How YouTube's new $35-a-month cable TV competitor could fix the biggest failure of its rivals (GOOG, GOOGL)

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On Tuesday, YouTube unveiled YouTube TV, its $35-a-month competitor to cable TV, which delivers a package of streaming channels over the internet.

With YouTube TV, the company is jumping into an increasingly crowded market of services looking to lure cord-cutters and cord-nevers back to pay TV.

Dish’s Sling TV, AT&T’s DirecTV Now, and Sony’s Vue are already fighting it out, and Hulu will enter the fray in the next few months. Even Amazon is rumored to be working on its own TV package.

But one thing that could give YouTube an early edge is if it nails the technical aspects of YouTube TV, something that the current players have struggled with. I don't mean the interface — though that is a plus — but simply making sure the product actually works, especially during high-profile events with a lot of viewers. 

The idea of a live streaming TV service is new, and the reference point for most people on how TV is supposed to function is cable or satellite. Cable, while subject to the occasional glitch, largely functions as advertised. When you want to watch something, it’s there.

The same cannot be said for the early streaming TV services.

Since its launch in late November, AT&T’s DirecTV Now service has been repeatedly smacked with technical issues, from strange error messages to huge blackouts. And both Sling TV and Vue have had their share of tech snafus as well.

“Something that tends to be taken for granted, but is actually a pretty herculean effort, is the years of video-serving infrastructure that we’ve built up,” Neal Mohan, YouTube's head of product, told Bloomberg. “Every minute, on average, more than 400 hours of content are being uploaded on YouTube and ready to serve. There’s an enormous amount of learning that went into that, which we can apply to this new YouTube TV experience to make it reliable and flawless.”

YouTube has a ton of knowledge in this area already, not just in delivering online video, but also in “live” online video. If YouTube TV actually works 99% of the time on Day One, YouTube will have a huge opportunity to snag market share.

Last month, AT&T announced it had gotten 200,000 additional paying video subscribers in the quarter ending December 31, “entirely driven” by DirecTV Now. By the end of 2016, DirecTV Now had only been in business for about a month. 200,00 paying subscribers in a month is impressive, and it means there’s a demand for the product. But so far, DirecTV Now has delivered a frustrating experience for many of those early adopters, who have taken to forums and Twitter to rant against the service.

This is an opening for YouTube.

The holes

The problems for YouTube might not be the tech, but rather the content deals it has signed.

While YouTube is pricing YouTube TV at a low $35 a month, and includes a cloud DVR that lets you skip ads, it has some major programming holes, especially compared to traditional cable.

YouTube TV is primarily based on deals with the four big broadcast networks: CBS, Fox, ABC, and NBC. This means YouTube gets access to content from those networks and affiliated cable channels. It's around 40 in total, including ESPN, Fox News, MSNBC, and so on.

But YouTube hasn't struck deals with some marquee cable networks like Turner, Discovery, Viacom, AMC, and A&E. That means no CNN, TBS, TNT, History, AMC, A&E, Comedy Central, HBO, and more.

YouTube is, however, trying to keep the sports offering robust.

"YouTube TV includes major sports networks like ESPN and regional sports networks like Fox Sports Networks and Comcast SportsNet, so you can watch your favorite NBA or MLB teams," YouTube said in a press release. "We've also partnered with local TV stations, so you'll also get sports and local news based on where you live."

The thinking is that, while YouTube won't necessarily convince established customers to ditch their $100+ a month cable packages, they might convince young people to sign up for pay TV for the first time. It's a market YouTube is uniquely suited to chase, as 26% of teens watch YouTube every day, according to Piper Jaffray.

YouTube

The end of the rainbow

But even if YouTube succeeds in nailing the tech, and getting a leg up on its competition, that doesn’t mean the streaming TV market will be an instant goldmine.

The margins on the early streaming TV services appear to be razor-thin, and the price point YouTube is offering isn't going to change that.

But the crux of that opportunity doesn't lie in big initial margins, it comes from the potential to fundamentally shift how TV ads work. As it stands now, TV networks sell most of the ad inventory for their shows. And in the early days of a YouTube streaming TV service, that will continue, with YouTube itself selling only a few minutes of ads per hour on its own service.

But that will change, Pacific Crest analyst Andy Hargreaves wrote in a note last month.

“Google's vastly superior data should allow it to monetize its ad inventory at superior rates to networks,” he wrote. “Over time, this disparity should allow Google to capture a greater share of total ad inventory on its service. Played out over several years, we believe the natural evolution of a successful Google vMVPD service [YouTube TV] would be for the roles of content supply and ad selling (both currently done by TV networks) to split, with Google managing the ad selling and networks relegated to content suppliers.”

In a nutshell, YouTube will be better at selling ads than the networks, and eventually be in charge of selling all of them. And that’s the real potential for profit: taking a huge bite out of the $200 billion global TV ad budget.

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