Investment Under Uncertainty and Real Options: The Economics of Building Online Video Editors

The very idea of fully web-based video editing tools comes across as a crazy idea for a business at first glance. Companies that wish to compete in this area must invest large amounts of capital before generating any revenue from users. This requires significant expenditures on software development, cloud infrastructure, and ongoing maintenance. While offering a relatively low-cost—or often completely free—service, revenue is typically generated through advertising and, potentially, through the sale of limited promotional features. Even though starting with a free online video-editing tool may appear risky for new entrants such as Clideo, the rationale behind this type of investment is grounded in advanced microeconomic and financial theories of investment under uncertainty. Such investments are commonly analyzed using real options theory, also referred to as real option pricing models (ROPM).

The Nature of the Risk

Online video editors are associated with three distinct but interrelated risks in a business sense.

1. There is a significant amount of sunk costs associated with creating a web-based video editor. Creating a web-based video editor requires years of engineering effort, obtaining licenses for video codecs, creating scalable rendering pipelines, and securing GPU-intensive cloud servers. These costs are basically irrevocable, as once you spend those costs to create the product, you will not be able to recover them if it is unsuccessful.
2. There is a high level of uncertainty surrounding user adoption of products like this. Even if a product has superior technical capabilities compared to competitors, many times there is little chance that the product will be successful based upon network effect, entrenched competitors, or the changing preferences of the creator. For example, a survey of small content creators conducted in 2023 indicated that less than 30% of the creators would be willing to pay for a video editor, even with the number of video creators growing daily on platforms like YouTube and TikTok. Because of this, making revenue projections regarding these types of products becomes extremely difficult.
3. The technology associated with video editing is rapidly changing. There are ongoing improvements being made concerning AI-assisted editing, video codec compression, and web-browser capabilities. Therefore, video-editing companies are required to continuously reinvest to remain competitive.

From the perspective of traditional net present value analysis, many of these investments would be considered unprofitable. Nonetheless, firms continue to invest in this category of products.

Real Options as an Economic Framework

Investment in the context of uncertainty reveals that a company is not committing to simply one large investment; rather, a company is investing in a financial instrument that gives it an option to invest in another financial instrument at some future point.

The launch of the first version of an internet based video editing platform is an example of what would be considered the premium price of an option. The company is creating a minimal amount of value in order to test for demand. If the company sees positive user growth, increased usage, and increased advertising revenues, the company then exercises its option and creates additional value by creating features, expanding servers, and creating a subscription based model for premium features. If the demand does not meet expectations, then the company's only loss is limited to what it originally invested to create the first version, and it may subsequently hold off on creating additional versions or eliminate the option altogether.

This also explains the reason many online platforms release versions with minimal capabilities; that is, the first versions allow basic trimming and saving of video files, then add additional features later, including the use of filters, artificial intelligence enhancements for sound or visual effects, and/or premium versions of the final video products. The companies continue to make step by step investments based on the actual level of demand they have seen.

Economic Forces Driving This Strategy

The real-options approach has several driving forces that make it a popular choice for online video editing.

Demand uncertainty in online video production is extremely high, yet demand signals are generated rapidly as users interact with the product. Daily active users, session lengths and export volume are examples of user metrics that allow for quick feedback on demand. Real-options theory states that because waiting can create value, this conforms to the principles of the real-options approach.

Cloud-based infrastructure has created the ability to modularly scale; whereas traditional software applications are associated with specific pieces of hardware, the architecture of cloud-based editing solutions allows for growth in capacity as demand grows, thereby lowering the cost associated with exercising the option when demand becomes apparent.

Lastly, the availability of advertising revenues from experimentation supports the cost associated with hosting the editing solution. For example, even limited traffic to an editor will generate a level of ad revenue that partially offsets hosting costs, making the premium on the option much less than it would otherwise be.

Real-World Examples

Traditional desktop software (e.g., Adobe Premiere Pro) generates the majority of its revenue through subscription fees paid by professional users. In contrast, online editors employ a variety of revenue models designed to provide users with greater flexibility. Clideo, for example, offers a wide range of lightweight tools for free, while monetizing select features through watermarks, premium exports, and similar mechanisms. This approach allows the firm to evaluate whether specific features justify further development.

The available data supports this comparison. The cost of GPU cloud computing in 2019 was less than half today’s cost per GPU hour, significantly reducing the overall expense of experimentation. Moreover, global consumption of online video has nearly doubled over the same period, increasing the pool of potential users and expanding the upside of successful platform innovations.

Ramifications

The real-options method alters the framework of the marketplace. As it promotes new entrants, there will be an increase in competitive intensity and accelerated innovation; however, this will also result in high rates of attrition for many of these new entrants. Most of these platforms will not achieve sufficient scale to take advantage of their growth options. In terms of consumers, a plethora of free tools will be available. In terms of businesses, there will be an increased degree of volatility regarding returns based on reliance on outside sources (like advertising) to drive revenue.

Conclusion

Creating an entire online video editing platform is a well-thought-out reaction to ambiguity—not a gamble. By thinking about the creation of the platform as a real option instead of a one-time investment, businesses can logically allocate resources despite sunk costs, uncertain user adoption, and the rapid pace of technological change. This is an example of investment under uncertainty, taking shape in today’s increasingly competitive digital market.