With over 1 billion users from all around the world and more than 70 local versions abroad, YouTube is the leading video-sharing website in the world. In 2008, the Chinese government has blocked access to the site to users in China. This move has allowed several video-sharing portals to rise in China, including iQiyi, PPTV, Sohu, LeTv, Tencent Video and the largest of these, Youku Tudou, Inc. (NYSE: YOKU). Controlling nearly a third of the online video market and looking to increase its presence outside of China, Youku Tudou, Inc. stands as one of the main competitors to YouTube.

Different Business Models

YouTube actively seeks for user-generated content. Purchased by the Google operating unit of the holding company Alphabet, Inc. (NASDAQ: GOOG) in 2006, YouTube maintains an ever-growing library of videos by providing payouts of ad revenues to content creators. By saving in production costs and focusing on lowering technology infrastructure costs, YouTube has been able to increase its ad display revenues throughout the years. In 2014, YouTube generated $4 billion in annual revenues.

In 2012, Chinese video-sharing rivals Youku and Tudou combined their services in a 100% stock-for-stock merger to create the largest video website in China: Youku Tudou. Despite the merger, the new company continued its strategy to license exclusive content to attract more viewers and, in turn, more advertisers chasing larger online audiences. In the first half of 2015, Youku Tudou reported 2.75 billion Chinese yuan ($451 million) in revenues.

Quest for Profitability

Despite its rising annual revenues, YouTube continues to roughly break even. In 2014, Google's video unit posted a $1 billion increase from its 2013 revenues. YouTube's revenues make about 6% of Google's total sales, but they do not increase its parent company's bottom line. A major factor is that the bulk of YouTube views come from videos embedded on external sites instead of on YouTube itself, chipping away at ad revenue.

Youku Tudou is facing a similar challenge, but for a different reason. Seeking top-quality video content for licensing is very costly for Youku Tudou, which paid $80 million in licensing fees for the first quarter of 2015. In the first half of 2015, the company posted a net loss of 859.5 million yuan ($140.96 million). The company told Reuters in 2013 that it spends more than 1 billion yuan ($164 million) every year in licensing fees. Additionally, since 2013, Youku Tudou has filed several lawsuits against other online video software firms and websites on the grounds of piracy, increasing the company's expenses.

The Future: Focus on Content Creation

Given their challenges to become profitable, both YouTube and Youku Tudou have set content creation as priorities.

YouTube

YouTube seeks to become an alternative to television by creating channels of high-quality entertainment created by its most popular users, including Swedish video game player PewDiePie and comedian Lilly Singh. To subsidize the additional production costs and provide a more seamless and ad-free experience, YouTube is pushing its YouTube Red initiative to consumers for $9.99 per month.

While leveraging its top talent, YouTube is also nurturing tomorrow's star content creators by giving access to state-of-the-art production resources (referred to as YouTube Spaces) to those users with at least 10,000 subscribers. Currently there are eight YouTube Spaces across the world with locations including Los Angeles, London, Berlin and Mumbai.

Youku Tudou

In August 2015, Youku Tudou announced a 10 billion yuan (about $1.6 billion) to produce high-quality, user-generated videos. Under a three-year plan, the Chinese company seeks to nurture 100,000 video channels by semiprofessional users who have more than 1,000 subscribers.

Youku Tudou set the goal of developing about 10,000 channels with monthly advertising income of over 10,000 yuan each and about 100 top-performing channels valued at more than 100 million yuan each. This is an ambitious goal because in 2015 the company only had 10 channels valued at more than 100 million yuan each.

In November 2015, Alibaba Group Holding Ltd. (NYSE: BABA) took over Youku Tudou for a total of $4.8 billion. Alibaba supports Youku Tudou's push for more high-quality content because Alibaba sees this channel as an opportunity to increase e-commerce sales. In some online videos, Youku Tudou offers a service that lets viewers buy the clothes that the actors on a show are wearing.

Risk Factors

In their quest for higher quality user-generated content, the two video sharing companies share the two same risks.

First, competitors are working hard to poach producers, editors, executives and content creators away from YouTube and Yukou Tudou. For example, the former head of Hulu, Jason Kilar, launched video startup Vessel promising content creators that they could make 20 times more revenue than with YouTube.

Second, despite its focus on content creation, YouTube and Youku Tudou continue to court distributors of premium television content. In January 2015, YouTube secured rights to content from the National Football League, Sesame Street and Thomas the Tank Engine. In June 2015, Youku Tudou became the exclusive online video marketing platform in China for the Marvel collection of movies and TV series from the Walt Disney Co. (NYSE:DIS). While such deals help attract more viewers, those same deals also make it harder for the companies to break even.

One risk that is unique to YouTube is that the North American is missing out on the Chinese online video market. Unlike Yukou Tudou, YouTube is not comfortable with the demands of the government of China to check for what it considers inappropriate or offensive videos. While other operating units of Alphabet continue to do business in China, YouTube is not one of them.

The Bottom Line

Youku Tudou's large share of the Chinese online video market allows the company to continue growing and gaining ground on YouTube. With a new focus on high-quality, user-generated content, Youku Tudou has taken a page out of YouTube's playbook to amass more viewers. While YouTube is not able to compete with Youku Tudou directly in China, YouTube is still the dominant player in video sharing in the world.

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