I can watch a video on my iphone and it will play smoothly. Watch the same video on my iphone and I find it jerky. This happens even if I let the entire video load up first.

Running 1.6GHz Centrino with 1GB RAM. XP Home and FF3.6.1
Playback hasn't been an issue in the past and despite not doing anything, over the last four months I've noticed this problem.
Ideas/

They keep changing the codecs. 480p Flash video is a real challenge to my Atom media centre now. However, I can play the 720p and 1080p HD Youtube videos perfectly with <5% processor usage, because it's in h264 mp4 rather than FLV and I have hardware acceleration.

The iPhone always uses a 240p h264 stream which takes very little power to play back.

Choices:

1. Always select 360p or 240p on the playback (little drop-down list bottom right), which will use less processing power.

2. Ensure you have a graphics card with hardware support for h264 and always watch HD Youtubes.

3. Download the video as an mp4 and play it in MPC.

It's a laptop.

I guess it's choosing the lower resolution. Will give it a bash and see if it works.

Keep an eye on task manager to see if it really is the CPU maxing out. If you're using Firefox, then you'll see "plugin-container" hit 100% usage, or 50% if you're dual core.

Well turns out 240p gives the normal/best playback.

Is it just processing power that retards the ability to play higher quality videos?

In most cases, yes. Look at your CPU usage in task manager. If it's running close to 100%, or 50% for dual core, then that's the bottle neck.

Modern video codecs are a bazillion times more processor hungry compared to the old mpeg 1 and 2 standards. They have to be very clever to enable better compression with lower loss in quality.