Online video grows explosively, but faces two key challenges

These days, it seems every VC is investing in online video services. The focus is on user-generated content and how to capture the power of users providing their own entertainment. The main problems are two-fold: much of the content submitted is owned by someone else and a dominant business model has yet to be established. Let's explore.

Recently, Knowledge@Wharton posted a story titled "The Rise of the 'Videonet'" about the push for online video, and discussed the buzz at the Supernova conference, which was co-hosted by Wharton West. There is certainly a lot of excitement, and I don't think many people dispute the fact online video is here to stay. To paraphrase Warren Buffett, the main challenge in returning value to investors is not in predicting macro trends, but identifying specific companies that have sustainable competitive advantages. Investing in yet another video website may not be the path to delivering long-term value.

Consider the competitive position of video websites. Many rely on their users to submit content, so they can't upset them too much by using noisy ads. Given the space is flush with cash, many video websites have refrained from including ads in videos. Of course, online video leader YouTube burns millions of dollars a month playing billions of videos that don't include video ads, but what do they care when Sequoia is footing the bill?

Of course, at some point they need to figure out a business model. Even with 43% market share of visits, MySpace is right behind with 24%, and MySpace benefits from a base of 80 million plus users. So what happens if YouTube includes ads and MySpace doesn't? Do you see a migration of users from YouTube to MySpace? Probably. So YouTube isn't ready to risk it quite yet.

It's in the best interests of copyright holders for YouTube and MySpace video to become really popular. Why? For starters, the most widely discussed reason is because viral videos actually drum up more interest in their shows that are on real TV, increasing ratings and driving higher DVD sales. But consider the nightmare scenario for copyright owners. If they sued YouTube out of existence, where would people choose to get their copyrighted content? Conditions would be ripe for ever more copyrighted material to flow through P2P. Copyright holders can negotiate with leading platforms for online video, but not with millions of people on an ungoverned P2P network. Thus, copyright holders want (or at least they should want) people to learn to use platforms like YouTube (or governed P2P networks like veoh, for that matter).

Given the push by VCs to invest in online video services, it's interesting we are not seeing more models like TurnHere. TurnHere is making 25,000 videos this year about specific locations (such as Los Angeles, New York and San Francisco), which are mostly of interest to travelers. Given this focus on function, these videos have clear paths to monetization, and that is already happening. Plus there's no ambiguity about copyright ownership. TurnHere outsources video production to pro filmmakers for $500 per video, and in exchange TurnHere fully owns that content.

TurnHere's growing library of videos coupled with its ever strengthening relationship with filmmakers are two points of differentiation more distinct than what you could say about many online video services (mostly YouTube clones). Of course, in theory no two works are really the same in content. The advantage for TurnHere is they are getting videos creating before a dominant business model is established. A dominant model would probably attract more VC investment and drive up the cost of making the videos. After all, there are only so many pro filmmakers out there, and TurnHere's filmmaker network already includes 2,000 of them.

In summary, the online video space holds a lot of promise, and I think people are right in saying we will see a lot more videos throughout all areas of the internet, not just on user-generated content websites like YouTube. That said, the real question is about business model. For now, a proven ad model for online video websites has not been established, and even when that does happen, copyright holders could still step in and demand significant compensation. Not owning the content certainly leaves a significant amount of leverage in the hands of copyright owners. But of course given sustained critical mass for one video service, it could actually hold enough leverage to keep copyright holders in check. That said, it will be interesting to see if more investment is directed towards models like TurnHere.

You can read more about my thoughts on TurnHere and listen to a podcast I had with TurnHere's founder & CEO Brad Inman by clicking here.

Market share chart and lists courtesy of HitWise. You can read more about the data here.

Note: I also posted this entry on the Wharton Tech Club blog.