06 Feb

$100bn is Right if Facebook is the New TV

Facebook’s stats are amazing:

  • A huge and loyal customer base: 845m users, of which a whopping 483m are daily active users (DAU).
  • Dream margins of 75-80%.
  • Cash reserves of $3.9bn, with the IPO come $5bn more.

But is Facebook worth $100bn? This means 17x 2012 sales and a P/E ratio of 60. Google’s current Price/ Sales is 5 and P/E is 20.

Discussing Facebook’s valuation, many internet pundits have quoted and retweeted a blog post by Silicon Valley VC Bill Gurley . Gurley’s excellent blog post lists several reasons why Facebook should be valued in the $70 to 100bn range. Regarding the much-cited threat of Google+, Gurley, who knows a thing or two about internet platforms, says that it is very, very hard to leave Facebook. Nobody likes to leave their friends behind.

In a recent CNBC show, Facebook was called a “beast.” The journalists went on to say that Facebook is “not a dotcom” but instead a “real company.” Nice statement, considering that Mark Zuckerberg’s Letter to Shareholders in the Facebook SEC filing begins with the words: “Facebook was not originally created to be a company.”

Facebook certainly isn’t a normal company and this is not your average IPO.

Thank you Wikimedia, Creative Commons Licence, for file reuse.

But if Facebook is to be valued at $100bn, it needs to grow. And growth does not mean number of fans, but paying advertising customers. In 2011, Facebook grew by a stunning 88%. But in Q4 2011, the company grew only by 55%. In it’s February 1 SEC filing, Facebook itself states that an 88% growth rate is not sustainable.

The global advertising market is an established industry. There are only two ways to grow: (1) Take revenue away from other competitors currently generating ad revenues, or (2) grow the advertising market as a whole.

The global advertising market is huge: $464bn in 2011 (all figures from Zenith Optimedia). However, the market itself does not grow significantly (+3.5% last year). And Google will soon make up almost 10% of the global ad market. Google already accounts for 44% of total internet-based advertising. Can the ad market sustain another rapidly growing internet gorilla? If Facebook starts to eat into Google sales, this would be detrimental for both companies; there would be little headroom for Facebook and it would be a savage and expensive competitive fight.

Offline to online substitution is the key. While Google sales grew by $9bn in 2011 alone (from $29bn in 2010 to $38bn in 2011), newspaper ad revenues were in constant decline in past years (dropping from $95bn to $91bn). Mind that we are comparing a single company to the whole newspaper industry. Of course, Google is not alone responsible for the decline of newspaper revenues, but there certainly was a competitive shift taking place with revenues moving from offline to online.

Facebook has a lot of potential to convert offline ad sales into its own revenues, too. Facebook ads have better branding power than search ads, so it may even have an advantage to Google. Facebook’s attack trajectory is against TV. With revenues of $184bn (2011), TV is much bigger than newspaper publishing. There is enough headroom for Facebook here for the next couple of years.

Can Facebook pull off being the new TV, at least in terms of attractiveness to advertisers? TV is the domain of large advertisers, such as Coca Cola. Coca Cola’s ad budget in 2010, for example, was $2.9bn.

A shift will not happen overnight, and television is a beneficiary of massive events, like this year’s Olympics in London. Facebook will certainly do all it can to persuade large advertisers to shift part of their ad spend. Getting large advertisers on board is the Number 1 challenge Facebook will face in coming months.

It is possible, however, that Facebook has the power to grow the whole ad industry. I hate to use the Groupon example, because the company has in my opinion been poorly understood. But Groupon uncovered a new hyperlocal demand for advertising among small, mostly service-based companies, which had been improperly addressed by conventional advertising offerings. There is no other way to explain Groupon’s massive growth in such a short amount of time.

Facebook has this potential to uncover new demand, too, but in many more ways than Groupon. Facebook is a top mobile application. Facebook’s mobile apps do not show ads now, but that is being changed as you read this blog post. Facebook ads can be hyperlocal (restaurant in your part of town), hypertimely (there is a sale near where you are right now) and hypertargeted (new book by your favorite obscure Brazilian author).

Facebook will generate new sources of ad revenues from millions of small companies who have never relied on advertising before.

The only limit to Facebook’s ability to generate advertising revenue growth is Facebook itself. The trick about advertising- offline and online – is not to overdo it. In the book SimplySeven I co-authored, we describe the downfall of MySpace, at one point in time much larger than Facebook. The quantity and quality of advertising always needs to be delicately balanced and MySpace simply overdid it, going for short-term cash instead of user satisfaction.

Facebook clearly recognizes the danger of ad overload, however. To quote again from Mark Zuckerberg’s letter in the SEC filing: “Simply put: we don’t build services to make money; we make money to build better services… These days I think more and more people want to use services from companies that believe in something beyond simply maximizing profits.”

Facebook will continue to grow if it executes well. Smaller advertisers will discover and use Facebook for hyperlocal, hypertimely and hypertargeted ads, even through they did not advertise much before. The bigger challenge probably are the large ad accounts, which embrace the branding power and emotional quality of television.

There may be a third source for revenue growth, however, beyond advertising. In a previous blog post, I described how the internet flagship companies eBay, Google and Amazon already generate US$1bn each with complementary business models – on top of its original business. Already today, Facebook derives more than half a billion (15%) of sales from non-advertising sources, the bulk of this probably from Zynga. Zynga sells virtual goods in its games, providing Facebook with a commission (it also buys advertising directly on Facebook). There is more. Imagine if Facebook would offer premium subscriptions to its 845m members. Or if it offered its own (cash-) payments system like PayPal? At the moment, Facebook is still focusing on its primary revenue model advertising and the challenge of winning over large accounts, but the potential for growth on top of advertising itself certainly is there.

13 Aug

Google, Amazon, Apple and eBay Are Each Making Over a Billion With Alternative Revenue Models

Much of the discussion surrounding high valuations of internet companies is besides the point. The valuations of successful internet companies are justified, because they reflect an increasing capability to monetize internet reach and traffic.

One way that this capability is manifested is through the diversification of dominant internet companies away from their traditional business models towards business model combinations. These companies are transforming themselves into multi-faceted and increasingly individualized monetization platforms, serving both an ecosystem of business partners and millions of end customers.

While the dominant companies Google, Amazon and Apple are still generating over 90% of their sales with their traditional business model, sales from alternative revenue sources are growing fast. Each of these mega-platforms now make a billion dollars or more from new revenue sources. Google’s new businesses – worth one billion – are enterprise subscriptions for its hosted email, office and search software, licence sales on Android Marketplace and the Google Checkout payments solution. More will follow, like Google Offers. In its financial reporting, Amazon unfortunately combines its direct internet retail sales with its third-party marketplace commissions. The split would be interesting. But Amazon Web Services for enterprises and other new businesses contributed very close to a billion in sales in 2010. More than four billion Dollars of Apple’s sales comes from its nontraditional internet segment: Selling software and music licences on iTunes and the App Store.

eBay beats them all with a whopping 40% of its sales originating from non-marketplace activities, mostly payments solutions and advertising. For eBay, alternative business models are a three billion Dollar business.

This trend towards using combinations of business models like building blocks can be observed among dominant internet companies, as well as new challengers. Once they achieve a dominant position in terms of reach and traffic, internet companies new and old are becoming very savvy about which business models to combine in what way. Twitter took a long time to develop its business model it is gradually launching now, which actually is a combination of two building blocks: Advertising for those enthusiasts who don’t mind sponsored Tweets and subscription payments for those that want a pure, unsponsored desktop. This is what personalized business models are about, payment in whichever way fits the individual best.

For established businesses and start-ups which are only now beginning to focus on growing their internet activities, the trend is good and bad. The dominant players are offering a number of standardized payment services which can be more or less easily integrated in a plug and play fashion. But there is always a dependence which often means giving up a significant share of revenues.

Setting up one’s own dominant monetization platform is difficult, but despite the challenges, a few companies have achieved this recently: Facebook, Twitter, Groupon, Zynga and Airbnb. Their valuations are high, but their powerful ability to monetize is unique.

Some of these companies are from the start not relying on a single business model, but are diversified into different monetization approaches. Facebook relies on advertising, but is also evolving its virtual currency, Facebook Credits. In the case of Zynga, developing outside revenue sources which are independent from Facebook is critical for long-term success. All these successful newcomers took their time to carefully select and test different monetization approaches and are still fine-tuning them.

Sources: 2010 Annual Reports of Apple, Amazon, Google and eBay.

14 Jun

Google’s Admeld Acquisition: Real-Time Ad Bidding Really is the Future of Ads

A couple of hours ago, Google officially confirmed the acquisition of Admeld, an advertising optimization platform for online advertisers. Admeld is part of a set of highly innovative companies in the rapidly developing space of real-time ad bidding.

There has been a lot of buzz about real-time ad bidding in the last weeks – with full length analyses in the Financial Times on 22.05.11 and The Economist on 05.05.11. This is justified, since real-time ad bidding represents a milestone in advertising innovation.

The question I ask myself is: Is ad bidding merely a continuation of a trend towards ever more targeted advertising, or are they something fundamentally new?

The term “ad bidding” alludes to something beyond advertising. Bidding takes place on exchanges and marketplaces. Individual buyers and sellers are matched to generate a transaction. The marketplace recieves a commission from the sale, in the event of a successful transaction. An agent brokering a sale on a marketplace accepts sales risk, but in turn receives a nice reward: A cut from the sale.

Googleplex Welcome Sign from Wikimedia Commons under GNU Free Documentation Licence

In part, this is what ad exchanges do: They match up individual consumers with very specific advertising offers. But they are information brokers only. What they don’t do is take on sales risk for the actual sale of the advertised item.

Ad exchanges do take targeting to the next level. A consumer is identified according to the clicks he or she carried out in the past couple of weeks. The individual could, for example, have looked at hiking boots on a web site selling hiking equipment. While he or she is surfing many days later, an auction runs real time in the background, selling advertising on these sites to interested bidders. In this case, the most interested bidder for this individual consumer may be the hiking equipment online retailer. If the hiking retailer wins the auction, the consumer will see hiking boots displayed on the web sites he or she is looking at, perhaps even in his or her favorite style or color and even at the appropriate price.

Real-time bidding has revitalized internet banner ads (which were beginning to be relegated to the dinosaur cabinet). It is a nice example for a business type that was thought dead, only to be revived by a new technology.

Real time ad exchanges are incredibly sophisticated, from organization, process and technology perspectives. Apart from Google, the 800 pound gorilla, there are many highly specialized companies. The data handling and analytical capabilities of these companies are impressive. There are players focused on the supply side of advertising, such as the recently acquired Admeld. The Supply Side Platforms (SSPs) are focused on publisher yield management. On the demand side, one of the leading companies is AppNexus. AppNexus manages data from its clients, which are the advertisers. In Germany the leading DSP is Sociomantic Labs. Sociomatic Labs has many of the most active ecommerce companies in Germany as its clients.

Ad exchanges therefore facilitate these brokered, real-time deals between different specialist agents, representing the publishers on the one side and the advertisers on the other side.

The deals are about one thing only: The individual consumer. On the one side, the individual is surfing on some web sites. On the other side, this specific individual has been identified as a potential customer and a price has been set for the value this customer brings.

One consequence of this type of deal-making is that the context of the advertising inventory itself is not so important as it was in the past. A potential customer may surf on the expensive home page of The New York Times but also on relatively cheap pages like a mountain camping site. Real-time bidding thus whittles away at the power of these big web sites. It is all about the individual customer and his or her purchasing intentions.

In a way, the capability real-time bidding brings to banner ads is long established in search advertising, which carries out individual targeting according to individual intentions. It also is a forerunner of what advertising will increasingly be like on Facebook. By its very nature, Facebook ads are about individuals and their preferences, too.

The price paid per brokered ad approaches a percentage of the potential sales ticket size, rather than reflecting the value of the ad inventory. This means that individually targeted hiking boot ads may cost less than individually targeted automotive ads. Wow. Imagine Super Bowl ads priced according to the product sold.

This is a huge step away from the traditional advertising model, for sure. It is too early to tell if is good or bad for the owners of popular, expensive domains – it may lead to revenue growth (due to elastic pricing) or decline (due to ads moving into the long tail and away from the big domains).

The more targeted advertising becomes, the more pricing will tend to reflect ticket size (of the product) and pocket size (of the individual customer), instead of the advertising inventory and the content itself. Performance pricing based on actions such as clicks is commonplace in this environment. Facebook ads will be priced like this, too.

But, search ads, social media advertising and real-time ad bidding will shy away from taking on sales risk (and being paid only in the event of a completed sale). As such, they are part of a proposition that involves customer acquisition and reach and motivation, instead of transaction facilitation. There is a reason for both and for both business models to exist. Marketplaces will stay marketplaces. Advertising will stay advertising.

10 Mar

Foursquare 3.0, Square and Augmented Business Reality: Casting Web-Based Business Models Over the Real World

Stage 1: Offline > Online

Just a few days ago, a friend offered some advice about our book on internet business models: “Why write a book about internet business models, everything is internet business these days.” At first, we did not get it.

Wait a minute, we thought, there still is a lot of difference between offline and online business. Just think of the different cost structures and competence requirements when running offline compared to online retail.

In fact, the relationship works the other way. It is not internet business which is shaping offline business. On the contrary, our buying experience from the offline world has shaped the way we perceive online commerce. This is why we have a limited number of seven basic building blocks of web business, the Simply Seven, in the first place. In our head, we carry around real-world metaphors for how we buy online.

Stage 2: Advanced Web Business

This is changing fast, however. Let’s call this Stage 2 for the sake of argument. As people are becoming more familiar with online business, they are accepting more sophisticated online business models. Fremium models are becoming ever more advanced. Business building blocks are being offered ready-made as web services on platforms and combined in innovative ways. For example, subscription systems available within the Apple Apps shop. Virtual currencies such as Facebook credits will lead to fascinating new business model innovations, including financial ones. There will be fewer “pure” building blocks used for monetization – as in the early Stage 1 days of Amazon, eBay and Google. Digital business is becoming more exciting all the time.

Stage 3: Online > Offline

In Stage 3, through mobile technologies and devices, web-based business is being cast over the real world. One could call this “augmented business reality.” We associate augmented reality with superimposed data over real world, real time images. Here, we are talking about superimposing digital business transactions over the real world, real time. The new device-based mobile payments systems by Square, Inc. are part of this development, but so is mobile advertising and mobile commissions. As a start date for Stage 3, maybe we should pick the 1st of December 2009, the day Co-Founder Jack Dorsey (@jack) posted to Twitter: “Announcing our new company, called @Square, which I’m thrilled to be a part of …” (Source: MIT Technology Review)

There has, of course, always been significant interaction between the real world and the web. But it has increased continually and has now reached the next level. In the beginning, catalogues like Yahoo! or search engines such as Google provided aids to navigate the internet world. Craigslist and Groupon are navigational aids which help us localize deals in the real world. Facebook connects real world people together and creates a social graph.

The next level we are talking about is the superimposition of digital business on the local, real-world environment. Some would call this mobile business, but mobile makes us think of mobile devices, which is only one part of the story. Maybe local commerce is a better term.

The observation that everything will have an IP-address and communicates with each other increasingly is nothing new. Kevin Kelly wrote about “the new biology of machines” in 1994. This is about the combination of a wired world and increasingly sophisticated web-based business models.

Square Inc. is not just enabling mobile payments, it is providing offline retailers with the rich data only an online retailer so far had access to. In a video for Stanford University’s Entrepreneurship Corner (dated 09.02.11), Jack Dorsey describes the dearth of data real world coffee shops live with every day. They know they made $400, but have no idea with what products, at what times, sold to which clients. There is no way to recontact customers with special offers and use these offers to build a relationship. Square is making money by realizing commissions for itself, but in the process, it is making offline retail become more like online retail.

TechCrunch and others have reported on Foursquare’s 3.0 version, launched on March the 8th, just in time for the SXSW conference in Austin. In a pilot carried out in cooperation with American Express, people can use their credit cards to unlock local merchant deals during the conference. The future of local deals are real time offers provided as bypassers move through a street. A street’s business will thus be reflected in augmented reality as one walks through it. Not everyone will enjoy being bombarded with coupons. But its not only about walking.

In automotive-obsessed Germany, a recent study found that younger clients don’t seek cars for status any more, but as mobile, wired platforms communicating online for purposes of entertainment, safety (with other cars) and, yes, to point out special commercial offers on the way (Source: “Nur voll vernetzte Autos locken junge Kunden an,” Die Welt, 10.03.11, page 12).

Our friend Max had it right after all, real world business is rapidly being subsumed by web-based business models.

21 Feb

Google’s One Pass Annoucement… yet another “Business Model as a Service.”

One Pass, Android Market and Chrome Web Store Have Broad Significance for Business On the Web – Not Just For Media

The announcement made by Google on the 16th of February in Berlin about One Pass, a micropayment and subscription payment service for newspapers and magazines, may at first glance seem like a specialized offering for the media industry.

Indeed, One Pass is an extremely interesting offering for media companies, because it charges a 10% commission payment – low compared to the 30% cut that Apple takes as a standard for being on its platform. Google also states that content providers will be able to access customer data, too. Eric Schmidt is quoted in the Financial Times (Tim Bradshaw and David Gelles, “Google’s One Pass to take on Apple,” 16.02.11) saying: “We basically don’t make any money on this.” A great message for media, because the more platform options there are, the better (as the music industry can attest to).

One Pass has a far broader significance for business on the web beyond media, however. It is only the most recent announcement made by Google regarding different payment solutions as a service. Its Chrome Web Store facilitates licence fee payments for browser-based games, Google Checkout is a unified payment system and Android Market is being extended rapidly. Not all these initiatives are faring equally well, but there is a lot happening, no doubt.

What Google is doing is a further important developent in the extention of the masheable web to include business model building blocks. The basic building blocks of internet business have been around for a long time. Our upcoming Simply Seven book provides a navigational guide to the seven different building blocks and highlights some of the main opportunities and threats associated with each. Now, a handful of powerful internet companies are offering these basic business building blocks as ready-to-go services, “business models as a service.”

Google’s many moves in this area are smart competitive reactions to the massive success of Apple in attracting developers and content owners to its App Store. What Google is doing will in turn result in reactions by others who have the ambition to extend their own business model funtionality to the web, such as Amazon, Microsoft, PayPal and also Facebook.

What Will Facebook Do?

The strategy of Facebook in the next months in this regard will be extremely interesting. Right now, the company is focusing primarily on creating a robust and sustainable social web business powered by advertising. Introducing advertising has been a learning experience for both the company and the Facebook user community. Facebook Credits, the mandatory payment system for Facebook games, is still pretty much contained to the social games area.

If the half a billion power house starts to offer “business model as a service” functionality, either through Facebook Credits or through another solution, start-ups and other internet businesses may not only see this as an interesting option, they may find that being on the Facebook business platform is a must have requirement. (By the way, this may be the reason Facebook is purposely not extending into this area just yet, because it would gain too much commercial power too quickly.)

Even without Facebook, the web has numerous ready-made business building block options available already today. Software, games and content can be sold as licences and subscriptions over App Store/ iTunes or Android Market/ Crome Web Store/ One Pass. Retailers can choose to sell their physical products over the third party marketplaces of eBay or Amazon.

Right now, these transaction platforms are available on the respective marketplace or mobile sites. We can expect these funtions to be integratable into any web site in the future, similar to the way Facebook Connect makes a user’s social graph transportable into third party web sites.

How Companies Can Take Advantage of the Emerging Business Model APIs as a “Fast Track” Business-Building Approach

Google and Apple are leading the way to build what essentially is a business model API. This is exciting for companies. We are moving from the ability to use services like SendGrid (massively scalable email service), Amazon Web Services (infrastructure web services), Force.com (enterprise applications) to yet another level. As these different internet business building blocks develop, it becomes easier and easier to launch complete web businesses from scratch very fast. However, the solutions provided by Google and Apple are not free and they do have strings attached. It is important to understand the offerings very closely especially the ownership of customer data.

The proprietary business building blocks offered by Apple and Google leverage these companies’ internet reach and ecosystem and generate sales from commissions. This should not be taken lightly. The ability to ask for significant commissions on sales of up to 30% (in the case of Apple) means that these companies are providing actual strong value add to their business partners to enable sales, in the form of reach, registered members, technical functionality and a device-based ecosystem. An important value-add is that Apple and Google provide a trusted environment – a big benefit for unknown brands. Executives from many other companies are watching Google and Apple closely saying: “I wish I could do that.” This includes media companies, mobile phone and device manufacturers and a slew of internet players.

In an interview for the upcoming book Simply Seven, Roland Manger, Managing Partner of the European venture capital fund Earlybird differentiated between two kinds of start-ups. Those which will attempt to independently build up their own user base and those companies, let’s call them “fast track start-ups,” which leverage existing platforms populated with users and built-in business model functionality. “Companies need to make a choice fairly early on in their lifetime,” Manger says, “if they want to make a good living with a smart idea on the back of a proprietary platform or if they want to own their whole value chain.”

But being a “fast track start-up” does not have to be a one-way street. Zynga is a powerful example of a highly successful company which initially leveraged the Facebook platform to make its social games popular. In the past months, it went beyond Facebook with independent web- and mobile-based games.

In fact, launching “fast track start-ups” based on a unique idea, but built on pre-existing business platforms, is a great way to test new concepts. Some of these will graduate to “whole value chain” status. One of the challenges is to integrate the different web services driven technologies and building blocks into a working and scalable system.

It is this “fast track” path to success which new style seed initiatives such as Y Combinator, TechStars, The Founder Institute and others are taking advantage of. (Everybody avoids using the term “incubator” these days.)

The ecosystem of leading internet platform players and new businesses is evolving extremely fast and resulting in significant opportunity. The power to facilitate business transactions is being added into the mix as efficiently as it is to integrate into the social web and build on other pre-developed web services.

Thank you Roland Manger for taking the time for an interview in the midst of your busy schedule and thanks Gabriel Matuschka for adding important insight to this blog. Roland Manger’s own blog can be found under “Bird’s-Eye View.”