clifford Nass, author of ``Wired for Speech'' and a media specialist at Stanford University, said media that rely on the handiwork of amateurs have historically failed.

``Curiosity sells in the short term,'' he said. ``But it's much easier to monetize talent. That's what it comes down to.''

But Tony Perkins, editor of the Always-On Network and founder of Red Herring magazine, believes YouTube critics are missing a massive behavioral shift.

``There is a new reality out there,'' he said. ``Consumers are voting very loudly that they enjoy content that is produced by amateurs and people they know.''

It is a movement too big to ignore, said Ian Schafer, chief executive of Deep Focus, a Brooklyn, N.Y., marketing agency that works with major entertainment companies. It placed Dimension Films' ``Scary Movie 4'' trailer on YouTube, where it became one of the site's most-watched videos. The terms of the deal were not disclosed.

Companies worry about their ads popping up next to content they may find objectionable, a concern when dealing with unpredictable amateur video clips and no-holds-barred comments areas that can be filled with insults and slurs, he said.

Still, Schafer added, ``There has to be an acceptable amount of damage you are willing to incur in order to figure this out. Any place where you've got that many people -- there has got to be a way to reach them with advertising.''

YouTube fan Jiang, who will be a freshman at the University of California-San Diego in the fall, said he is willing to accept ads -- to a point. Too many flashing ads would turn off users like himself, he said. So would ``spam videos'' that at first click appear to be non-advertisements.

``If they are careful,'' Jiang said, ``they will do a good job and chances are people will keep going to YouTube.''