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on2logoGoogle’s YouTube division is a victim of its own success. A source inside the company told TechCrunch that YouTube streams close to 1.5 billion video clips every day. That makes sense, if you think of it as everyone on the Internet watching one clip daily.

Google CFO Patrick Pichette told Fortune that the company now collects ad revenue on 13 percent of the clips it serves. Still, streaming videos to customers costs money. Video content on YouTube can run up to 100 megabytes per clip. YouTube has another bandwidth-eater: Its search engine, the company told Fortune, is now the second busiest on the Net after Google. (Customers upload 20 minutes’ worth of video to YouTube every minute, but that’s nowhere near the amount of outbound traffic.)

This is why Google has agreed to buy video bandwidth reducer On2 for about $106 million. On2’s main product is video compression technology for the Adobe Flash player YouTube uses to play videos. Compression technology analyzes a video stream and figures out how to reduce its size without losing video and audio quality.

For customers, On2’s tech may speed up the download time before a clip starts and reduce the total network traffic eaten up by watching lots of YouTube. For Google, On2’s big value add will be reducing the costs of serving a couple of billion clips a day by reducing the amount of network capacity required to transmit the video to customers.

On2’s technology could reduce network costs for YouTube enough to bring profitability in reach.

The bigger news is that YouTube’s operating costs for video may not be anywhere near what many observers believe them to be. Credit Suisse analysts estimated in April that YouTube would lose $470 million in 2009 based on $711 million in operating costs. But a separate report by IT cost researchers RampRate pegs the number at only $174 million, due to smart management of its video delivery system.

Why would Google let everyone believe YouTube losses are so high? RampRate said it best: “A whiff of potential profit is an irresistible lure for predators such as copyright lawyers circling user generated content monetization and content partners that are all too ready to turn on their distributors.”


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