ADTELLIGENCE_White Paper_Monetization of Social Networks_Chapter3

ADTELLIGENCE GmbH
Mannheim, Germany
www.adtelligence.de
info@adtelligence.de

“Cashing in” on Connections – Monetizing Today’s Social Networks
White Paper (2009)

Chapter 3 – Business Models for the Internet of the Future

Contents

3. Business Models for the Internet of the Future

3.1 The Pressure to Monetize

3.2 Direct or Indirect Monetization?

3.3 Subscription Models

3.4 Freemium Models

3.5 Virtual Goods and Currencies

3.6 Advertising Revenue

3.7 E-Commerce, Affiliate Models
3.8 Market Research

3.9 Chapter Summary

www.adtelligence.de 2

Contents





3.4 Freemium Models



3.7 E-commerce, Affiliate Models

3.8 Market Research

3.9 Chapter Summary


Broadband Internet Access:
Paving the Way to Market Successes

The spread of broadband Internet access
Technical Origins
has led to growing numbers of Internet
users, more innovative ideas for Web
Affordable, applications, and increased capital
Broadband investments into the market
Attractive Uses of
Internet
the Internet  Improved bandwidth brought forth
new features on more Web pages

Innovative,  There was a cycle of new ideas,
Usable More Users including the "Web 2.0 revolution"
WebFeatures and ultimately, a huge push for
users to jump online
Web 2.0
 The Web 2.0 "hype" and high ratings
of new ideas led to many second-
More More More round funding investments
Innovation Founders Financing


Plenty of Funding, No Plans
for Monetization

• Venture capitalists funded start-
ups with increasing users,
Venture focusing mainly on growth; and
were satisfied with the vague Lack of pressure to
Capital business models companies
presented monetize in the early
Financing • First-mover investments was the
dominant approach as the
stages of Web2.0
Web2.0 hype transpired
Growth was the main
focus for companies
and their investors
• Even players like Microsoft, during this time
Acquisitions Google and News Corp acquired
Web 2.0 companies Recession forces them
through • In addition, group synergies to monetize earlier
established focusing on user growth were at
the forefront, rather than an than planned
businesses efficient business model
(MySpace, Hotmail or YouTube)


Investors Relationships and
Their “Network Effect”

For the investors of various Web 2.0. start-ups, the “network effect” and overall growth of the young
social network’s user base was at the forefront of strategy. How to actually make money, on the other
hand, wasn’t the focus of their equation at the time. Here is an example of the network effect from the
sale of Friendfeed to Facebook. The VCs are often invested in many different companies which fit
together only in a portfolio view.


The Economic Crisis and
the Pressure to invest

 Within just weeks of the global economic
crisis, there was an intense rethinking among
investors in terms of business and investment
strategy

 The pressure on the venture capital firms grew
Economic and dramatically due to high cash burn rates of
financial crisis of their newly created businesses
2008/2009
 Even for the well established businesses, the
pressure was increased by the high levels of
debt built up from their acquisitions

 The start-ups of investors’ portfolios were
brought under even greater pressure to find
ways to monetize their business


Rapid User Growth in Social Networks
Show First Signs of Market Saturation

Increased Growth Nearing Market Saturation?

Since 2004, Social Networks showed dynamic Two-thirds of all Internet users visit Social
growth among users. Facebook, founded in 2004, Networks today
registered its one millionth member at that time and
currently has more than 290 million members In Russia, Internet users spend an average of 6.5
“Student directories” of Germany currently have hours logged in to Social Networks
more than 15 million members
Already 75% of the German, Swiss, American, and
Since 2008, growth leveled off in most countries. Australian online population are members of at
This was partly due to the beginning market least one social network
saturation and partly to new, specialized competitors
(see examples) More than 80% of all students in the United
States and Germany have a profile on at least one
Also in 2008, the first signs of Social Networks trying social network
to win over users from other networks became
visible


Pressure from Investors:
“It’s go time…or else!”

Pressure
from
Investors
“How do I
monetize
my social
Competition to network?”
survive in a
Saturated
Market


Contents





3.4 Freemium Models



3.8 Market Research

3.9 Chapter Summary


Good Business Models include both Revenue
and Expenditure Models, with an Emphasis on
the Revenues!

Basis of
“Business models are perhaps Knowlege
the most discussed and least and
Features of
understood aspect of the Web. a Product
There is so much talk about
how the Web changes
traditional business models. Usable Go-to-
But there is little clear‐cut Products Business Market
That Add Model Strategy
evidence of exactly what this Value
means.”

Professor Michael Rappa
Revenue
The real
Model focus is
Expenditure here!
Model


Distinguishing two Revenue
Models: Direct and Indirect

Possible Revenue Models for Social Networks

Direct Indirect

User Pays for Usage: Third-parties (businesses) pay for access
 Per time spent using service. (most to services (exploiting the reach of the
frequent model, e.g. monthly fee) social network):
 Per feature/functions used (regularly  For the placement of advertisements
or for one time usage)  For the sales of third-party products
 For the use of the network as a market
research channel

Virtual Market
Subscription Freemium Advertising E-Commerce
Goods Research


Contents





3.4 Freemium Models




3.8 Market Research

3.9 Chapter Summary


Subscription Models: The Challenge
of getting Users to pay

Subscription revenue models charge for usage of services on a reoccurring schedule (daily,
monthly, yearly, etc.)

The advantage is that revenues are calculated well in advance, and the services are pre-financed
by customers (Similar to the print media business models)

Subscription models are only successful if users see a direct added value – especially in
comparison to a similar service that is available for free. For example, streaming music directly
rather than downloading it to a shopping cart, checking out, having to wait, etc.

One challenge that businesses face is to get users to overcome the “payment hurdle.”
In most cases, there is a free trial period (examples: myYearbook, Napster), which allow the user
to test the network for limited time

Despite these hurdles for first time users, many companies use the “Freemium” business strategy
(see next chapter) where basic site functionality is freely available, and extra “premium” features
must be paid for


Contents





3.4 Freemium Models




3.8 Market Research

3.9 Chapter Summary


Freemium Model
Monthly Fees for Premium Features,
Basic Versions for free

Freemium models combine free usage with premium features and functionality

The term “premium” generally offers higher-quality services (more storage space, use of advanced
archival or search functions, etc.). An excellent example of an Acquisitions
Freemium model for specialized services can be found at www.myartspace.com

For some services, the premium version is exactly the same in terms of performance, but
is simply free of third-party advertising. (example: www.myyearbook.com)

User fees for premium services are usually charged on a recurring basis, similar to the subscription
model.

The Freemium model has the advantages of predictability and pre-financing for the business, as
already mentioned in the subscription model

XING, a popular site for business networking in Europe, premium members have the advantage that
they can see all users of the network and send messages to them (a powerful lead generation tool).
Messaging is normally a standard function among social networks, but in the case of creating
business contacts, it is a premium service.


Freemium Models
Accepted only by Certain User Groups

When users make the decision whether a premium membership is worth it or not, features
that help cut down time-to-information play a decisive role (quicker and easier search, less
advertising, direct access, etc.). For this reason, the use of Freemium models in the business
sector (where time equals money) is more widespread than with normal social networking
sites that target students and young adults.

It is clear from this example that a user’s willingness to pay for certain services are quite
different. The “premium range” usually offers a package of functions and services that carry
relevance to only a certain class of individuals (and higher pricing), and therefore may deter
other users from purchasing those services.

A solution to this dilemma could be the settlement of individual bids set up to be analogous
with virtual goods, which are touched upon in the following chapter.

Components of premium offers are subject to frequent changes in order to keep pace with
future competition. For example, no one pays for access to e-mail today, but they do pay for
mobile e-mail access - in the near future however, this may no longer be the case and new
premium services will need to be developed in its place to continue to monetize the business.


Specialized Social Networks
Freemium Services to Customers


Contents



3.4 Freemium Models




3.8 Market Research
3.9 Chapter Summary


Pay-As-You-Go
An alternative to Subscription and
Freemium Models

The willingness of the
Every single user pays for the users to pay for
Subscription Model individual services/
same features and functions
content is often very
different

Some users don’t pay, and Standard-premium
only use the basic version packages sometimes
Freemium Model don’t offer enough
Some users pay for the
value (It’s either “all or
Premium version
nothing”)

“Pay as you go” model: Offering individual
products 'on demand' for the customer (virtual
goods) and can make for a happy alternative
for the business(operator)


Breakdown: “Pay as you go”-
Model und Virtual Goods

“Pay as you go” Model and Virtual Goods

Individualize Profiles
Premium Services Gaming Features
and Character

 Virtual gifts, birthday  Representation of  Extra lives for
greetings, greeting the profile (skins, game character
cards, etc. etc.)  Wizard by World
 Spam filters for  Avatar features of Warcraft
profiles (e.g., clothing, etc.)  Equipment and
 Personal song on armament for war
the profile games
 Game level
expansion.


Virtual Goods
Already established in today’s Social
Networks

Virtual goods in Social Networks can be seen in many Social Networks today, especially in Asia. (In all type
of social network models from value-added services, to pay-as-you-go models, etc.). The largest social
network in China, QQ, has estimated revenues of approximately €100 million in 2009

Facebook, which also sells virtual goods, is only in beta stage. Even still, current transactions of these
goods approximate U.S. $75 million, quoted from a recent statement from Marc Andreesen in 2009. There
aren’t classical premium features, rather little virtual gifts & items with a price of up to one US dollar

The best known example of virtual goods comes from the platform Second Life, which was originally
created and used by professional developers and became extremely profitable. After a slew of year-long
technical difficulties, the platform is up and running today and growing at a strong pace. It has to be
admitted that gambling, etc. is big in Second Life and it was used to launder money by the mafia

Especially in the games sector, where companies such as Vivendi / Blizzard or the German company
Gameforge have created 3D worlds and hundreds of millions of virtual goods - mainly clothing and
equipment for game’s characters (swords, armor, weapons, and wands). Commenting on their own
success, Gameforge’s CEO adds:

“Even in the virtual world, People want to look good!”


The Business of Virtual
Goods: Second Life

In Q2 2009, $144 Mio of User2User transactions were made in
Second Life. 750,000 new unique users join the network every
month
Source: Secondlife.com


Virtual Goods
An Exciting Stream of Revenue for
Social Networks

Advantages

 Long-tail monetization is definitely possible Put in perspective,
virtual goods create an
 Tests the users willingness to pay extraordinary revenue
stream for operators of
 To test features, free credits are offered Social Networks.
 Increases the attention span of users in the
network, and benefits from the effects of new However, this model
advertising methods. continues to pose
some technical
 Increases the attractiveness for external content challenges for the
creators (labels, publishers, developers) who can operators.
earn money by developing items for the platform

 Creates rewards / opportunities for user-generated
virtual goods


“Pay As You Go” Models
The Business Accounting Challenge
still remains!

Virtual goods typically require the introduction of a virtual currency
 Internationally, it is a challenge to create such a system – in a huge virtual economy, like Second Life,
users exchange currencies from around the world and need a fixed or more sophisticated free flow
exchange rate
 Changing costs for users to move from one platform to another is unclear for the user
 High user acceptance rates are a must ("price tags" visible in US dollars)
 Rewards for user-generated content can be easily distributed (E.g. Amazon reviews will be rewarded
with cash / credits, etc.)

Especially when the business opens this virtual world to external providers, a secure billing system
must be accounted for (especially in small amounts / keywords: micro-payments). The business poses
major challenges including tax implications that need to be resolved.

Payments from individual users need to be accounted for:
 Especially for young adults and teens without credit cards and/or bank accounts, this challenges legal
barriers (“How do they use their pocket money for transactions?”)
 Solutions need to be found to avoid the billing of small amounts or to enable cost-effective measure for
smaller transactions.
 Alternative models are also possible (example: Apple iTunes voucher cards at electronic stores, but
these can be expensive and complicated)


Contents





3.4 Freemium Models




3.8 Market Research

3.9 Chapter Summary


Lousy Pennies for Social
Networks?

“You Get Lousy Pennies on the Web”

Prof. Dr. Hubert Burda
Owners of Hubert Burda Media
at Digital Lifestyle Day 2009

 This provocative statement is true and false at the same time, and not only for
traditional content models.
 Even in Social Networks, the situation is divided - as shown in this report’s
previous examples from German “student directory” Social Networks vs. China’s
QQ
 The trend of advertising budgets is shifting to Internet advertising due to the rising
numbers of social network users (and general Internet usage). Hence, only very
few sites with technological advances are profitable from measurable campaign
results, via Google.


Online CPMs
Generally quite low, especially
compared to the Cost for Content

With display ads and similar forms of online advertising, publishers earn very little per 1000
ad impressions (CPM) in comparisons to the costs of traditional business models - this is also
true for Social Networks.

This is especially true when one considers that only certain parts of the page are actively in
demand from advertisers (tops of websites, for example). Even leading websites usually sell
approx. one third of the advertising spaces in their network.

In particular, sales-oriented campaigns are valued on their commission rates (as well as their
performance) and on their overall reach and communication.

Unfortunately, public Social Networks and other media sites don’t publish their net CPM
figures, but experts in the field can confirm basic ad tendencies of low CPMs.

Nevertheless, advertising on Social Networks is on the rise. According to a study by Comscore,
currently 20% of all online advertising in the United States (in terms of ad impressions / page )
is done by Social Networks. It is likely this percentage that has been calculated is significantly
low due to the fact that Social Networks are converting such low CPMs.


Advertising Revenue from Social
Networks in Terms of CPMs are
comparatively low

Difficulties in Comparison Gross-Net Quadrant1)

 Intra-media CPM comparisons are
CPMs in Euro Plausible
associated with large uncertainties Margins
 Gross-Net Quadrant: Price lists have lost their
binding character and can be interpreted Prime-Time TV 10 - 15 40% - 50%
only as a guide
 In addition, CPM-comparisons with clear News Magazines 7 - 10 ca. 30%
target audience definitions are meaningful in
National
limited use Newpapers
10 - 15 ca. 30%

 Nevertheless: Today’s established Top-Content
Sites
30 - 40
60% - z.T. >
80%
advertising methods offer solid returns. Large Social
15 - 25 Up to 99%
But, in the online space, CPMs continue Networks
to be freely negotiable and are in the 1) Figures have relative tendency - real values are highly dependent on
range of one Euro for Social Networks. concrete performance indicators and parameters. Prices according to the
supplier's price lists; population ranging from 14 years of data and the main
form of advertising
Source: Expert interviews


Intelligent online Advertising
Models realize significant revenues

Social networks like MySpace and Facebook already earn significant
advertising revenue. But in comparison to their scope and potential
impact of communication, these numbers are still low.

The key here is that by using the enormous amount of traffic,
they should be able to monetize networks with simplest of methods.

Also noteworthy is that both companies have developed specific targeting
technologies and continue to refine them even further
(see more in later chapters).

Because specialized Social Networks lack the mass of users, they generally target their specific
audience of users and concentrate on integration with the larger Social Networks. They haven’t yet
been successful with this method.

An example of immensely successful monetization of a huge amount of traffic is, naturally, Google.
But even Google faces the problem of not being able to offer an environment for the traditional
campaign – including testing and models to establish CPM-based advertising.

Consequently, Google is focused on a very special auction model, which increases the value of
frequently searched words.


MySpace and Google
First Social Networks with
Advertising Revenue

MySpace, Fanta,
Band World


Contents





3.4 Freemium Models




3.8 Market Research
3.9 Chapter Summary


E-Commerce Affiliate Model
A special Form of Advertising

 Although Social Networks are not ecommerce platforms, they could learn a lot from them
 By integrating directly into a social network, a business can significantly increase its revenue
 Asian Social Networks have established “virtual stores,” which allow users to order “real
goods” for virtual money. These shops, from their look and feel, are perfectly integrated into
the world of Social Networks, allowing users to easily make the connection between the
virtual and real world and recommend products (compare the Facebook Beacon idea!)
 Amazon opened its platform to third-party vendors (Marketplace) and have helped
monetize their own business by leveraging its large numbers of users.
 The key to success is not only the target group, but the individual response of the user. E-
commerce will only continue to be successful if the users continue to stay interested in
buying online
 Commission of such an integrated shop could be a potential revenue stream down the road.
The first step in this direction for many Social Networks would be to experiment with
affiliate models. For example, a cooperation with vendors like Zanox or DoubleClick – but
even here success lies within the target group


QQ - The most powerful Virtual
Currency in the world?

 The Chinese government restricted the exchange of
QQ currency for real goods because the
establishment of this virtual currency didn’t allow
for them to tax goods being consumed, which
resulted in massive losses for the state
 Nevertheless, the QQ currency continues to boom
because of the difficulties in trying to ban a currency
which only exist on PCs and mobile devices – like US
dollars in developing countries
34
Source: plus8star, own analysis
http://english.mofcom.gov.cn/aarticle/newsrelease/comm
onnews/200906/20090606364208.html

Contents





3.4 Freemium Models




3.8 Market Research

3.9 Chapter Summary


Social Networks offer interesting
Approach for Market Research

 Social networks’ ability to attract individual users and create new channels
for market research provide companies with an interesting opportunity and a
potentially lucrative revenue stream
 Users of Social Networks not only communicate their interests, wants, and preferences in
their profile, but also their dislikes – and share them with their personal social network
 This interactive behavior offers companies the chance to directly address and involve users
(those fans of a certain brand or early adopter of a technology, for example) in their focus
groups or new product launches

 Social networks will be able to monetize by granting marketers this type of access
when, and if they create the proper conditions:
 If they are capable of clustering their users into these special interest groups, specific
models for targeting are required and the ability to filter results from the focus groups,
including Social Data Intelligence, is a key success factor

 If this succeeds, they will be able sell access to this data for very high price.
“Facebook will make deals” says Tim Draper of the big VC Fund DFJ in 2009


Contents





3.4 Freemium Models




3.8 Market Research

3.9 Chapter Summary


Among the Approaches
to Monetizing Social Networks
Advertising still offers great potential

Possible Revenue Models for Social Networks

Direct Indirect

Virtual E- Market
Subscription Freemium Advertising
Goods Commerce Research

 As we’ve already discussed, both direct and indirect models offer different methods
of monetizing the social network and creating revenue channels
 These methods have numerous possibilities in today’s Social Networks and haven’t
been fully unleashed – especially for the Freemium and virtual goods models, where
there is still a significant amount of untapped potential
 In the area of advertising alone, there is already an enormous user acceptance and
openness to new methods, which can be tapped by modern models of targeting
technologies


ADTELLIGENCE_White Paper_Monetization of Social Networks_Chapter3

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