Universal Music Group and Google finalized their long-awaited deal to create a new music video service called Vevo, expected to launch before the end of the year.

Vevo is designed as a central repository for all UMG video content initially—including music videos, interviews, concert footage and so on—and eventually to include that of the other major labels and independents.

YouTube will provide the technology behind it, and will be the first online streaming video service to syndicate its content. As UMG’s existing licensing deals with other services--such as Yahoo, MTV and AOL--expire, those too will syndicate their content from Vevo.

While many details remain unclear—such as whether Vevo will have better quality video than YouTube, or exactly how other labels will share in the business arrangement—Google chairman and CEO Eric Schmidt said he believes the Vevo service will solve YouTubes’s recent spat of music licensing disputes.

“I’m quite convinced that we are dependent on the success of a growing and profitable music industry,” he said. “We need the economics to work so that great content—in this case, music—becomes available. We’ve been previously struggling as to how to come up with this.”

Over the new year, a licensing dispute with Warner Music Group caused the service to either remove or mute any videos that contained music by the label’s artists. In the last month, YouTube stopped hosting music videos of any kind in the U.K. and Germany after balking at licensing fees asked for by the PRS For Music and GEMA, respectively.

At the heart of these disputes is money and, to this point, YouTube has underperformed. The company estimates it is selling ads against about 9% of all videos on the site, up from 6% last year, but CreditSuisse analyst Spencer Wang estimated in a recent research note that it would lose $470 million this year even while revenues increased 20% to $240 million.

While YouTube may be responsible for 80% of UMG’s online video streams, and contributes “tens of millions” in revenue, the label feels that YouTube, and the online video space in general, is leaving money on the table. UMG executive VP of the label’s eLabs division Rio Caraeff earlier this year told Billboard that advertisers pay an average of only $3-$8 for every thousand views that their ads receive. While that has resulted in “tens of millions” in revenue, UMG and other labels would like an ad rate on par with the CPMs that TV and movies command online—upwards of $25-$40.

The idea behind the Vevo plan is to create a scarcity of advertising inventory for the purpose of driving up rates. To date, labels licensed their music videos to multiple online services, such as YouTube, Yahoo, MTV and others in return for a cut of the advertising revenue sold around these videos. With all these services competing for many of the same advertisers, simple supply-and-demand drove down advertising rates even as views rose.
The hope is that Vevo will command these rates by creating a single point of negotiation for advertisers who wish to buy space on music videos. Both Vevo and YouTube will host the videos, and both companies will split the profits from the ads they sell around them.

“The ads are served in either places or both places, the content is served in either places or both places, and there’s a common backend that makes sure all the revenue gets split up the right way,” says Schmidt.

The Google CEO credits UMG chairman and CEO Doug Morris for conceiving of the Vevo idea. Negotiations began last year when Morris—at the recommendation of U2’s Bono—reached out to Schmidt to rethink how advertising and sponsorship models worked for music online.

“We’ve gone from $74 million loss in producing videos for promotion to last year we probably had a $70-80 million profit,” he says. “So this is the next step in taking a video to the next level of monetizing it.

Morris is also tasked with bringing the other major and independent labels on board so that Vevo is not just a UMG service, a process Morris says is ongoing and progressing well.

“We will eliminate the middleman in our transactions for the first time with this service,” Morris says. “The record business has always had a store in the middle. This will put us in direct contact with all of our consumers. We look at it as a groundbreaking thing and I think it’s going to change everything between music and the Internet.”

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