It’s advertisers, not features, that will decide who wins in Social

July 6, 2011 Lou Franco

When Napster came out, the tech media was obsessed with the power of peer-to-peer. This classic Joel Spolsky article nailed it:

A recent example illustrates this. Your typical architecture astronaut will take a fact like "Napster is a peer-to-peer service for downloading music" and ignore everything but the architecture, thinking it's interesting because it's peer to peer, completely missing the point that it's interesting because you can type the name of a song and listen to it right away.

All they'll talk about is peer-to-peer this, that, and the other thing. Suddenly you have peer-to-peer conferences, peer-to-peer venture capital funds […].

Social features don’t drive revenue directly

I’m starting to feel like it’s the same with social features. The features themselves are not what makes money. The bulk of Facebook’s revenue comes from advertising (over 90% for in 2009 according to The Facebook Effect), and that’s for three reasons.

#1 They have a lot of traffic

The social features are a good way to create traffic, especially pageviews-per-user, but if there’s some new idea in the future to drive traffic, advertisers might migrate to sites that do that.

#2 The ads are worth more because they are targeted better

Advertisers are used to targeting by demographic, but have only had pools available to them. That means that if a media property has 60% of its viewers are in my target demographic, then the value is  only 60% of what it could be. For many advertisers the location, age, and sex of the user is all that’s needed, and Facebook has that because its users are highly incented to give real information.

They could improve here, especially by getting their users to list interests better, because interests are a great target.

#3 They invented a conversion that’s worth more than an impression

In addition Facebook has a really simple, well-integrated, light-weight conversion – a “Like”, that starts off a permission-marketing oriented conversation with the user. The value of an individual “like” is small, but Facebook helps you get a lot of them.

The result is that advertisers should be willing to pay a little more for an ad. The ridiculous amount of over-supply means that they don’t have to yet.

This is the same formula Google used for search

AdWords have the same three characteristics. Google provided the best search, so they got all of the traffic. Then, they used the natural information provided for a search to target an ad. Finally, they let people bid on clicks, which were worth more than impressions, and then they optimized the system to get clicks (by showing ads at the top). Like Facebook, they originally started with a vast over-supply, but it’s much more competitive now, and the system is optimizing in Google’s favor.

So, what’s next after social?

Using this as a blueprint, we can try to predict what’s next after Social, if we can figure out how to do better along those parameters. I have no idea what it is, but here are some guesses:

Custom TV: Facebook has 750 million users, but that pales in comparison to TV. No one likes TV ads, and they aren’t well targeted. But, Apple TV has my real identity, and Apple could try to learn a lot about me, so the ads (and content, of course) could be highly targeted. To close the loop, they need to let me interact with the ad in some way to open a channel for future communication.

Custom radio, magazines, newspapers, etc, are just variations on this idea – the iPad perhaps makes some of the latter ones more possible.

Excellent content built around brands: I don’t think this can be done to scale, but one example to follow here is Mad Men. It’s a show about advertising, and the content is sometimes a perfect brand advertisement – so much so, that you probably aren’t fully aware that you are watching an ad. Hasbro’s Hub TV is another example – game-shows made from the family games that they sell. The extreme here is Morgan Spurlock’s Greatest Movie Ever Sold.

The Little Orphan Annie scene in A Christmas Story is an example of what happens when this breaks down. The key is that the content has to be good, and the product placement has to make sense. The first steps will likely be bad auto-content generators. I can imagine advances in AI making this plausible at some point.

And, finally, if I’m totally wrong about Social features, and they become a way to drive revenue directly, it’s probably through selling digital goods, not advertising.

This hasn’t been a profitable choice so far. Apple probably sells more downloadable items than anyone, and they run their stores at break-even. And, when the authors of the Simply Seven website tried to find a public company primarily in the digital licensing space, they could only come up with Real, and said:

The company we were left with, Real Networks, had dismal financial results in 2009 and 2008. Just one company in the digital license sales category and that one loss-making on top of it; this does not really give us much to base our comparative analysis on.

So far, no one has been able to build a company in this space with earnings to rival the web advertising giants, but perhaps the viral nature of social will do it. If so, it appears that Apple’s Ping is the biggest attempt, but the concept will probably only take off if a social company adds digital licensing, not the other way around.

About the Author

Lou Franco

Lou is the former Vice President of Product Development at Atalasoft.

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