Why Hulu Is Winning the Online Video Race

As the worlds of technology and media collide, the same contest keeps getting played out over and over again: lumbering old-media companies take on nimble new-media upstarts, and usually the new-media guys win, since it's easier for them to figure out the content business than it is for the content companies to figure out the techie stuff involved in launching an Internet business. Apple outfoxed the music companies and now in effect controls their business. Google reaps billions by selling ads that run next to content created by others—while some of those creators, newspapers and magazines, teeter on the edge of the tar pit. In video, Google figured it could work the same trick again, so in late 2006 it spent $1.65 billion to acquire YouTube, a site that had built a huge audience by dishing up user-generated videos and pirated clips from movies and TV shows. YouTube wasn't bringing in any money, but Google believed it would figure something out. Meanwhile, Apple was trying to lure movie and TV studios into the iTunes store, just as it had done with music labels.

But this time the old-media guys fought back. In 2007, a few months after Google bought YouTube, NBC Universal and News Corp. announced they would jointly build their own Internet video site. Conventional wisdom among Silicon Valley pundits was that the site, called Hulu (named after a Chinese word that means "holder of precious things"), would be an epic disaster—or "Clown Co.," as they dubbed it. Old-media guys didn't "get" the Internet, detractors said, and partnerships between bitter rivals never work.

But guess what? Unlike YouTube, Hulu had legal access to great content—shows from NBC, Fox and others. And it had great technology—a clean, simple user interface and a smart search engine. Today, just one year after its launch, Hulu has gained the upper hand. "The empire is striking back," says Arash Amel, analyst for researcher Screen Digest. Amel estimates that while Hulu attracts far fewer visitors per month than YouTube (8.5 million versus 89.5 million), in financial terms Hulu is actually doing better. He estimates that last year Hulu took in $65 million in U.S. ad revenue and cleared $12 million in gross profit, while YouTube generated $114 million in U.S. revenue but had no gross profit. This year Amel estimates Hulu's revenue will grow to $175 million in the U.S. and that YouTube will take in slightly less. (Neither company confirmed these figures; Amel developed revenue estimates on his own.)

YouTube has lots of content, but from the perspective of advertisers much of it is utterly worthless. Nobody wants to tout their brand amid user-generated videos that could turn out to be almost anything, Amel says. He reckons that only 3 to 4 percent of the clips in YouTube's library are able to carry advertising, while at Hulu 100 percent of the library can carry advertising and 80 percent of the streams Hulu delivers have advertising attached. YouTube says Amel's estimates are too low, but won't provide the actual figure. YouTube also insists that advertisers aren't scared off by user-generated content, though YouTube now is striking deals to add more TV shows and movies to its mix.

Perhaps the smartest move Hulu's founders made was looking outside for talent. They recruited a former Amazon division chief, Jason Kilar, to be Hulu's CEO, and a 28-year-old former Microsoft researcher, Eric Feng, to oversee development. Feng, who was living in Beijing, assembled an eight-member team in China that banged out the initial Hulu code in two months, and the site went live four months later, in March 2008. Much of the code writing still gets done in Beijing, where Hulu employs 30 engineers. The rest takes place at headquarters in Los Angeles.

Hulu's team is trying new approaches to advertising that they hope will be more palatable to viewers, and more effective as well. One idea: a viewer can choose to see ads interspersed throughout a show, or can watch a single long advertisement up front. (But either way you can't skip through the ads.) Another example: a carmaker lets the viewer choose to see an ad for a pickup truck, a crossover SUV or a sports car—so the viewer gains some control, and the advertiser doesn't waste a pickup-truck ad on someone who wouldn't be caught dead in one. Hulu also has taken a unique approach to distribution, striking deals with nearly 30 affiliates (these include MySpace, Yahoo and MSN) that run Hulu videos on their sites. The idea is to bring content to the audience, rather than forcing the audience to come to the main site to watch shows.

Hulu insists it's not really competing with YouTube. In fact, its real victim might be cable companies. Why pay $100 per month for a cable subscription when you can get so much great stuff online at no cost? Movies and TV shows are flooding onto the Internet, not just through Hulu but through upstarts like Veoh and Joost, as well as established players like CBS, which operates TV.com, and ABC, which offers TV shows on ABC.com. The lesson in all this? Fun as it may be to watch someone's kitten playing with a piece of string, last night's episode of "The Office" makes for a more compelling experience. Turns out those old-media guys still know something about how to capture an audience—and make money from it. "We've come a long way from Clown Co.," says Jean-Briac Perrette, the president of NBC Universal Digital Distribution and a board member of Hulu. They have indeed.