Hulu Launches: Great Product, Still Screwed

From Silicon Alley Insider, March 11, 2008:

Hulu finally launches, adding Warner Bros. and Lionsgate. CEO Jason Kilar says 5 million people have viewed Hulu videos in the past month and that 80% of Hulu's videos are viewed at least once a month.

Five million is an impressive number given that Hulu has been in a closed beta test, and as we said over the weekend, the product is great. As we also said over the weekend, however, we still have big doubts about Hulu as a business (see below). Judging from his quote in the NYT, CEO Jason Kilar is still optimistic that he can win over CBS and Disney as content partners, but as Michael Learmonth explained yesterday, this will be easier said than done.

Why We Think Hulu Is Screwed

So it's time to revisit its potential as a business. First, Hulu's product is great -- much better than we initially expected. Jason Kilar and his team have done an excellent job. Hulu's content is still limited, and it is still too slow in posting videos in real-time (to find the stuff that just aired that everyone's talking about, you have to go to YouTube), but these problems can be solved. Overall, the service is slick, easy to use, and a pleasure to watch.

Alas, products are not the same as companies, and Hulu-the-company is still in a tough spot. Why? In short: it's still too dependent on a handful of content partners, it bears most of the costs of streaming videos while its partners take most of the revenue, and its content partners are also its primary shareholders, which creates a major conflict of interest. Specifically:

• What people love about Hulu is the ability to watch TV shows and movies, which Hulu doesn't own. The TV shows and movies are owned by Hulu's content partners, who keep most of the revenue, while Hulu bears most of the costs.

• Hulu doesn't even have exclusive online rights to these TV shows and movies. Why not? Because Hulu's content partners don't want to give up control and limit their options (even though they own equity in Hulu). Hulu's content partners already offer most (or all) of its content online. Hulu have some exclusive rights, but fewer than you think (these rights are spelled out here).

• Hulu's minimal exclusivity provisions last only two years. Why? Because Hulu exists to give its network owners what they want -- control over their content and an attractive revenue share. The networks don't want Hulu getting too powerful, lest they lose control and/or get a worse revenue share next time around. One way to ensure that you don't lose control is to retain the ability to walk.

• Hulu's economics are lousy: Hulu bears all of the R&D and streaming costs (high) and gets only 20%-30% of the revenue (depending on whether a distribution partner is involved). As video resolution goes up, Hulu's economics could get even worse.

• Hulu's value to users has already been compromised by its owners conflicts of interest. For example, only some TV shows are available on Hulu, and others disappear after five weeks (the site's owners must protect their core businesses!).

• Hulu appears to have given up on the idea of becoming a destination site and is already in negotiations with YouTube about a distribution agreement (or so said YouTube a few months ago; Jeff Zucker at Hulu owner NBC denies this; News Corp's Chernin says it's possible -- WSJ). Broad distribution is good for usage, but bad for Hulu's economics and stand-alone value proposition. If Hulu.com were the only place to find TV content online, it might have had a chance to become a destination site and keep more of the revenue.

• Even Hulu's network owners are not convinced it will be a viable company -- and what's more, they don't care. In an interview with the New York Times, NBC president Jeff Zucker made his priorities clear: "At a minimum it's another way for us to offer our content to users and get paid for it ... If the site itself does well, that will be gravy on top of it."

Hulu: The Modern-Day @Home

One reason we are pessimistic about Hulu's prospects is that we see it as being in a similar position to the 1990's era @Home.

@Home was created by the cable industry in the late '90s to help industry participants compete against AOL and solve their Internet infrastructure problems. @Home sold itself to Wall Street as "the largest broadband ISP," when in fact all it did was provide network services to cable companies, who retained most of the value. Similarly, Hulu is selling itself as "the largest collection of premium video" when in fact it is mostly just a captive distribution mechanism for TV networks.

@Home was owned by the same cable companies it was dependent on for subscribers and revenue. For obvious reasons, @Home's cable partners and owners always looked out for their own interests first -- just as Hulu's owners are looking out for theirs. @Home entranced investors for a while, including some of the Valley's top venture firms -- just as Hulu has entranced at least one VC, Providence Equity Partners.

Hulu has shown an ability to attract non-owner media companies as content partners (Sony and MGM, for example), but this doesn't mean much: As far as we know, Hulu isn't requiring anything of these partners -- no exclusivity, for example -- and it's likely cutting them a sweet revenue share (which is good for them, but not for Hulu).

One of @Home's fatal problems was that its equity owners, the cable companies, were competitors. The competing interests ultimately prevented @Home from doing what it needed to do to build a sustainable business. A similar dynamic exists at Hulu: Owners News Corp and NBC aren't exactly the best of friends.

Unfortunately, when the weakness of @Home's business model was finally revealed, it went bust. We hope the same fate doesn't befall Hulu.