The next time you hear about an online business that gives away its product or service away for free and 'monetize the eyeballs' that result, consider this:
- The Number of Users is Finite - Growth in the number of users or eyeballs eventually slows down as a sites users nears the saturation point, and eventually the total number of users peaks. This is especially applicable to social networks like Facebook, Twitter and Foursquare.
- Advertising Revenues Will Eventually Peak - Advertiser's pay for ad impressions or the number of eyeballs that can see their ads. Since the number of users is a finite number, social media revenues will grow in some proportion to total users. Social media ad spending represents a fixed percentage of total advertising dollars in the U.S. and social media's share of total ad spending has shrunk 25% since its peak in 2007.
- Social Networks Eventually Reach A Critical Inflection Point - The number of Facebook users has already reached saturation in the U.S. and parts of Europe. As growth in users begins to decline ad revenues will also decline, and will eventually peak. The social network will eventually have to depend on other revenue streams to continue growing.
According Rick Bullotta, a co-founder of ThingWorx, every online web business, including the major players like Google, Facebook, Twitter and Foursquare, play a constant game of stealing a share of the total ad revenue pie away from their competitors. In other words, they're all locked in a sort of zero-sum game.
Technology innovations, including the growth of mobile devices like the iPhone and Android smartphones and tablet computers like the iPad, has created entirely new media channels that did not exist before, and advertiser's have been quick to exploit these new channels in order to reach their target market. This has created a shift from traditional online display advertising to mobile display ads embedded in apps and social games. The shift in total dollars has not been proportional, as many advertiser's are still experimenting with mobile media and just beginning to understand how to measure their ROIs and effectiveness of their social media ad spending.
According to many startups Mr. Bullota has seen,"Most are built on an advertising model". Some are directly dependent on an ad-supported revenue model or indirectly dependent on web or marketing analytics, or make money through display ads that appear in their digital content. The latter is especially true of mobile apps, social games, music downloads, online video, internet radio and photo sites.
The problem with all social networks is that there is a very low value-added component. The reason for this is because they don't make anything of real value that you can smell, touch or taste. In my opinion, social networks don't even solve a real problem in the marketplace. Zuck created Facebook as a way to meet chicks. This may have been a problem for Zuck and his geek friends, but I doubt it is a problem in the real world. Truth be told, Zuck knew he was on to something when he reached 1 million users, then it became 10 million, but he still didn't know any way to make money off of Facebook except advertising, because if he started charging, he knew users's would leave the site. Today, if you go to Facebook's homepage, it says, "Facebook helps you connect and share with the people in your life". That's a whole lot better than saying, "Facebook helps you connect with chicks".
Because it is difficult to place an intrinsic value on Facebook, or Twitter for that matter, social networks have decided not to charge, but to position themselves as a new media channel for advertiser's. Facebook presently has about 600 million users, Twitter is approaching 200 million users. Those are real numbers that advertiser's can relate to, in much the same way that the Super Bowl pulls a worldwide viewing audience of 100 million+ houeholds, the Grammy's can pull 26 million households or the Academy Awards can pull 37 million households.
Whereas e-commerce was an enhancement of existing brick-and-mortar retail stores, the ad-supported revenue model is merely a way to steal market share from traditional media. Nothing much is created in the process other than a new level of human interaction and connection which has some benefits, but hard to quantify in dollars and cents like you can a new Apple iPad or Ferrari sportscar.
One of the problems with the ad-supported revenue model is that, other than a few commercial online business sites like SalesForce.com, eBay, Zappos.com, Amazon.com, to name a few, there's no exchange of goods between the site and the user. This is the conumdrum of social networks, and the key reason why they have had difficulty charging for their services and have earned the label of "freemium" businesses. In the real world of brick-and-mortar economy, entrepreneurs find a need and fill it. Small businesses create actual products and services to fill that need. A market quickly develops and an economy is born. This is the basis of Capitalism.
In this article I hope to demonstrate that all social networks are competing for a finite number of users and their ad-supported revenue model can no longer create exponential ad revenue growth over the long-term. As a consequence, social networks are rapidly reaching a critical inflection point where user penetration ultimately reaches the saturation point and advertising revenues stop growing and eventually peak. The limits on social network growth are explained below:
1. Social Network Penetration Maximizes - The total number of social network subscribers is a finite number. As you near the inflection point, growth in social media pentration begins to dramatically slow down, and the total number of social media users eventually peaks. In the case of Facebook, I put this number at about 1 billion members. This is Zuck's number, not mine, just so we are clear about that. In a blog dated February 5, 2011 titled, "Facebook Will capture 67% of Global Social Media Revenues in 2011, But Can It Reach 1 billion Members?", I provided evidence that Facebook's North American penetration has already peaked and growing in low single digits. This has also been confirmed by several social media experts. Most of Facebook's user growth will be international, namely fromAsia, Europe, Latin and South America.
Facebook has not earned much traction from India, Japan, South Korea and Russia, where its market shares are in the low single digits. Facebook is also banned in China where it has only 700,000 members and even if it were allowed to operate there would be facing some formidable competition from several Chinese social networks. So I dare ask, "Can Facebook reach 1 billion users?"
Zuck was counting on China in order to grow to 1 billion users, but the number could be a lot less than this, somewhere between 850-900 million users is my guess, but I also thought the iPad would flop. Clearly, Zuck is very concerned about being banned in China, necessitating a goodwill trip to Beijing in December 2010, which proved to be not very fruitful.
2. Revenues-Per-User - According to Silicon Valley Insider, Facebook has one of the smallest revenues-per-user when compared to other technology leaders:
Facebook had reported revenues of $1.860 billing for the year 2010. If you do the math, Facebook's revenue-per-user is $3.10 ($1.860 divided by 600 million users). Twitter ended the year 2010 with revenues of $45 million. Twitter's revenue per user was an abysmal $0.2368 (45 million divided by 190 million users). However, Twitter did not officially rollout its Promoted advertising platform until October 2010, and then it was to only 35 and 40 national brands on a test basis, so this average is not for a full year.
According to eMarketer (see above), Twitter and Facebook are projected to generate $4.o50 billion and $150 million in revenues respectively in 2011. The average revenues per user will depend on the number of users they will have by the end of 2011. If you hypothesize that Facebook and Twitter will increase their user base to 850 million and 250 million respectively, then their average revenues per user will be $4.74 and $0.60 respectively. The above assumes that Facebook and Twitter will increase the number of users for 2011 by 59% and 76% respectively. Facebook's revenues-per-user for 2011 will only increase by 27.4%. There is no comparable measurement for Twitter, because their revenues in 2010 were for less than a third of a full year. In any event, the growth in revenues per user do not correlate with the increase in the number Facebook's users. In short, advertising revenues for social network are not linear (straight line), but are an elongated S-shaped curve, sloping upwards initially to form a concave curve, but eventually slopping downwards to form a convex curve over time--the classic case of diminishing returns. This is definitely a cause for concern, and it is my belief that Facebook and Twitter know this, and are moving rapidly to develop other revenue streams. Facebook has already done this by adding social games, virtual goods, location-based check-in services and is now testing a daily deals program similar to Groupon and LivingSocial. Twitter is sticking to its Promoted marketing program.
3. Facebook Reaches The Advertising Revenue Inflection Point - According to eMarketer (see graph below), Facebook's U.S. advertising revenues have reached the inflection point, and growth will begin to decline, and will eventually peak. As a consequence, Facebook will become more dependant on foreign advertising to generate continued ad revenue growth. Foreign advertising revenues began to grow exponentially beginning in 2010, and this trend will continue through 2012 and a few more years beyond, but will eventually reach an inflection point, and begin to slowdown and convex.
To my knowledge, several social media experts have mentioned the inflection point, but nobody has ever made an attempt to visually graph the inflection point or explain how it works. In order to accomplish this, I played a series of "what ifs" and had to make several assumptions and series of calculateed guesses about Facebook's future user counts beginning with the year 2011, and the affect this will have on future advertising revenue growth. This is what Facebook's Inflection Point curve might look like:
Okay, here's my definition of the inflection point: The inflection point is the point in time when the Gap between the Ad Revenues Curve (upper curve) and No of Users Curve (lower curve) is at its widest. I refer to this as the "Ad Revenue-to-User Gap" or The Inflection Point. According to my calculations, The Gap was at its widest sometime in mid-to-late 2o10, and the Ad Revenues and No of User lines gradually transform from convex curves to a concave curves. Over time, The Gap gradually narrows until growth in users and advertising revenues finally peak.
Facebook's Inflection Point is not carved in stone, and a lot of things can happen to prolong The Gap from narrowing. In Facebook's Inflection Point graph, I made reference to several Exceptions which can prolong growth in the number of users and advertising revenues. The biggest "if" is China. If China ends its ban of Facebook (and other social networks) this changes the entire ball game, but the point in time when the inflection point occurs is only extended into the future. In short, the Inflection Point theory remains intact--user growth finally peaks, growth in advertising revenue begin to decline, and eventually peak.
There will probably be some pessimists among you, who hold to the "Holy Grail" theory, which is not really any kind of quantitative theory, but mostly "Facebook Love". I welcome your criticism. If you can make valid points, I will be only too happy to include your recommendations into the formulation of an Inflection Point theory.
4. Social Media Advertising Effectiveness - In a number of blog posts about Facebook, I have raised serious doubts about Facebook's effectiveness as an advertising platform for the following reasons:
- Marketer's still not certain about social Media.
- A study showing that Facebook does not drive traffic to retailer's websites.
- A WebTrends survey that Facebook ad-performance in 2009 and 2010 was abysmal when compared to other media channels.
- Less than half of marketer's like Facebook, with the general concensus that Facebook ROIs suck.
5. Social Media Fatigue - Anyone who believes that interest in social networks will continue unabated are in for a surprise. A few social media experts have mentioned that some social network users will eventually reach a state of boredom or burnout. "Facebook Fatigue" has already begun to set in, especially among teens, who began to leave Facebook in droves beginning in 2007/2008. I talked about teen fatigue in a previous blog post dated March 9, 2011.
The same fate that MySpace experienced can eventually happen to Facebook. Several startups, bored with Facebook, have created niche-driven social networks. Twitter, YouTube, Cafemoms, Beebo and Groupon are a few such examples. This trend could have a profound affect on Facebook's user and advertising revenue growth, as user's begin to switch from one social network site to another, or spread usage between social sites, and advertiser's try to decide where to allocate their advertising dollars--Facebook, Twitter or both.
In Facebook Inflection Point curve I assumed 760 million users by the end of 2011, and wouldn't you know it, this appears to be right on track, but China remains the wildcard, and one needs to keep this in the back of their mind.
Once again, remember my Inflection Point theory:
- The number of social network user's is a finite number.
- As the growth in the number of users begins to slow down, advertising revenues reach a critical inflection point, revenue growth slows down and eventually peaks.
- Growth in total revenues can only be sustained by adding additional revenue streams.
I know that I have not been very kind to Facebook (or Twitter for that matter), or share the same enthusiasm of other social media guru's, who praise the site as a social media "holy grail". I won't go that far, in fact, I am a bit pessimistic that it can reach the $4.050 billion in advertising revenues for 2011, without a major new source of revenue besides advertising. Facebook Places was supposed to be the major revenue generator, but so far has been mostly a dud, not only for Facebook Places, but Foursquare and Gowalla. Impressive user numbers, but not much in revenues.
Facebook's experimentation with daily deals appears to be a desperate attempt to capitalize on the growth in group buying and popularity of daily deals. Google has made a similar move, and Facebook, with over 600 million users, definitely wants to exploit this opportunity. Again, all this does is shift advertising market share from one site to another.
Although some businesses appear to be interested in location-based check-ins to drive traffic to their front door, adoption remains a serious problem, with only 4% of internet users using it regularly. There is also a significant gender gap, as only one-third of users are female. There are also a lot of concerns over privacy and a fear of being stalked, especially among females. The verdict is still out on location-based check-in services. I have been one of the biggest critics and remain somewhat pessimistic.
Courtesy of Tommy Toy, PBT Consulting