The Brooding Savage

Social Networks are the decade's biggest digital success story in terms of valuation.  But their faltering ability to generate real income points to a valuation bubble -- similar to the Web of 1999.  Is there reason to believe these businesses will find their footing and justify the hype?  Their future success may depend on an historical perspective, a broader business strategy, and some common sense.

 
First it was Sergey Brin in Google’s January analyst call. Then AOL CEO Randy Falco in an internal memo.  Now this week, Facebook’s new COO Sheryl Sandberg has made it unanimous.  No one has a clue how to effectively monetize the enormous traffic spiraling through Social Networks.  Sandberg told CNN.com “How we get [to advertising profitability], I don't think we know yet.”

To anyone moderately involved in the digital industry, these C-level comments are no surprise.  Just as astonishing as the growth of Social Networks has been their pitiful earnings.

A few weeks ago, Wired’s Kevin Kelleher expressed the dilemma in terms of ad pricing.  While robust in many online sectors, CPMs are trivial on the social nets.

“Lookery, an ad network specializing in social media, offers display ads on MySpace, Facebook, and Bebo for only 13 cents per thousand times the ad is served (CPM); Yahoo's average CPM is estimated at $13. Video ads on MySpace reportedly fetch just $25 per thousand showings; CBS charges $50 on affiliated sites, NBC as much as $75.”

My earlier analysis is that the networks artificially inflate even these pitiful CPM figures.  MySpace for example, has removed vast tracks of ads from it’s member profiles and other pages in an attempt to restrict inventory and buoy inventory prices.

Based on it’s current traffic, MySpace should be raking in $4.3 billion, but it’s minuscule $550 million in ad revenue last year didn’t even warrant a line item in the NewsCorp annual statement.  

What’s the solution?  MySpace may be rolling out Music Service as a way to create higher-value ad inventory.  It’s not a bad stop-gap strategy – but they have yet to come up with any idea to monetize the vast majority of pageviews.

Facebook launched the best effort so far -- the Beacon social advertising platform. Members and privacy advocates simultaneously hated the idea. Wired’s analyst still mistakenly predicts that Social Advertising will be the ultimate solution…all evidence to the contrary.  (I suppose in the absence of genuinely good ideas, you have to cling to the bad ideas or risk total despair.)

Social Networks Are Not Alone.

Email is still the biggest online product in use today.  Hotmail has about 220 million users.  Yahoo! Mail has a reported 260 million users.  But nobody talks about how widely profitable Yahoo Mail is. Visit the site and you’ll see mostly unpaid house ads and low-CPM banners.  Meanwhile, Yahoo executives consistently tout display advertising, search monetization and media content as the company’s revenue drivers.

Some numbers:  Assuming the average yahoo mail user checks his email 15 times each month, and views an average of 5 ads, that would result in 19.5 billion ad impressions on Yahoo mail.  It’s been reported that Yahoo earns an average CPM of about $13 – applied to mail, that would result in $253.5 billion each month, or $760.5 billion quarterly. 

Yahoo is reporting about $875 million in marketing services each quarter from it’s own site and properties.  Assuming my conservative estimates, Mail would account for 86% of all of Yahoo’s onsite revenues.  It would also exceed Yahoo’s offsite ad revenues by 26%.  Clearly, mail isn’t earning Yahoo’s average CPM.  More likely, Yahoo is receiving an average of $1 CPM for it’s mail inventory, or is artificially inflating CPM value by eliminating some of the inventory.

Five years ago, Instant Messaging was the hot communication application on the Web.  But even at its peak, IM was never the revenue driver for either the market leaders, AOL or Microsoft.  AOL bought ICQ in 1998 for $240 million in cash – but it didn’t recoup that expense through advertising.  Instead AOL and Microsoft both viewed IM as a must-have utility for the success of their portal businesses – and they made money by driving their IM users to high-value pages like news, sports and entertainment.  

Before IM there was chat – yet despite loads of low-value ad impressions, chat revenue never garnered headlines as a money-maker.  Neither did message boards or news groups.  In fact, it’s nearly impossible to find an example of a site that made significant revenues directly from any of these communication utilities.

Here’s my point, when the Social Networking bubble bursts, analysts will recognize Social Nets for what they are:  a communications utility.  They are a robust combo of mail, messaging, and personal profiles – innovative, but not earth-shaking.  And these types of utilities have always underperformed as revenue generators. Instead, profitable businesses have historically used communications to attract users, who are then monetized via branded content franchises like news, sports and entertainment.  

Where the Not-So-Smart Money Is

Analysts seem oblivious to historical truths. At WebProNews, Rich Ord has said “Social media is a different type of advertising platform from information-oriented websites and the two should not be compared.”  I love this quote for its nostalgia value. 

In 1999, respected analysts from the Wall Street Journal and BusinessWeek also justified ridiculous dot-com valuations based on the “potential” of Web audiences.  When critics pointed out the failure of companies to monetize their traffic, the rallying cry was that web businesses were a different type of media company, and were not subject to traditional market valuations.

Now as then, common sense should rule; is Facebook really worth more than Sun MicroSystems?  Is MySpace worth more than Ford?   

The assumption is that if users are worth money, then more users are worth more money.  Theoretically, an infinite number of users are worth an infinite amount of money.  It’s simply not true.  

There is a point of diminishing returns in Web advertising.  Enormous traffic creates a glut of inventory, which inevitably drives the value of ads down.  The most highly valued inventory on the Web is branded, high-quality media content – and it’s valuable because the content adds value to the advertiser.  When Target advertises on MTV.com, the brand benefits from MTV’s youth-oriented content, giving the brand a youthful effect.  In contrast, utility inventory lacks the compelling context that advertisers need to help build identity and image, and in many cases may include negative images. The result  is that advertisers have no cause to align their brands with these products.  Unlimited inventory and negative brand association is a perfect storm for low CPMs.

Social Networks mistakenly believe they can use more robust targeting to counter the lack of real content or context.  Good luck to them.  Assuming the practice can ever clear regulatory hurdles, all targeting will do is drive up the cost of keywords on AdSense – mediocre revenue gains limited to direct marketing.  In the end, behavioral targeting will be a vast impressive technology, relegated to a bullet point on an ad network’s standard sales presentation.

In the meantime, Wired is still pronouncing, “the idea that ads can be a social experience is the industry's best hope.”  In my opinion, the best hope is to face the historical reality, and begin reshaping social networks as a traffic driver, rather than a revenue generator.