The eocnomics of free and consumer internet startups

Fred Wilson wrote a post over the weekend talking about Chris Anderson’s book Free and how it applies to consumer internet businesses (if you are unfamiliar with the basic arguments of ‘Free’ then I have written about them before, most recently here, and Alan Patrick has a very useful take here).

Fred’s point is that consumer internet services are cheap to start which makes it possible to get large numbers of free users relatively inexpensively, which you can then find other ways to monetise, either via advertising or by selling them something else, often with a freemium model.  Moreover, most of these companies will maintain an attractive free offering as that makes them ‘super hard to compete with’.

I buy all of that, and Fred cites Facebook as a great example of a company which has executed brilliantly on this strategy, with revenues forecast at around $575m this year from a combination of advertising and upsell (originally via Silicon Alley Insider):

  • $125 million from brand ads
  • $150 million from Facebook’s ad deal with Microsoft
  • $75 million from virtual goods
  • $200 million from self-service ads.

Moreover, as Fred points out revenues from payment services and off-site ads will most likely strengthen this story further over coming months.

Turning to what this means for other, smaller, consumer internet startups these Facebook numbers tell a slightly different story.  They only have $125m from brand ads, which is around $0.5 per user for the year – which is a frighteningly small number from the perspective of most companies in this industry who in addition to smaller size have to content with the problems of less frequent interaction than Facebook (ie fewer page views and ad impressions per user) and a much weaker brand with advertisers.

For me all this has two conclusions:

  1. For all but the largest consumer internet startups today having a free offering might well make sense (and probably does for most of them), but as soon as there is any scale there is a clear imperative to start finding that upsell opportunity because ad revenues alone are unlikely to make the difference. 
  2. There must be some way to get brand advertising to start paying on the web and on social media at better rates than $0.5 per user per year.  Lots of people have been working on this (very obvious) problem, but I have yet to see anything which really cracks it.

For completeness, if somebody cracks 2. then 1. obviously becomes less of an issue.

  • Every ad sales agency I speak to says the same thing: advertisers will pay premium rates on the web, but not to be associated with User-Generated Content (UGC). The limitation that social networks have is that they have millions of users that brands are afraid to be associated with, just in case it turns out they are Nazi-sympathisers or write hate mail about Michael Jackson (for example) which tarnishes the brand.

    So I don't think the question is whether we can higher advertising rates on the web: we clearly can. The key question is whether the model separates into an advertising model (where brands only want to participate in sites which have some level of editorial control) and a micro-transaction model (where consumers pay to consume content on high-traffic social network sites).

    Of course there will be some blurring, and I always believe that advertisers will migrate to where the users are. But in this case, maybe they'll migrate at low CPMs only…

  • It is not beyond hope to imagine that with appropriate technology we can get beyond this fear that agencies have of getting associated with the wrong content. Particularly if we can better demonstrate that the ads actually work.

  • I have to disagree here – the main issue is response rates or brand recall rates. Advertising is just not effective when you are trying to get someone's attention when they are focused on communicating with their friends. As more application get built on a/the social platform and people start carrying out a broader set of tasks on/around facebook I believe this will change (search, watching TV etc.)

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