Advice for YouTube: Find a Subscription Model to Keep Viewers Clicking

In the eight years since it was launched, YouTube has grown into the largest video service in the world. Every day, more than one billion people watch clips on the site’s million-plus channels. And until now, all that content — everything from anonymous home improvement and make-up tips to the news clips, comedy shows and music videos that seem to instantly go viral — has been free.

Now, however, the Google-owned service is entering a new phase. In early May, YouTube moved ahead with long-rumored plans to begin a subscription-only service for premium content.

Roughly 50 channels, including National Geographic for Kids and Sesame Street, have joined a pilot program aimed at convincing viewers to pay for access to their favorite programs and performers. If they succeed, YouTube wants to add more of the site’s strongest channels to the subscription service. “This is just the beginning,” the company said in announcing the start of the paid programming. “We’ll be rolling paid channels out more broadly in the coming weeks as a self-service feature for qualifying partners.”

YouTube’s goal? Z. John Zhang, a Wharton professor of marketing, says the move is a bid to become a bigger competitor to traditional television and cable programming and subscription-based streaming services such as Netflix, Hulu and Amazon Instant — and to grab even more of the eyeballs, advertising and revenue sources that now go to those rivals. The video service wants to develop more of the higher quality programming that viewers crave — and for which advertisers might willingly pay more. Allowing the artists and producers who upload content onto the site to charge for their programming is intended to give them the additional financing needed to grow — and to give YouTube itself a potentially lucrative new revenue source to add to the advertising that now supports the site. Analysts estimate that advertisers paid about $4 billion for YouTube ads last year and that the site will attract $5 billion in ad money in 2013, Bloomberg Businessweek reported.

“The problem with YouTube’s current model is that as more and more content gets uploaded, there is a lot of garbage. It’s very difficult to find anything relevant and interesting. And the video quality is really variable,” says Zhang, who teaches a case study on YouTube in his classes. “If I’m an advertiser, I don’t want to have my name next to some video that looks bad. Advertisers want better quality, so YouTube needs a segmentation strategy.”

The question, of course, is whether YouTube can carve out a corner for paid programming without alienating the enormous audience it has built up that has grown accustomed to accessing all the video it wants for free. Charge too much, and the viewership numbers will tumble — which means YouTube’s advertising revenues would fall as well.

Zhang and other observers say much will depend on the type of subscription programming YouTube can develop, along with the pricing strategies the paid channels decide on as they begin charging for their content.

“YouTube will have to recognize the different types of users they have and then figure out how to charge each for what is most valuable to them,” says Wharton marketing professor Jagmohan Raju. “It is not easy.” The biggest challenge, he adds, will be discerning the fine line between “those who are willing to pay for higher value and giving it to them versus those who don’t need it and therefore won’t pay.”

Moreover, the strategic decisions aren’t entirely in YouTube’s hands. Though YouTube will undoubtedly work closely with the channels that opt to add subscriptions, the video service won’t be charging directly for access to content itself, nor will it control the fees the channels charge. Instead, it’s allowing selected channels to charge viewers directly for access to their content. YouTube will then take a cut of whatever fees they charge — a model, says Wharton management professor Daniel Levinthal, that’s similar to what Apple does when users download an app or a publication from the iTunes store.

45% versus 35%: What’s Your Number?

As the experiment gets underway, the roster of channels willing to sign up so far remains fairly skimpy. With a few exceptions, no mainstream brands or prominent young stars who have already built up a strong following on YouTube have agreed to begin charging for their content. The initial subscription channels are mostly a grab bag of little-known programs focused on such areas as autos, sports, movies and fitness.

For now, the major players appear to be waiting to see if those channels succeed with paid programming before they will jump on board. And according to reports in the tech press, many may also be reluctant to give YouTube as big a share of potential subscription revenues as it wants.

Though the company hasn’t released figures publicly, it reportedly keeps 45% of the advertising revenues that its content creators currently attract. Industry sources expect the subscription split will follow similar lines, with YouTube taking 45% and the content creators pocketing 55%.

The size of that cut recently led one prominent YouTube partner and content creator, Jason Calacanis, to decry its tactics. In a widely discussed blog post entitled, “I Ain’t Gonna Work on YouTube’s Farm No More,” Calacanis dismisses what he refers to as the “45% tax” imposed by the video service. “It’s a horrible ‘business’ deal for content creators to invest in YouTube,” he argues.

To succeed, YouTube will have to win over more creators of the popular content that viewers want to watch. To get the big players, Calacanis believes that YouTube’s cut should be closer to the 30% Apple takes in. But even if YouTube can’t initially draw the biggest digital stars, Zhang and others say there are many directions it could take to bulk up its subscription lineup.

One critical question is what type of programming is best suited to the subscription model. Levinthal suggests that one approach would be to create packages of high-quality advice programming. Already, YouTube is full of “How To” videos in every conceivable category, but wading through an array of different quality offerings can be a chore. “YouTube could use its branding and bundling to help viewers sort out the best,” says Levinthal. A viewer might pay $5 to go directly to the top cooking videos, for example, and not have to bother with the rest.

Beyond “How To” programming, other content libraries featuring older shows or niche interests — much like the collections of past seasons that Sesame Street is making available– could also be successful if the major media companies decide to offer them to the video service. One critical advantage YouTube has over cable as a distribution channel: Online, the niches don’t have to be huge to draw a big enough audience to be financially viable. “They just have to be good; it has to be a pretty juicy niche for people to be willing to pay,” says Levinthal.

Another potential avenue for YouTube would be sports and other special events, or on-demand programming — much like the events HBO and other cable channels now charge for. There is no reason YouTube, too, couldn’t charge for a special featuring a popular comedian or for footage of a sold-out concert, notes Zhang. And while YouTube doesn’t currently have the ability to stream live events, that could prove a lucrative avenue in the future.

“They have a TV-like audience — you can do a lot of things once you have that mass,” says Zhang. “You can sell live concerts or boxing on demand. Once you start charging, you change the nature of the service you’re providing.”

Upgraded Delivery Options

Along with developing popular niches and content areas, experts say YouTube’s subscription services could also give content developers more room to offer non-traditional formats, such as shorter pieces or user-directed viewing, than advertisers or traditional cable companies might support. Or they might add value in other ways — offering a synchronized recipe box with featured cooking channels, for example, or bookmarking tools that allow subscribers to create libraries of their own customized content.

Some viewers might also be willing to pay for upgraded delivery options, Raju adds. Subscribers might get access to a show before the general public can see it, for example, while some might be willing to pay for a higher quality stream that enables them to watch a film on a big screen rather than a laptop.

If YouTube can offer that type of additional value in niches where viewers have demonstrated a strong interest, it “has the potential to develop a disruptive new service of specialized cable channels that offer content developers much better [financial terms] per viewer than a traditional cable operator would,” says Levinthal. “It can’t just be: ‘This used to be free; now you’ve got to pay for it.”

Whatever programming YouTube ultimately adds, an equally critical question is how much to charge for it. Aside from iTunes and similar app stores that have developed in recent years, limited data exists on how much customers are willing to pay for online content. And online or off, getting customers to pay for something they have previously consumed for free is always difficult. Even popular content creators who have built a big following on YouTube risk losing much of their fan base if they start to charge — perhaps another reason why the biggest entertainment programmers on YouTube are not yet participating in the subscription launch. Moreover, traditional media companies have other options for distributing their content online, including Netflix and Hulu.

What, then, are the optimal pricing strategies for video content? That, too, would vary considerably depending on the programming. A comedian or musician might be able to charge a higher one-time fee for a special concert than another producer could charge for a single episode of an ongoing show. “Immediacy and timeliness matter,” says Raju. “People are more willing to pay for things they wouldn’t otherwise have access to.”

At the same time, a producer of a web series hoping to draw a loyal following would face a very different decision. It might make more sense to set pricing to keep viewers coming back repeatedly rather than maximizing the charge for any individual download. In that case, says Wharton marketing professor Eric Bradlow, co-director of the Wharton Customer Analytics Initiative, pricing should be set with the flexibility to reflect different consumer habits.

“The right solution to this problem is to let the customer decide the optimal pricing option for him/her by providing a menu of options,” says Bradlow. “Letting customers self-select the plan that works best for them is always a good idea.”

With an ongoing series or a library of content, for example, Bradlow and others argue that providing a menu that will attract the broadest range of customers makes the most sense. Some viewers might want to sample just one episode of an ongoing cooking series or a comedy show. Others may want to watch a whole season’s worth of episodes — but they won’t pay full price for every single one.

“There are really two types of customers, and most channels would likely want to use a combination of subscription and a la carte pricing to attract them both,” says Zhang. “If you are a regular, frequent viewer, then a subscription makes sense. But if you are only an occasional viewer, a subscription will scare you off. So channels will want to have both.”

That appears to be the strategy taken by a number of YouTube’s initial pay channels. Subscriptions to the PGA Digital Golf Academy go for $4.99 a month or $34.99 a year — a 40% discount — while channels as diverse as Gay Direct or the Rap Battle Network charge $2.99 a month or $24.99 a year.

Not all the new channels offer consumers a choice, however — although those that don’t have kept prices modest. The Sesame Street channel charges $3.99 a month for access to several past seasons, for example, while access to channels devoted to yoga, fitness and Ultimate Fight Championship programming runs $5 to $6 a month.

And what of the viral video, that unique phenomenon of the YouTube age? One argument content creators have raised against adopting a subscription model is the fear that it potentially limits viewership, cutting off the ability to go viral that has driven much success on the Internet. Looked at another way, however, Zhang argues that such phenomena are really a missed revenue opportunity. The trick is starting to charge viewers only after a video has begun to take off.

“Imagine if you took the ‘Gangnam Style’ video, and you put it into a premium channel after it started to go viral,” he says, citing the popular Korean music video that has drawn close to 1.7 billion hits since it was uploaded last July. “There are many people who would have paid to see it at that point.” It creates a potentially large market that YouTube has only begun to exploit.

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