Internet companies and the billion dollar money drain

     Over the last ten years, more than $43 billion was invested in 7,200+ Internet-related companies (PWC MoneyTree report 2012). 50% of those companies will disappear within the first three years of operations, and the average venture capital fund will fail to even return back the capital plus management fees as per the Kaufman foundation report. But blaming the venture capital model is just scratching the surface of the real problem. The root cause of these poor returns is the lack of sustainable and user-friendly monetization mechanism beyond the unprofitable display advertising business model. Ad funded Internet models are a $40+ billion money drain....

     During the past five years, worldwide Internet user base doubled, yet online advertising grew less than 70%. Between 2012 and 2016 online ad spending is projected to grow 14% CAGR (eMarketer), but this growth does not factor in the erosion in display advertising revenues that will come as a result of the rapid migration to mobile and the most likely scenario is a contraction of the total display ad category. Mobile is extremely hard to monetize using traditional display and search advertising as discussed in previous posts (Making web 2.0 profitable beyond display ads). This means the gap between user growth and profitability will continue to increase, creating pressure on the leading portals, digital media companies, social and business networking sites and forcing them to explore new avenues to monetize their audiences.

     Paid content revenue dominates the mobile web. Only 5% of the global mobile Internet revenues come from advertising while 73% comes from eCommerce and 22% from paid services. 54% is paid digital content: apps, ringtones, music, video, etc (Morgan Stanley 2011). The role of micro transactions is key in the mobile web, which will be also known as “the paid web”.

     While Apple is leading the path on monetizing audiences through micro-transactions, effectively reinventing themselves as the largest eMarketplace (Apple reinvented: the profitable web) and increasing the average revenue per transaction 100% over the past five years (47% of apps are paid with an average price is $1.99; June 2012 Apple store data), Facebook, Linkedin, Yahoo!, MSN, AOL, and a long line of Internet companies backed by venture capital are struggling to monetize their audiences. These companies suffer from their audience migration to mobile devices and to apps in the smaller screen form factor, the continuous erosion in CPM rates, and the end-user apathy towards online display ads, coupons and paid search results.

     As an executive advisor to large and emerging tech firms and advisor to venture investment firms, one of my focus areas for the past five years has been in monetization technologies for profitable Internet companies and I have actually delivered on Internet companies’ turnaround by implementing profitable models. These days, I am highly skeptical of advertising as a valid monetization mechanism as I think it is a macroeconomic nihilism. There are always better ways to monetize audiences, as long as one is delivering value in return for engagement. Leading companies in terms of engaged audiences, such as Google, LinkedIn, Yahoo!, and Facebook, are starting to test new monetization in the form of “application” stores, e-commerce, eWallets and payment mechanisms, paid digital content, and by selling their “audience” as a qualified “panel” to serve the need of the online market research industry.

     Market research is a good and overlooked example of an adjacent monetization mechanism for large audiences. It is a $31+ billion industry (ESOMAR 2011) and more than 70% of that money is spent offline using outdated tools. Online market research makes up $9+ billion of that and is monetized through micro-transactions in a B2B model, where the average price per completed survey is around 2x to 4x the average revenue per user per year reported by most successful social networks and Internet portals, hence online market research constitutes a valid monetization mechanism for those large audiences.

     The same algorithms used to serve targeted and relevant advertising based demographics and observed behavior can be used to create virtual samples of survey respondents in real time. This opens up the large audiences built during the Web 2.0 boom to an adjacent form of monetization, where users continue receiving the benefits of the free-Web by paying with time responding to surveys, in addition to the time they spend looking at ads.

     While this introduces new opportunities and potentially doubles the total addressable opportunity for online audience monetization, it is still not enough to bring balance to the macro equation of social networks, Internet software companies and digital media companies. The only reason to think that Facebook is worth $70b is if one believes they will be able to monetize their audiences via ecommerce, transactions and other yet to be revealed monetization mechanisms. With 50% of their users migrating to mobile and 25% of those users accessing Facebook via third party apps that are not exposed to ads, the current revenue trends are just not sustainable in the short term.

     Hybrid mechanisms, such as Apple or Android stores where users pay for premium digital content or digital goods through micro-transactions and are also exposed to some sort of transactional-advertising, are a more sustainable model. There is simply not enough online advertising money or minutes spent online to pay for the billions invested thus far in Internet-related deals by venture capital and corporate venture capital over the past ten years. These Internet companies and large audiences never delivered on the promised monetization, but the audiences were built. As corporate and venture capital learn the macroeconomic realities of ad-funded models, the time is ripe for innovation on profitable consumer Internet companies. Traditional online advertising is looking like a $40+ billion money drain.