Internet Strategy (2/3): Money, Money, Money

In the previous post, we talked about the viability of internet businesses being tied to their profitability. <begin sarcasm> Wow, what a revelation! <end sarcasm> When looking to invest in an internet business, the most important question has always been, “How will you monetize it?” The good thing about internet businesses is that, despite the lessons learned from the 2000 bubble, investors are still willing to project “eyeballs” into dollars. This is why companies like Facebook can receive $15 billion valuations despite having negative cashflow, no earnings, and minimal revenues. (Though, they expect slightly less negative cash flow in 2008!) But, if you want to stay ahead of the curve and try to realistically appraise a rising internet star’s value, you’ll probably have to pay a little more heed to valuation than some other net investors out there.

The Three Paths to Monetization
All things come in threes, right? Well, with internet business, it may be true. Along with the three business models come three monetization models - itemized, subscription, and advertising.

Itemized monetization is my description of the revenue strategy employed by merchandisers and some service companies. This is your traditional monetization model. Brick-and-mortar stores charge you for each thing you buy, internet companies provided that they can quantify their product or service in discrete units can also attempt to do this. The itemized monetization model has worked well for E-Bay and PayPal, service firms who charge per transaction, and also Amazon, a merchandiser. Unfortunately, it is difficult to charge for itemized usage when running a content business and sometimes even for services. Would it make sense to charge users per search on Google or per story read at NYTimes.com?

The subscription model is similar to itemized monetization and helps to solve some of the payment and collection issues involved in businesses which create value through repeat usage – i.e. content and service providers. This implies creating “members only” zones on a site and charging for the delivery of content or the usage of a service. Subscription essentially allows a company to create a faux itemization by imposing time blocks or usage quotas and then charging.

The problem with the above two models is that due to the internet’s ability to rapidly disseminate information, content and service provision is highly competitive. Subscriber models rarely work because acceptable free alternatives nearly always exist. Even a strong and reputable brand like the Wall Street Journal has had difficulty finding a way to profit from online subscriptions. The subscriptions themselves do not produce enough revenue and destroy one of its strongest value drivers – usage.

Why might usage be important? Well, because at the moment, the strongest monetization strategy for web businesses outside of merchandisers has been the advertising model. This can range from things as simple as serving advertisements on the website to collecting user data and selling it to parties interested in serving advertisements on your website. Facebook has been doing everything it can to leverage its users into a valuable advertising pool to little avail. Why is this?

Well, online advertising revenues are growing at an astounding pace. And, some firms, particularly Google and companies which specialize in ad serving like Double Click and Value Click have been able to take advantage due to their scale and ability to target a wide audience. Unfortunately, internet advertising is kind of like a bottom trawling fishing boat. You use a very big net, scoop up whatever you can, and hope that a few really great catches will be inside. No one, as of yet, seems to have found a truly good way to monetize social networks and blog networks. The belief is that because content providers provide targeted access to certain demographics, they ought to be able to charge premium prices for their ads. Unfortunately, it seems click-thru rates on sites which should be better targeting consumers are no higher than that on a big web portal. Sometimes, even worse.

What to Look For
Knowing the three standard methods of monetizing users for an internet business is half the battle. Choosing an appropriate way monetize them is the big question. So far, the best internet companies seem to only achieve success and growth through scale. For example, as its user bases plateaus, EBay is finding itselfstruggling to spur growth in its core auction business. Google has found its success serving advertisements as a result of its 50+% market share while Microsoft’s internet unit which for the most part attempts to copy Google’s success with the addition of leveraging its portal/content network to interested advertiserscontinues to post losses. AOL, the next ranked internet portal behind MSN and Yahoo!, also struggles to find ways to make profit.

In the end, the long term winners online will be those who find a way to monetize niche user bases. There can only be so many portals, so many large ad serving companies, or search engine sites. Unfortunately, scale is something only a handful of competitors can have. But, there’s always room on the internet for quality content or time saving services. There just needs to be a more effective way to monetize on that level.

Next up: Three internet strategy case studies