The real reason that Google bought YouTube?
The $1.65 billion purchase of the video-sharing site could actually be a boon for traditional TV ads.
NEW YORK (Fortune) -- When Google spent $1.65 billion for 19-month-old online video phenomenon YouTube, it was portrayed as a sign of the triumph of online video. And in important ways it is. But the voluminous coverage missed something central. Google's interest in the video-sharing site, ironically, also has a lot to do with its belief in the staying power of conventional broadcast television and cable.
It's important in watching Google (Charts) never to forget that it makes just about all its money from advertising. The fact that its role in advertising keeps growing is what, in turn, keeps its stock in the stratosphere, thus giving it the $128 billion market capitalization which enabled it to purchase YouTube with stock.
Many writers recently pointed to the obvious opportunity for a Google-owned YouTube to profit from placing video ads next to the 100 million video streams that YouTube claims users view there each month. That is surely one reason Google can justify paying so much money, but a closely-related reason may be even more important.
Google has for about a year-and-a-half been talking about its ambition, considered quirky or worse by some, to extend its auction-driven ad sales model beyond the net into what we think of as "old media." It has said it wants to get into the business of placing ads in print, radio and television.
Indeed, while last week's YouTube purchase was Google's largest, the second largest was January's $102 million acquisition of dMarc Broadcasting Services, a company with a successful automated system for placing ads on radio stations all over the country.
Television advertising is the biggest ad market of all, still dwarfing the Net. Last year it totaled $61 billion in the United States compared to the Net's $8 billion. Google executives confirm that the company bought YouTube in part to better position itself for getting into the business of selling traditional television advertising.
Google CEO Eric Schmidt has not been secret about his ambitions to do so. This summer at a conference he said Google would soon deliver "targeted measurable television ads" and complained that today when you watch TV you see commercials that are "a waste of your time," and "clearly not targeted for you."
What separates Google's current ad service from what has come before is its orientation towards results. Advertisers only pay for ads that attract user attention as evidenced by clicks. But the way Google enables its advertisers to get results has a lot to do with the process of repetition and refinement that identifies the most effective ads.
Google's most successful search advertisers are those who methodically experiment with multiple messages. Sometimes they try thousands of combinations of different texts displayed in response to various search keywords, quickly - often in hours - eliminating those that don't attract the clicks of users and refining those that do, until they arrive at the ideal combination of message and keyword.
A similar process of refinement takes place in Google's AdSense service. It places ads on the Web sites of affiliates with which it shares ad revenues.
I don't know if they're right, but Google's managers now seem to believe they can do the same thing with print, radio and TV, albeit with much of the testing taking place on the more immediate and low-cost medium of the Internet. Buying YouTube will give Google a platform on which advertisers can experiment with TV ads in different forms.
If you were a big TV advertiser, before you spend what is sometimes millions for a primetime spot, wouldn't you like to know how it fared on YouTube compared to alternate versions? How many people willingly chose to view it? How many clicked through for more information? Did it perform better adjacent to some kinds of content than others? Presumably Google has a variety of ideas about how it could help advertisers evaluate TV ads online before placing them offline.
If Google can offer advertisers such tools to test the efficacy of offline ads, it could put them in a far better position to also assist in placing those ads. Google can buy ad inventory in TV, radio, and print to place ads there it pre-tested online. If it chose to, I suppose, it could even create its own offline media products on which to host such ads. (This part is purely my speculation, by the way.)
When Google advertising boss Tim Armstrong first explained to me that he believed the repeat-and-refine approach used for search ads could be extended to other media, I was skeptical and didn't understand. Now, in the wake of the YouTube deal, I finally think I do.
Google's competitors are mostly still trying to figure out how to better take advantage of today's online advertising opportunity. Meanwhile, Google is already looking ahead to a still-to-come era when the Web links tightly with all other media.