Google's YouTube Premium Is Poised to Be a Hit

 | May 18, 2018 | 11:36 AM EDT
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Over the last decade, YouTube has emerged as one of the biggest video entertainment sources for a generation of consumers, and the biggest one for some of those consumers. That's one big reason why a subscription service that combines ad-free YouTube with original content and a music service that's fully integrated with YouTube's site and apps should have a lot of appeal.

On Wednesday, Alphabet/Google (GOOGL) announced it's replacing the $10-per-month YouTube Red subscription service it launched in 2015 with YouTube Music Premium and YouTube Premium, two separate services that cost $10 and $12 per month, respectively. Music Premium pairs the kind of offerings typically provided by rival music services -- audio-only streaming and downloads, playlists, music recommendations and standalone mobile apps -- with ad-free viewing and downloads for YouTube music videos, as well as access to remixes, covers and live versions of songs not found elsewhere. 

Music Premium will launch in the U.S. and a handful of foreign markets next week, followed by Canada and most of Europe.

YouTube Premium, promised to launch "soon," combines Music Premium's services with a pair of YouTube Red services: Ad-free viewing and downloads across the whole of YouTube, and access to YouTube's original content. For now, Google will continue supporting the Google Play Music service that had been part of the YouTube Red bundle (existing Google Play Music users get access to Music Premium), but one has to think Google will shutter Play Music in time rather than run two music services with many overlapping functions.

Spotify's (SPOT) shares fell 1.6% on Thursday following Google's announcements, and Pandora Media Inc.'s (P) shares fell 2.8%. Nonetheless, Spotify, Pandora and Apple (AAPL) are likely breathing a small sigh of relief that Google is charging $2-per-month more for YouTube Premium than it did for YouTube Red.

How YouTube Music Premium and YouTube Premium Stand Out

Music Premium appears to address what has been the biggest weakness of the modestly-successful YouTube Red: The substandard quality of Google Play Music relative to rival services such as Spotify and Apple Music, and the disjointed user experience that came from having a music service that was completely separate from YouTube's site and apps. Considering how much music video viewing happens on YouTube -- dozens of videos have now seen over 1 billion views -- the ability to do things such as watch those videos ad-free or download a song playing on a music video makes for a good selling point.

Google's AI/machine learning strengths could be an overlooked advantage in this fight. YouTube, which has gotten very good at using AI to recommend videos and channels to users, is touting the ability of Music Premium's home screen to "dynamically [adapt] to provide recommendations based on people's listening history, where they are and what they're doing." It also promises the service will feature an advanced search engine that lets users search for a song or video by describing it or inputting lyrics.

The appeal of ad-free YouTube is easy to see: YouTube now sees over 1 billion hours of daily global viewing, and (judging by third-party data) accounts for a giant percentage of mobile video viewing in the U.S. and other big markets. Ad-blockers can let users avoid YouTube ads on PCs without paying, but they don't work on YouTube's mobile and TV apps, which now account for much of its viewing.

And while no one will confuse YouTube's original content library with Netflix's (NFLX) , it should act as a selling point as well, particularly given the role hit originals have played to date in driving streaming subscriptions. The recently-launched Karate Kid offshoot Cobra Kai gives YouTube one popular original to promote, and Google seems intent on creating additional ones.

Why Apple and Spotify Don't Need to Panic Just Yet

For all its strengths, YouTube Premium's price ($2 per month more than what most music subscription services cost) makes it slightly less of a threat to the likes of Spotify and Apple than it would be if YouTube stuck with Red's $10-per-month pricing. And this will be even more true if YouTube doesn't offer family and student plans that are competitive with Spotify and Apple's family and student plans (details are scant for now).

In addition to pricing, inertia and switching costs work in the favor of the incumbents: Spotify and Apple Music now have over 125 million subscribers between them, and many of those subs have put a lot of effort into creating libraries and playlists that would have to be rebuilt if they cancelled their subscriptions and signed up for YouTube Music Premium or YouTube Premium. These subs have also generally provided lots of listening data to Spotify and Apple that has been used to personalize their music-listening experiences.

Basic economics seem to have driven YouTube's decision to charge $12 per month for Premium. $10-per-month music services generally have low margins due to the huge licensing payments collected by music labels. Spotify's subscription business, for example, only has a gross margin of around 25%. Throw in the value of the advertising revenue YouTube loses by providing an ad-free service, and the cost of financing originals, and there's no way that the company could charge just $10 per month for YouTube Premium without incurring a lot of red ink. Even at $12 per month, the margins probably aren't all that high.

It wouldn't be surprising to see Apple, which is financing a slew of original shows and reportedly plans to launch them in March 2019, adopts a pricing strategy similar to YouTube's. The company could keep charging $10 per month for Apple Music, and a couple or few dollars per month extra for access to its originals.

The Big Picture

Though it's arriving very late to the fight and more clarity is needed on family and student pricing, there are plenty of reasons to think that YouTube Premium will be well-received, assuming YouTube aggressively promotes the service to its user base.

Getting to even 20 million YouTube Premium and Music Premium subscribers (slightly over 1% of YouTube's monthly global logged-in base) would likely serve to create a $2 billion-plus annual revenue stream for the online video giant. And over the long run, YouTube has a shot at having a much larger subscriber count than that.

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