Facebook and the end of the Web

This week Facebook released a barrage of announcements that reveal a stunning level of ambition.  You have to ask, are they really the next Google, but with evil?

I can’t speak to the question of evil, but I do have a mental benchmark for the next Google, and it isn’t simply about being the next giant tech company.  The next Google would have to create an entire sector of economic activity, keeping a dominant position worth many billions of dollars while also creating many billions of dollars of value for other companies.

Before Google, the commercial Web was motley mix of emerging media, with some interesting economic opportunities in portals, ecommerce and auction.  Google created and dominated search advertising, but the utility that search brought to the Web was a major driver in the overall economic growth of all advertising on the Web, including display advertising.  Today the entire commercial Web runs on advertising, and Google helped create many more billions of dollars than it captured for itself.

If Facebook merely becomes the world’s best ad network, they would not be the next Google.  They would simply be the biggest winner in the economy that Google helped create.  They could even suck all the oxygen out of Google’s room and thereby kill Google, but that wouldn’t make them the next Google any more than John Wilkes Booth was the next Abraham Lincoln.

I think Facebook’s ambitions go far beyond advertising.  I’ve got no crystal ball showing the future, but the analogue from the past that seems relevant to me is television.  TV was once a wondrous new technology, giving rise to a new world of entertainment and news media.  Businesses quickly hooked the economic engine of advertising to the media of television, and decades of fantastic growth followed.  It once seemed a given that television would hold a central place in our media lives forever, and that it would always be free.

And then cable TV came along.  You might not remember this personally, but cable TV was initially a terrible affront to consumers.  People had become accustomed to getting a huge amount of media for free, and now these horrible new companies wanted outrageous fees every month for the same kind of media.  This could be very painful for a consumer with devotion to a particular kind of content, for example a sports fan seeing important sporting events disappear into the hole of paid TV.

Could the same thing happen to the Web?  An entire generation has become accustomed to Web media as free media, and assumes that will be true forever.  But cracks in that assumption have appeared recently.  We’re seeing a new wave of paid content efforts on the Web.  More importantly, we’re seeing platform owners make good money from Web-like content, like Amazon with Kindle and Apple with iPhone/iPad.

Amazon and Apple have shown that you can make money from digital content if you own all the important parts of the value chain, from digital content rights to an ecommerce store to a payment service to a physical device.  Facebook could be about to find out whether you really need the last link of that chain.  They might not need control over the physical device, because they have something even better in the social graph and identity management.

Facebook knows who you are and knows who your friends are, and they own that information in a way that no one ever has before.  Add in the right content relationships, a payment system, and a universal interest indicator, and that becomes a complete enough platform to enable more paid content on the Web.  A hidden key may be that their payment system is a prepaid credit system, which allows small transactions that would otherwise have burdensome costs and usability barriers.

That may sound a little abstract, so I’ll offer up this fanciful example:  I go to visit Pandora for music, and Facebook and Pandora immediately know it’s me.  They know what kind of music I like, and they know what kind of music my friends like, so they are able to recommend some really great music for me.  Right there I have already participated in a content transaction:  I have offered my valuable tastes and contact information to Facebook, who handed that info over to Pandora – you have to think that Facebook gets paid for that.

And Pandora was glad to pay, because I really like that music they recommended.  In fact, I liked it so much that now I’m going to sign up for a Pandora subscription.  I’m about to reach for my credit card when I realize, hey, I can pay for this with Facebook credits!  Oh, I see I’m a few credits short.  No problem, I’m going to go this this Facebook game, SheepWorld, and rack up the extra FB credits I need – then back to Pandora to pay.

A bunch of little transactions happened in that scenario, and none of them actually involved me pulling out my wallet.  In fact, it seemed like fun, it didn’t seem like I was paying at all.  I was able to participate in a new economy because I’m a Facebook user, and now I’m getting used to paying for premium content.  And when the New York Times puts up its paywall, I’m not going to care so much because I’ll be paying with Facebook, which separates the media consumption experience from the payment experience.

Sound a little farfetched?  Could be.  But there was a time when I couldn’t imagine paying for TV.  Both free broadcast and paid cable television still bring in a lot of money, but cable is a much better business.  If Facebook enables new revenue opportunities on the Web for content creators, they will enrich themselves and enrich others even more.  I won’t like it, just as I didn’t like it when I started paying for TV.  It would be the end of the Web as we know it.

privacy matters

What is going on with Facebook’s constant gyrations about privacy policy?  Does anyone really care?

A little while ago I suggested that online privacy concerns are best addressed by free market solutions, not governmental regulation.  I’ve discussed the topic with quite a few entrepreneurs, investors and professional marketers, and the overwhelming view in that group is that regular consumers just don’t care about online privacy.  “They” say:

  • privacy is too complicated a topic for consumers to understand
  • no one reads privacy policies
  • consumers can be distracted from privacy concerns with the offer of just about any shiny object

Much of that might be true – but I also took the time to talk to a bunch of “regular” consumers.  And these things are definitely true:

  • consumers know that their privacy is being compromised by many online services
  • consumers do not like being taken for granted
  • consumers will avoid services that abuse their information, and will seek services that use their information properly

These two sets of “truths” are not mutually inconsistent.  To me, they add up to:   Online services can gain a competitive advantage by giving consumers the most sensible default choices along with the right advanced options for privacy – make it simple, but make it right.  I think Facebook believes this, and that’s why they keep tinkering with their policies.  They understand that a lot of their initial attraction was a result of making different privacy assumptions than more open services like FriendFeed and Twitter.  They know that even if no one ever reads their privacy policy, if they make the wrong choices about privacy, they will lose users.  As they saturate their available audience, they have to figure out how to strike the right balance among their different demographic bases, all the while competing with the advantages that more open services have.

These are extremely nuanced choices, but getting them right makes the barrier to competitive threat all the more defensible.  And these are product choices; this is something that many I’ve talked to misunderstand:  people think that this privacy stuff is just legal mumbo jumbo or regulatory mishmash.  That’s plain wrong – laws and regulations are just the cart behind the horse.  In a social product where community is paramount, policy choices are product choices.

hey facefeed, let’s just be friends

I can’t help wondering if Facebook’s acquisition of FriendFeed isn’t an overreaction by the giant social network, in response to the deafening buzz around Twitter.

It must have irked Facebook that the tech blogosphere has been obsessed this year with Twitter Twitter Twitter – Facebook’s growth has been just as impressive, arguably more so since it’s rarer to grow a large base much larger than it is to grow a small base into a medium-large base.

So in the past year, Facebook has tried to buy Twitter and has copied features of both FriendFeed and Twitter.  And this acquisition appears to be about bringing the values of FriendFeed to Facebook.  Among those values are an emphasis on product openness and sharing beyond your circle of friends.

But what if users don’t want to be more open?  Could it be that Facebook grew so fast because its users regarded the service as a safe place to share their lives with only a close circle of friends?  If Facebook becomes more like Friendfeed, will the service become less attractive to a mass audience?  (I’m certainly going to have to rethink my social media use.)  Maybe it’s only folks like the 250 that believe that everyone wants to share everything all the time.

Oh sure, Facebook has and will have a variety of privacy settings that give people choices about what to share – but these are terribly confusing and difficult to use.  More importantly, a company has to choose a single dominant brand image.  Will Facebook remain the place where friends can share their lives?  Or will it continue to morph into a knockoff of its less popular competitors?

Early indications are that Facebook will integrate FriendFeed’s staff, which is likely to lead to shuttering the FriendFeed service.  I think that could be a lost opportunity.  Facebook might do well to reaffirm its core brand as a more private place for friends, and retain FriendFeed as a brand extension that focuses on open data and public sharing.  That way they can serve the mass market and the avant garde with different product philosophies and branding.

virtually great currency

The acquisition of SuperRewards by Adknowledge is a notable milestone in the evolution of virtual currency business models. This is the first time an independent virtual currency platform has been acquired by a company outside of the virtual goods category, and so the first time that a virtual currency has achieved monetization for someone other than its creators and users. We’ve moved into the peak of the third phase of business models for virtual currency.

The first phase was a sort of prehistory where virtual currency was a gameplay feature of massively multiplayer online games – points that players could gain through the completion of tasks, and use to acquire in-game items that were valuable for further progress in the game. Although points have been a feature of most videogames since the inception of the medium, the relevant new thing about MMOGs was the operation of a “persistent” online economic environment. That meant that even when particular players weren’t online, the service constantly maintained an environment where items of value could be acquired and traded. Much of the trading of items for value was “off-service” – often against the game rules – but this was the first step in virtual currencies breaking free of gameplay rules.

The second phase started when online services that were not solely game-oriented used virtual currencies to encourage trading of service assets – this time trading currency for service items wasn’t against the rules, but specifically designed to encourage sales within the service. Korea’s Cyworld was a pioneer in this use, with “Cyholics” using “acorns” as a medium of exchange for digital presents that users could buy for themselves and each other. Chinese Internet portal Tencent built QQ coins into a $900 million economy, while in the U.S., Second Life users are heading towards $450 million (in U.S. Dollars) of Linden Dollar transactions. The authorized use of virtual currency within these services led naturally to implicitly or explicitly authorized use of their virtual currencies outside of the traditional boundaries of the service, demonstrated by Chinese users buying real-world items for QQ coins and Second Life users setting up 3rd-party currency exchanges and virtual goods stores. (As an illustration of the differences in culture, it’s interesting to note that the Chinese government eventually banned the use of virtual currency for “real” items, and that Linden Lab rebuilt or acquired the third party services.)

In the third phase, we have businesses that were natively built as a platform for virtual currency to be used on other services (rather than a feature of an economy within a more comprehensive service). Some have stayed closer to virtual currency’s MMOG roots, like PlaySpan and LiveGamer, while others have tried to ride the wave of social media apps platforms, like TwoFish and SocialGold. SuperRewards and OfferPal brought a new twist by using marketing offers as the underlying value to the virtual currency.

This part takes a little bit of explaining. For any currency to gain favor with a user base, there must be some underlying value to the medium of exchange – from a consumer point of view, this is sometimes expressed as a demand that the currency be “backed” by something of value. In ye olden days, governmental currency was backed by precious metal; in theory you could turn in your dollars to the government in return for equivalent value in gold. Most governmental currencies came off the gold standard decades ago, and are now backed by the declaration of the government that the currency is legal tender. The meaning of this declaration is a little murky both in theory and in practice.

Suffice to say that there are virtual currencies that emulate most of the historical models of real governmental currencies. e-Gold tried the gold-backed model, to disastrous result. Some virtual currencies are run as essentially stored value systems for governmental currency, so ultimately they are backed by the same declaration of the government. QQ coins to some extent, and Linden Dollars to a greater extent, are free-floating media of exchange that are backed by the commercial viability of their operators – a private rather than governmental declaration of value (this is not as revolutionary as it may seem, since in many ways it’s similar to airline miles and other customer loyalty programs).

By using marketing offers as the underlying value, virtual currency operators can sidestep some of the difficulties involved in demonstrating that a currency is sufficiently “backed” to satisfy customer demand for stable value. This technique introduces significant complexity and cost by introducing many additional parties to the value chain, but now SuperRewards has demonstrated (to its investors if not yet a skeptical public) that this kind of backing does create a valuable virtual currency. OfferPal is not far behind, and of course is now far ahead in terms of its ability to maintain an independent business.

So what’s coming for the fourth phase of virtual currency business models? That’ll have to be the subject of another post. But for now the developments to watch are the competition between Facebook and MySpace in their own virtual currencies, app developer currencies from companies like Zynga, and the continued progress of OfferPal.

advertising in 3 E-Z slides

Has the Internet ushered in a revolution in advertising, or is web advertising destined to fail?

I couldn’t begin to have an opinion without some basic context about advertising, so I gave myself a crash course.  Here’s the 3 most important things I learned:

1.  Advertising has multidimensional sectors.

Two of the fundamental axes in advertising are the lines between brand and direct response marketing, and between online and offline ads.

ad status

I can’t do the differences justice here, but essentially brand marketing is intended to make you feel a certain way about a product, while direct response is intended to make you take an immediate action regarding a product.

The concepts seem simple, but whenever new media arises, it can be quite tricky to determine what kind of advertising is suited to the media.  When the Web first burst into mass acceptance, some advertisers treated this new medium as a branding opportunity, plastering their logos and flashy campaigns wherever they could.  Google was among the first to realize that direct response principles fit the Web much better than branding – deliver ads against search results and you have a natural audience to act upon that hyperlink.

But the Web continues to evolve, giving continued opportunities to make the wrong choices about ads.  When social networks like Facebook reached mass popularity, many advertisers tried to deliver targeted direct response advertising to demographics discovered through the social graph.  But “banner blindness” and the very social intent of these sites combined to make pure direct response ads ineffective.  The better strategy for advertisers in social networks is to build a community and create engaging viral media to enhance the brand.

So the lesson here is that advertisers have to make very savvy choices between brand and direct response advertising as the evolution from offline to online continues.

2.  Online and offline ad spending patterns are currently inverted.

In the excitement about the growth of online advertising, it’s easy to forget that offline is still much bigger, with online making up roughly $23 billion of a $137 billion U.S. ad market.  These numbers are even more interesting when examined along the divide between brand and direct response.

 

According to one estimate, around 75% of offline ad dollars are spent in brand marketing, while 80% of online ad dollars are spent in direct response.  Because offline is so much bigger than online, that means that direct response offline (a.k.a. “junk mail”), makes up around $28 billion.  Yep, junk mail is bigger than the entire Internet ad industry.

Now here’s a point that’s a little more abstruse, but I hope it’s worth the time to understand it:  the advertiser’s spending pattern is inverted in online vs offline.

Offline brand advertising is expensive to create, but reaches a mass audience, so the spend per viewer is low.  Take a Super Bowl ad:  a 30-second commercial can cost $4 million (for air time and a lavish production cost), but with 95 million viewers, that’s only 4 cents per viewer.  Let’s call this low cost per viewer a mass spending pattern.

Offline direct response advertising total cost is lower, but higher per person reached.  For example, it can cost $50K to produce and mail a catalog to 10K recipients.  At $5 per person, that’s 125 times more expensive per person than a Super Bowl ad!  But it works because of the targeting – those 10K people have been identified by the advertiser as being likely to be interested in the product.  This low threshold, high cost per viewer is a targeted spending pattern.

The patterns are rewired online.  Search advertising and email campaigns are direct response in that there is a clear desired action (usually a click).  Though the cost of the keyword or email campaign can be relatively low, the distribution is very broad, so the cost per viewer is extremely low –  this is a mass spending pattern.

Conversely, doing effective brand advertising on a social network requires really identifying the target demographic and crafting a creative campaign to get that ballyhooed viral explosion.  That means relatively high creation cost and a specific audience, resulting in a high cost per viewer – this is targeted spending.

So offline, brand advertising is mass spending while direct response is targeted spending.  And online, brand advertising is targeted spending while direct response is mass spending. Or at least, that’s the way it is today . . .

3.  Successful advertising tactics will seek equilibrium.

Pundits are always rushing to declare failure, or any new method the death of all old ones.  But offline advertising feeds online, and online direct response may morph into “brand response.”  Advertising, like nature, restlessly searches for equilibrium.  The story above is heading towards a more stable balance so the value of the spending better matches the returns.

ad future

It’s not controversial to suggest that offline ad dollars will move online – that’s more an observation than a suggestion at this point.  And it’s also been an observable trend that offline direct response marketing is declining at an even faster rate than offline brand marketing, because Internet direct response has rapidly become effective for larger audiences.  But I’m adding two conjectures that aren’t easily observable today.

First, online brand marketing will grow at a faster rate than online direct response.  This means that social media like Facebook and Twitter (like them, not necessarily those two) will grow revenues faster than Google.

Second, online brand spending will revert back to the offline spending pattern of mass rather than targeted, and online direct response will similarly go to targeted spending rather than mass.  I believe that dominant social media sites and practices will arise that allow brand advertisers to reach a large audience at a low cost per viewer.  At the same time, increasingly effective data collection on Internet consumers will allow data holders to sell highly targeted direct response ads at premium prices per consumer.

What does it take to get from here to equilibrium?  In monetary terms, holding the total ad industry constant at $140 billion (not a safe assumption):

  • $50 billion will move from offline to online
  • $15 billion will move from offline direct response to online direct response
  • Online direct response will grow by $20 billion, while the revenue per viewer seeks a relatively high number
  • Online brand marketing will grow by $30 billion, while the revenue per viewer seeks a relatively low number

That is a lot of money sloshing around, in a lot of different directions.  I think it’ll happen within 5 years.

that’s entertainment

Is social media entertainment?

Of course it is, whatta silly question, you say. When people spend their leisure time engaged in updating their profiles, messaging each other with pokes and posts and status updates, posting and viewing photos and videos – well, that’s entertaining. The answer to the question from the user’s perspective is undeniable. But of course the fun in any analogy is to see how far you can extend it, so I’m really wondering if social media is entertainment from a business model perspective.

Think of a big-budget movie. A group of people get together around a concept, script or performers. They raise financing in excess of $100 million from traditional studio and independent interests, often pre-selling shares in future revenue stream. Many dozens, sometimes hundreds of people are employed in executing the vision into the reality of the work on screen. Distribution occurs not just in theaters, but downstream on DVD, TV, and of course the Web. A successful blockbuster returns hundreds of millions of dollars in a burst, and a continuing annuity essentially forever.

Is this so different from what we’ve seen in social media? From Tribe to Friendster to MySpace to Facebook, it’s been a hits-driven business. People assemble around a concept and produce, and it seems that there is a limited window for the concept to catch fire with the broader public. If and when it does catch fire, there is a period to maximize revenue during the peak of popularity, and then a long slow decline. Maybe the curve is a little more like a successful TV series than a blockbuster movie, but the dynamics are the same: the production of a media experience that has temporal value for audience entertainment.

This is certainly an analogy that most social media companies would resist. They prefer to think of themselves as technology companies, building a platform for media delivery, or even becoming a fundamental part of the infrastructure of communication.

It’s not easy to define a platform on the Internet. You would think the concept of infrastructure is simpler. It’s relatively easy to envision the most concrete elements of the communications infrastructure: the physical wires (be they fibers, cables or tubes), the hardware of routers and switches and terminal devices, the often unglamorous stuff that moves the bits and bytes around. Database and storage are surely infrastructure components as well.

But can a software service company become part of the infrastructure? This isn’t a question of offering infrastructure services in a cloud of computing – it’s a question of whether a service that is not about transport and storage of information can be considered essential to modern communication.

In areas where that can be considered a serious question, we have an enormous market. Search is the prime example. Without search, the way we communicate and create on the Internet would be severely hampered, in the same way it would be hampered if we didn’t have significant storage or large databases. And search is a good example of a putative infrastructure element that must be provided as a service – which means a business can be built around it. Coming up with a protocol like TCP/IP may give birth to the Internet, but it doesn’t necessarily give rise to any dominant business for its creator.

So are the companies involved in today’s creation of social media making infrastructure? Can essential services be built in social media that become a fundamental component of communication? Even if so, is the social graph going to be as enriching as TCP/IP (that is, in more of a spiritual than monetary sense)?

Or is it all “just” entertainment?

social networks and the dunbar break

A couple of months ago, The Economist noted that the Dunbar number appears to apply to online social networks like Facebook.  I’ve since been thinking about the threat this represents to Facebook’s business, and all social networking businesses.

To recap:  The Dunbar number is a theoretical limit to the number of social relationships that one person can maintain – this number is often estimated at 150.  Facebook’s “in-house sociologist” confirmed that the average Facebook user has 120 “Friends” (i.e. other Facebook accounts linked to the user’s account).  Moreover, when measuring the interaction between users, such as comments on each others’ accounts, men average regular interaction with only four people, while women average six people.

You see the problem?  It’s too easy to leave social networks:  you’ll leave as soon as your six closest friends do.  From Tribe to Friendster to MySpace, no one has been able to hold on to their users.  Given that history, Facebook and Twitter have to fight more than just faddishness – they have to fight the cognitive limits of the human brain.

Ironically, social networks do not have the full benefits of network effects.  A really robust network effect means that each additional user of a network adds value to the network for all users.  In social networks, once all of my friends have been added, I don’t really care if any more people join the network.  And that means that the converse is true:  once all of my friends leave, the network has no value to me, no matter how many other users are still on the network.

The ”’Dunbar break”’ occurs at the point at which so many of your contacts have left a social network that you no longer value the network.  Dunbar’s number suggests that this point might be as high as 150, but looking at the actual interaction on Facebook, your personal Dunbar breaking point for Facebook could happen when as few as half a dozen of your friends leave.

That’s why Facebook and other social networks must paddle furiously to try to add value that scales across all users with a true network effect.  But with advertising and applications and ”’lifestreaming”’, they haven’t quite found the magic formula yet.

Does current media darling Twitter hold the key to defeating the Dunbar break?  As a combination of social media and broadcasting, it has some intriguing possibilities.  Ask yourself:  Once all of my friends are on Twitter, do I care if anyone else joins?  And would I care if all my friends leave Twitter, while the rest of the world joins?  A lot of people are answering those questions differently for Facebook and Twitter, which is why Twitter is such a popular dance partner these days.