Will social networking sites ever make money?

Users of Facebook et al resent ads and expect a free service. So how will these sites ever turn a profit?

by Andrew Saunders
Last Updated: 09 Oct 2013

To some, they are the undisputed darlings of web 2.0, spearheading a virtual revolution that will replace the net as we know it with a connected world where status, street cred and even employability are determined not by the old credos of class, geography and education but by the number and quality of nodes on your personal global network. To others, social networks such as Facebook and Twitter are the last word in navel-gazing - online platforms for the swapping of trivial opinions by the terminally self-obsessed.

Whichever side of the fence you prefer to be on, if the grand vision promised by the boosters is to stand a chance of coming even halfway true, the big social networks will have to start doing something that they have so far singularly failed to do - making decent, sustainable profits. The question being asked with growing urgency out in the real world, where the wheels of commerce have yet to become frictionless and still need greasing with plenty of moolah, is: can they ever do so?

Some veterans of the dot.com bubble of the late '90s have their doubts. Michael Wolff, American author of Burn Rate, the most compelling first-hand account of life in Silicon Valley in that frenzied period of boom and bust, is one. 'Social media is based on the internet model, and we are right to be alarmed by that model. It creates moments of intense enthusiasm, but they do not - cannot - last.'

Enthusiasm is the word. Facebook has signed up a mindboggling 300 million users in just three years. That's a fifth as many followers as the world's largest religion, Christianity, has accrued over two millennia, and it's still growing fast - five million new users a week.

Founder Mark Zuckerberg's ambition is also of biblical proportions. He wants to get to a billion users in a year or two, and - having turned down at least one billion-dollar offer, from Yahoo! - shows no inclination to sell out. Facebook has attracted a zealous following from the investment community - the purchase of a 5% stake by Microsoft in 2007 valued the company at $15bn, although more recent share sales suggest $5bn is closer.

And yet in its more established territories, Facebook is already old hat. How long can it find new markets where punters still think it is cool, to make up for those where it has passed into the ranks of the web establishment?

Blake Chandlee, commercial director EMEA for Facebook, is ex-Yahoo! and was Facebook's first international employee, way back in 2007. He is confident the firm has what it takes to stay at the top for a while yet. 'How do you avoid being blindsided by the next big thing? I asked Mark (Zuckerberg) exactly the same question when I went for the job,' he says. 'He really wants to connect users, to make Facebook more of a utility than a content-driven thing, like some other social sites.

'Facebook is about nodes and edges - it enables you to keep in touch much more effectively with people at the edges of your network, people you might know only superficially, than you can in any other way. That has real global appeal, more so than content plays.'

At least Facebook has viable revenue streams - it makes money from advertising on the site, and is exploring other sources of income, such as stored credit, which users can spend on the site, and a new VOIP telephony service to compete with Google and Skype.

Last month, Zuckerberg announced that Facebook will be cashflow-positive this year, which means that it will earn more in revenues than it spends on capex - a vital turning-point for any start-up.

But it's very cagey on exact figures. Even mundane facts such as employee numbers are not 'officially' public (it's around 1,000 people, by the way) and revenues and expenditure details are closely guarded secrets. 'Leaked' estimates suggest annual revenues of around $500m and climbing fast, prompting sceptics to wonder why getting cashflow-positive has taken Facebook so long, and whether it can sustain such a frenetic pace of growth and technological diversification without burning out.

Twitter, meanwhile, the uber-fashionable new kid on the block, has much less in the way of visible means of support. The micro-blogging site was founded in 2006 but didn't really get going until last year. It now has 45 million users, of which nearly three-quarters joined in the first five months of this year, according to data from Twitter research specialist (yes, such firms do exist) Sysomos.

Endorsed by celebs such as Stephen Fry and 'Mr Demi Moore' Ashton Kutcher, it has attracted more than $100m of funding. That includes $35m raised at a valuation of $250m earlier this year, and $50m or so raised last month at an eyewatering $1bn valuation. All for a company with no clear source of income.

The unprecedented - and to some inexplicable - mass appeal of posting short (140 character) messages on any subject at all in real time on the Twitter site seems to have taken even founders Jack Dorsey, Biz Stone and Ev Williams by surprise. They neglected to work out a business model before they got started - a source of embarrassment now that they've hit the big time. Having maintained since very early days that it would never look to advertising on the site to make money, Twitter recently changed its terms and conditions to allow it to do so - in theory, at least.

In July, it was reported that Twitter had spent $15m getting to 30 million users, so, compared with those profligate '90s dot.coms, it is prudently managed and should have plenty in the kitty. So why the need for this latest round of funding? Sceptics suggest that the founders are keen to extract as much cash from the VCs as possible before the true scale of Twitter's 'monetisation problem' becomes a deal-breaker.

The question of whether to go for growth or profit is a classic social-media dilemma, says Nic Brisbourne, partner in venture capital firm DFJ Esprit. 'Does profit matter? Yes, in the long run it matters tremendously. Any business is only worth the sum of its future net cashflow, and without profit you haven't got any of that. But the key phrase is "in the long run". The revenue potential of a business like Twitter or Facebook is theoretically proportional to its user base, so providing you have the capital to cover your losses, it make sense to grow the user base. That's adding more value. But you have to transition to thinking about profit.'

He believes that Facebook has passed this financial rubicon, but that Twitter is not yet in a position to. 'Facebook is clearly in revenue mode - there's definitely a viable business there. The question is: will it be a Google, or will it be an AOL? But Twitter is right at the beginning of the cycle - it doesn't have the revenue to go for profit, even if it wanted to.'

The question bothering investors in social media must be: how long will it last? It is the pace with which these bursts of fame and fan-dom succeed one another, says Wolff, that makes the social networking business model suspect. Dominant players can rise and fall so quickly that they never have time to earn investors their money back.

Look at what happened to MySpace, the first social network to make it really big, he says. 'There's a company that pretty much created the market, had a potential valuation of some $20bn at one point; now it's the sick man of social media.'

MySpace collected 50 million users in two years, a number that looks less impressive today than it did then only because of the extraordinary numbers subsequently posted by Facebook. But it rapidly lost its mojo in the face of its sharp-elbowed new rival. It has now made 30% of its workforce redundant and is bleeding ad revenue at the rate of 15% per annum. Being acquired by Rupert Murdoch's News Corp - whose lamentable record in the online arena is well known - didn't help.

Even Zuckerberg and his all-conquering chums may not get much more than an hour or two in the sun. Peter Cook once said of arch-rival David Frost that he 'has risen without trace'. The same could be said of Twitter, which, revenue or no, is now clearly way cooler than dreary old Facebook, at least for the opinion-formers of the online community.

In such a world, where both technology and user behaviour are transient, little can be taken for granted. 'It's a Facebook game now, but what happens next?' asks Wolff. 'Will Twitter upend Facebook? Will Facebook acquire Twitter? Suddenly, we're talking about a strategic defence of a business that hasn't even defined what it is. What are they preparing to defend exactly? We don't know.'

The UK has its own, smaller, cautionary tale in Friends Reunited. Bought by ITV for £120m in 2005, when it had 15 million members and solid revenues from advertising and paid subscriptions, its model was undermined by the arrival of Facebook - yes, them again - which offered better functionality for free, as well as a much bigger hype machine. Although profitable in 2007, it rapidly went into reverse, and when ITV disposed of what remained of Friends Reunited earlier this year for a paltry £25m, it made a thumping loss of £95m.

But it's easy - and often unproductive - to knock new ideas before they've had a chance to prove themselves. Let's retreat from all this naysaying and take a rational look at what is going on. Are social networks really inherently hard to monetise, or is the conspicuous lack of profit from some players simply a natural part of early-stage business life?

It's the latter, argues Facebook's Chandlee. 'Where we are at is consistent with business trends for the last 100 years. It amazes me that people so often say we are not monetising; I think we're doing a pretty good job. The pace of change here is like nothing I have ever seen. We're clearly building a robust and commercially viable business.'

Furthermore, it's simply not true that social networks can't turn a profit. Many do, typically the niche players whose backers don't have quite such deep pockets and whose businesses were built from the start with ROI in mind - firms such as LinkedIn, a network for professionals which has inevitably attracted the moniker 'The Facebook of business'. Since it declared itself profitable in 2007, it's arguably more successful than its bigger and better-known rival. But, like Facebook, it also plays its financial cards close to its chest: revenue and profit figures are not revealed.

The quantity of its membership may not be in the premier league - 43 million - but their quality is outstanding, says Christina Hoole, marketing director for Europe. 'Eighty-one per cent are university-educated, the average age is 41 and the average income is £75,000.'

Those are the kind of numbers to make any advertiser drool. And, in a sector where the pedestrian reality of making money can often look like an afterthought, its business model is copper-bottomed. 'Our revenue model is mixed - roughly one-third each advertising, subscriptions and corporate solutions,' says Hoole.

Ironically, sales to corporates have been particularly strong during the downturn, because using LinkedIn as a recruitment tool helps clients to do their own headhunting - at a fraction of the price charged by specialist recruitment firms. 'You can seek out both active candidates - those looking for a new job - and passive ones. These are the people who aren't looking but might move for the right offer.'

Adds Hoole: 'We're in a privileged position, because people's professional networks last for life; they take them from job to job.'

It's also easy to forget that social networking is a young sector, and that people are still feeling their way in it. There's a lot more value to come, says Peter Ward, co-founder of another niche player, UK-based social network for travellers Wayn.com. Wayn may have 'only' 15 million members, but it has been profitable almost from the start, he says. 'There's this idea that all social networks are the same. They are not. We can do more specialist, focused things on Wayn that they couldn't do on Facebook.

'Social media has plenty of untapped value, but a lot of people who claim to understand social media don't. Success depends on using the power of the medium and understanding the psychology of your users.'

Twitter's lack of obvious revenue streams has led to speculation that the firm's best hope for the future is to get up the noses of bigger rivals in order to encourage them to buy it out - something it has managed with considerable aplomb. Rumour has it that at least one such approach has been rebuffed by Twitter's top team. Did they not want to sell, or was the price too low? Only time will tell.

Internet veteran Brent Hoberman, the co-founder of Lastminute.com who now heads up the PROfounders investment fund, thinks a sale could be on the cards for Twitter. It certainly worked well for his investment partner Michael Birch, who sold the social network he founded, Bebo, to AOL for $850m last year.

'Microsoft, Google, Facebook - they'd all like to buy it,' he says. 'The question is, would a sale kill it?' In other words, how many users would desert a corporate-owned Twitter on a point of principle? Hoberman doesn't think it would amount to many. 'Maybe the techies who were on there first would stop, but in the mass market I don't think many users would care very much who owned it.'

Facebook's Chandlee points to another advantage enjoyed by social media that should certainly please the traditionalists. 'We are fiscally very conservative, we keep our employee base low. Plenty of people here went through the dot.com crash; they know what that felt like and they don't want it to happen again. Comscore says we're the third most popular website in the world, and we've done that on less than 1,000 employees - fewer even than Google.'

So will social networking ever pay? Almost certainly, yes. You may not share the desire to broadcast your entire personal life to the world on Facebook, or share your every waking thought with the Twitterati, but a lot of people do - these are some of the fastest-growing businesses on the planet. 'I'm optimistic that sites with mass scale, and well-differentiated niche sites, will do well,' says Hoberman. 'The middle market will struggle.'

After all, as Michael Wolff admits: 'You have to say that if it's not possible for someone to make money out of the intense engagement of all the millions of people who use social network sites, we might as well all give up.'

Good point. Someone should Tweet it.

 

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ADS, DATA AND APPS - Where the money comes from

For a medium that prides itself on novelty, the lion's share of revenue generated by social networks still comes from a traditional source - advertising. Despite the hunt for alternative sources of income, this won't change quickly. 'For the foreseeable future,' says Facebook's Blake Chandlee, 'advertising will remain the dominant revenue stream.'

The received wisdom is that if people in social networking mode are less receptive to ads than those merely browsing, but social networks know a great deal about the habits and proclivities of their users. That kind of data should allow them to identify precisely targeted audiences, something the internet has long promised but never quite delivered. Hence the ongoing battle over who can do what with all the personal data that users type into social network pages. 'So far, a lot of online advertising has not really added much to what can be achieved in a magazine,' says DFJ Esprit's Nic Brisbourne. 'That will change.'

So expect to see a raft of more sophisticated techniques, from product placement via interactive ads to the 'engagement' model, which tries to make ads more palatable by encouraging feedback from users. Some professional-interest sites have better data than mass-market rivals.

There should also be a good business in selling data on what people are saying about brands to corporate clients - 'analytics'. 'It comes down to whether you can influence people's buying behaviour without upsetting them. I think the answer is yes,' says PROfounders' Brent Hoberman.

The other possibility is in the topsy-turvy world of apps - small pieces of software designed to run on top of a social network and to do something users find fun or useful: Tweetdeck on Twitter, for example, or Facebook Connect.

Developers don't get charged for using the underlying platform to sell their app. So although Twitter itself makes no money, several developers are doing very nicely off the back of it. Will Twitter use some of its war chest to snap up the most successful apps?

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