For the past few years I believed that online media companies were failing due to content costs.  Traditional media was accustomed to spending $100K per minute for TV programming or $200 for a newspaper story, and you couldn’t recoup that level of expense on the Internet.  I also watched as companies like “The Huffington Post” performed really well with virtually no content costs (at least for the first few years).

However I had a recent discovery that the cost of content actually comes in third place among the list of media company expenses, behind the cost of acquiring traffic and selling advertising.

It is very expensive to build an online audience.  For instance, if you produce video for YouTube or Hulu, your distribution costs are 45% of revenue.  And if you try to build your own direct-to-consumer portal (called uHuluTube) you are looking at a $100MM expense.  If you try to go it alone, the only strategies that I have seen predictably work are to manipulate SEO, manipulate Facebook edgerank, or create a viral loop, like “Plaxo email hacking”, to drive free traffic.  Unfortunately all of these are subject to change and it is hard to stay ahead of the competition.

The second major expense on the digital side is ad sales.  In the TV industry an average salesman will sell $20MM-$40MM a year in advertising.  Similar economics exist for glossy magazines on the print side.  But if you take that same salesperson and put him or her in digital they will only sell $2MM-$3MM/year.  Digital budgets are smaller, the audience is more fragmented, and in digital you don’t get pass-along or other tricks to get advertisers to pay for fictional viewership.  One of the problems with addressable advertising is that it is addressable.

In short, sales expense online is 20% of revenue instead of 2% of revenue in traditional media.  Distribution costs are 45% of revenue.  That means two thirds of your revenue is consumed before you even produce a single piece of content.

As far as I can tell, the winners in online content have all adopted one of three strategies: 1.) Create a platform where other people give you massive amounts of free content (like The Huffington Post) because it drives free traffic via SEO, 2.) Build/buy an ad network so you have a profitable business attached to an otherwise unprofitable business, or 3.) Make money by selling digital content to a movie studio or TV network.

I don’t think there is a panacea in here for the traditional media businesses, but I suggest exploring options #1 or #2 above if you want to position your business for the next 20 years.