YouTube Infrastructure Costs Vastly Overestimated: Report

YouTube is much closer to breaking even than widely thought, says a firm with intimate knowledge of global infrastructure costs. A widely publicized Credit Suisse report that said Google (s GOOG) would lose $470 million on the site this year neglected to account for factors such as peering traffic, wholesale bandwidth deals and cheap data center locations. Where the bank said YouTube’s costs will amount to $711 million in 2009, RampRate, a San Francisco-based company that advises large companies on IT infrastructure, says the actual cost is $415 million.

YouTube - RampRate vs Credit SuisseGiven Credit Suisse’s revenue estimate for YouTube, that would give the site an operating loss of $174 million this year. If you use other people’s revenue numbers — for instance, Jefferies said $500 million — the site would actually turn a profit.

Here’s where RampRate sees YouTube saving money.

  • Google uses peering for an estimated 73 percent of its bandwidth; Credit Suisse did not account for this at all. Peering is where ISPs trade traffic to reduce the cost of transit, and essentially means Google does not pay for that bandwidth. Google’s peering partners are known or thought to include Level3 (s LVLT) and AT&T (s T).
  • By negotiating for additional paid bandwidth, Google can probably bring down costs to 50 cents per Mbps.
  • From the report: “YouTube content is by definition ‘long tail,’ which means the storage it requires can be of a consumer-grade commodity quality. Google’s core competency is in managing commodity server/storage farms. At current rates, its servers likely cost no more than $500 apiece, and can add a sub-$100 1TB hard drive to produce a net cost of $.60/GB. Even with an aggressive 1-year refresh cycle, that is just 30% of the $2.35/GB projected by Credit Suisse.”
  • Google also lowers its serving and storage costs by using out-of-the-way locations for its server farms such as Iowa and Finland.

RampRate extends its analysis to say that maintaining an illusion of massive losses for YouTube is actually beneficial for Google. The theory is, Apple let the market think that its music-selling iTunes business was just a money-losing front to sell iPod hardware, so was able to keep its own costs and customer prices low, and therefore became a dominant force in music sales online. Likewise, the second YouTube is thought of as a money-making bonanza, its ability to negotiate goes down, and the lawsuits pile up even more than they already have. “I believe they’ve been very smart in managing the P&L to their advantage to negotiate better deals with creators,” said RampRate chairman Tony Greenberg.

Google also gets to use the tremendous YouTube audience and bandwidth to negotiate better deals for its overall business. “Basically their access to broadband eyes gives them an unparalleled negotiating chip to get lower costs,” said Greenberg. And further, through YouTube Google is able to broach new expansion initiatives like edge caching and co-location with the same ISPs.

From the report:

“Far from being an infrastructure money pit, YouTube is key to reducing
operational costs for other Google initiatives while also allowing Google to catch up to the superior
network performance of competitors like Microsoft (s MSFT), which currently boasts 10 times as many peers and 17% fewer hops to remote reaches of the Internet.”

Is RampRate right that Google’s non-monetization of YouTube is really a ploy? A scheme that conniving sounds a bit too much like a conspiracy theory. But we’ve seen via YouTube’s growth as a search engine how the site relates back to Google’s core business. Perhaps it fits neatly into the infrastructure expansion business as well.