Watch Funny Videos--Google Will Pay!

Most great tech companies start out with one great idea, and for Google it was figuring out how to make money off the work of others. Google doesn't publish any books or magazines or newspapers. It doesn't employ writers. Yet Google probably makes more money off the printed word than anyone else on the planet. (It might make more than everyone else combined.) Three years ago, Google set out to bring that freeloading business model to the world of video, when it spent $1.65 billion to acquire YouTube, which was then an 18-month-old video-sharing site that was losing money like crazy.

Google wouldn't make any movies or TV shows, of course. Instead it would get people to send their videos to YouTube. Then Google would place ads next to those videos and keep most of the money. The dupes churn out the content, and Google gets richer! What a brilliant idea! Users felt like they were getting a great deal because they could upload videos for free—and it never occurred to them that they were turning themselves into unpaid employees of Google.

But the plan hit a brick wall. It turns out advertisers weren't crazy about placing their brands next to that "user-generated content." Yes, YouTube generated some advertising revenue, but not enough to cover costs. Worse yet, YouTube became wildly popular. The dupes did as they were supposed to, and started flooding YouTube with videos. These days YouTube is the third-biggest site on the Internet, with 426 million monthly visitors who upload 20 hours of video every minute. But the more stuff people put on YouTube, the more computers and data-storage equipment Google must buy. Google also pays to ship videos across the Internet to viewers. Instead of creating a digital gold mine, Google has created a digital sinkhole—the bigger YouTube gets, the more Google must spend to keep it running.

Now Google is trying to dig its way out of the hole by signing deals with Hollywood companies to get "premium content" (i.e., actual movies and TV shows, the kind that someone spent money to make). Problem is, unlike those naifs who upload home movies of cute kittens and laughing babies, Hollywood companies don't give stuff away for free. To get Hollywood content, Google must pay licensing fees. Also, the Hollywood guys all operate their own video sites, and they want to keep the lion's share of any ad revenue and give only a tiny portion to YouTube, says Arash Amel, analyst with researcher Screen Digest. Amel suggests that Google may need to commission its own programming, just as HBO started out as a distributor, then evolved into a type of movie studio.

Google is also trying to bring in cash by plastering ads all over YouTube. There are ads in the sidebar next to the video window. There are "preroll" ads that run before a video clip. There are ads overlaid on top of videos. There are "click to buy" ads that take you to Amazon's music store. Google is also selling branded home pages to promote movies—Warner Bros. has one for the new Harry Potter movie, for example.

Yet all this frantic effort isn't producing very much. "We have yet to realize significant revenue benefits from our acquisition of YouTube" is how Google puts it in its SEC reports, where YouTube shows up in the section titled "Risk Factors" as an example of how "the anticipated benefits of many of our acquisitions may not materialize."

Google is not admitting defeat on YouTube. "We're growing the business by experimenting, innovating, and learning from both our successes and failures," a spokesman says. He adds that he's really peeved about the way analysts keep trying to estimate how much money YouTube is losing. He's also peeved that reporters keep publishing those analyst estimates. To be sure, those estimates are all over the place. Nobody seems to have a clue what's going on inside YouTube. Why doesn't Google just provide the actual figures? After all, Google CEO Eric Schmidt often touts the virtue of techno-driven "transparency." Well, don't hold your breath.

One thing is certain: however much YouTube is losing, Google can take the hit. The company has $18 billion in the bank and this year will generate nearly $6 billion in net profit on sales of $22 billion. Google might even be happy to lose money on YouTube, because this lets Google cry poor when it negotiates licensing deals with Hollywood companies, says Tony Greenberg, CEO of Ramp-Rate, a con-sultancy and re-search company. At the very least, the deal has given Google a leading position in a market that someday will be huge. The real challenge for Google is that to prosper in online video it will need to learn a new way of doing business, one in which it is no longer enough to just scoop up all the money while others do the heavy lifting. That, for Google, will take some getting used to.