Social-networking sites work to turn users into profits

SAN FRANCISCO -- It is the burning question in tech circles, and Mike Murphy answers it before it is completed.

"I hear it every time I'm on a (tech) panel," Murphy, Facebook's vice president of media sales, says with a wry smile.

He's referring to the inevitable question on when Facebook and other social-networking sites will turn their steep market valuations into mounds of currency. (Invariably, Murphy answers that Facebook has a long list of major advertisers.)

Facebook, MySpace and other social-networking sites have been the rage of the tech industry for more than a year. Following investments by Microsoft and News Corp., the companies are valued in the billions of dollars and are considered blueprints for how to build a website. Yet a deeper question lingers: How are they going to consistently produce profits to match their soaring valuations?

It is a parlor game that has Silicon Valley buzzing. With online ad spending booming into a nearly $50 billion market this year, there is plenty of money to be had. Big-name advertisers are drooling over millions of young, affluent consumers who are spending more time on their online profiles than in front of TV and movie screens. They are particularly smitten with the prospect of tailoring ads to people's specific interests.

But Google commands a sizable chunk of the market — especially in the USA — leaving dozens of social-networking sites to scramble for a piece of the advertising pie. Plus, there is the ticklish task of sites and advertisers pitching products without trampling the privacy of consumers.

Short of striking it rich with online ads or creating a new revenue stream, how can so many sites leverage their vast audiences? In many respects, it is the same query that dogged portal companies in the mid-1990s and search engines in the early '90s. Some were sold. Some went public. Some went belly up.

The ongoing challenge is to concoct a potion — be it through banner ads, premium subscriptions or licensing agreements — that no one has perfected. Facebook, crown jewel of the field, is valued at $15 billion but barely turns a profit.

"You can't have a $15 billion market valuation based on advertising alone," says Bill Eager, co-founder of bSocial Networks, a maker of software that helps social-networking users market to each other. "It's the single most-asked question in this field."

Forrester Research analyst Charlene Li has pondered the next stage for social networks. She envisions the ubiquitous sites will, in five to 10 years, "be like air: They will be anywhere and everywhere we need and want them to be."

Eager estimates there will be as many as 250,000 sites that call themselves social networks within a year, compared with about 850 today. "Everyone will reposition their site to take advantage of this phenomenon. It happened before with portals."

To get there, though, there is that little matter of making money. "Facebook's real problem isn't privacy, it's monetization," says Dave McClure, a start-up adviser and angel investor in Silicon Valley. "It's not too early to worry about how Facebook makes money."

Murphy and other Facebook executives are well aware of that concern. "Advertisers follow people," says Sheryl Sandberg, a former Google executive who recently was named Facebook's chief operating officer. "We have 70 million active members. Once you have engaged users, the revenue will follow in that order."

The Web economy

Seth Goldstein, whose company SocialMedia Networks helps create ads for social-networking sites, says sound economics underpin the hype of social networks. "More and more people are spending more and more of their time within the Facebook ecosystem," Goldstein says. "This is the largest aggregated, engaged audience. Period."

Social networks present an enormous opportunity — maybe the biggest in tech since e-mail. The sites have simplified and amplified connections between people online, creating a thriving ecosystem of small programs that let friends interact through games, greetings, video clips and more.

Nonetheless, a fundamental challenge is that the networks often are "walled gardens," closed to the rest of the Web. Avid Internet users must maintain separate accounts on different social networks, blogs, photo-sharing sites and instant-messaging services. In each case, they must invite the same friends to each separate service.

Services such as AOL and CompuServe were early walled gardens before they became widely available websites. The same with early e-mail services and instant-messages.

Last week, both MySpace and Facebook addressed the issue by announcing they will soon let users share profile data with other websites.

"We're taking those walls down," says Amit Kapur, MySpace's COO.

Facebook will let members take their personal profiles to any website that wants to host them. For now, MySpace is opening user profiles only to a few sites, including Yahoo and eBay.

Social networks are the latest iteration of the Web economy. But unlike e-commerce sites and search engines, they offer a more intimate setting for friends to share information. It is also conceivable that social networking, like e-mail, will never make piles of cash.

Facebook's ambitious plan to reshape advertising — via a new approach to social marketing, called Beacon — was a bust. The idea was to inform friends whenever a Facebook member purchased something from online retailers. When consumers protested its invasion of privacy, Facebook CEO Mark Zuckerberg acknowledged the miscue and promptly apologized.

Even Google, as close to a money mint as anything online, has struggled. Google has a deal with Rupert Murdoch's News Corp. to place ads on MySpace, and owns Orkut, which flopped in the USA. Co-founder Sergey Brin recently admitted the "monetization work we were doing there didn't pan out as well as we had hoped."

"No one has done for social media what Overture and Google did for search," says Martin Green, vice president of business at Meebo, an instant-messaging program that works across multiple IM services.

"There needs to be an AdWords for (social networks)," says David Carlick, a partner at VantagePoint Venture Partners, referencing Google's ad system that displays text ads related to search terms.

So far, several players have managed to cash in to varying degrees:

•MySpace. Since it scored a $900 million, three-year deal with Google in 2006, MySpace has been profitable. And it has given News Corp. a nice turn on its $650 million acquisition in 2005; Richard Greenfield, an analyst at Pali Capital, expects MySpace to haul in $700 million to $800 million in revenue in fiscal 2008, mostly in advertising.

MySpace last month forged partnerships with major record labels Sony BMG Music Entertainment, Warner Music Group and Vivendi's Universal Music Group to offer its 117 million members tickets, ring tones and artist merchandise.

Driving a good chunk of sales is a project launched last summer called HyperTargeting, software that mines the profiles of MySpace users to deliver ads tailored to their interests.

Hundreds of advertisers are part of the program, including Toyota and Taco Bell. Another income source is the sale of mobile ring tones and ads.

MySpace isn't through. It is "definitely looking into subscription services" and emerging international markets such as India and Japan, says CEO Chris DeWolfe.

•Facebook. Despite some hand-wringing over its fate, Facebook stacks up well compared with Google at the same juncture in its history.

Facebook hopes to double its revenue to $300 million to $350 million this year, its fourth of existence. Google's revenue soared fivefold, to $440 million, in its fourth year.

The 70 million-member network has ramped up revenue with the sale of banner ads through an agreement with Microsoft, targeted-ad programs for local businesses and the sale of virtual gifts. Those gifts, such as a birthday cake or a popping cork of champagne, are affixed to a user's profile in the manner that someone would sign a high school yearbook.

"We believe there will be a diversity of revenue — with brand-name advertisers, local advertisers and direct-response advertisers," says Chamath Palihapitiya, Facebook's vice president of product marketing.

•LinkedIn. The business-contact site has built a booming business in five years through banner ads from the likes of Porsche and Microsoft; subscriptions; job postings charged to corporations and small-business owners; and corporate sales to Symantec, MTV and others. LinkedIn is developing other revenue streams, including research services to locate experts.

"It is a global, interconnected world, and we are the one professional network," says CEO Dan Nye. The 250-person company boasts 21 million members and is adding 1.2 million per month.

Social-networking site Bebo, recently acquired by AOL for a knee-buckling $850 million, is parlaying its popularity with a predominantly young audience — many are 13 to 24 years old. It has struck up marketing initiatives with advertisers such as Nike and Apple, says Ziv Navoth, vice president of marketing and business development at Bebo, which has 43 million users. That is a key reason it has been profitable the past 18 months.

•Vertical social networks. Social networks that cater to the specialized interests of their members offer a premium of eyeballs and opportunity for advertisers, who want a safe, well-lit place they know and trust.

"If you have the right audience and the right engagement, you can build a real media business," says Tina Sharkey, CEO of BabyCenter.

For most social networks, the goal is to carve out a niche where they fit in a market dominated by generalists MySpace, Facebook and Bebo, says Aaron Levie, CEO of Box.net, an online file system.

So far, several have. Imeemhas established itself as a music and media social-networking site with 25 million unique visitors each month. Xing, a business-contact list service popular in Europe, says its revenue doubled in 2007 — to $30 million, from 2006 — because of premium subscriptions, an e-commerce marketplace and banner ads.

Meanwhile, Ning, a free platform for do-it-yourself social networks, has helped create more than 260,000 networks. The company estimates that, by the end of 2010, it will host some 4 million social networks, with tens of millions of members, serving up billions of page views daily.

Show me the money.com

Opportunities abound. Though the U.S. market is largely sewn up among the Big 3 of MySpace, Facebook and LinkedIn, the international market is wide open. China alone has jolted to $1 billion in online ads last year from nothing a few years ago.

ZenithOptimedia estimates online ad spending worldwide will soar 26.5% this year, to $47.7 billion. Total ad spending worldwide, by comparison, is expected to grow 4.6%, to $653.9 billion this year, says Universal McCann.

It won't be easy, with so many social networks slugging it out. "The pressure is to scale up revenue and then show a profit," says Kent Lindstrom, president of Friendster, the one-time red-hot social network in the USA that has since become popular in Asia, with nearly 50 million members.

Speculation veers from the dire to the giddy. "Honeymoon is over for social networks. They need to start generating revenue now or bow out of the race," according to a new report from In-Stat. Yet Venture capitalists are taking bets on the IPO possibilities for Slide, a maker of widgets for Facebook and MySpace, among others.

SocialMedia CEO Goldstein is betting it will be late this year or early 2009 when name-brand advertisers flock to Facebook, Slide, Ning and others. Coincidentally, that's when investors expect revenue to ramp up.

Silicon Valley is keenly aware of the vagaries of empty dot-com promises. Just ask any of the once-promising start-ups in the portal and e-commerce markets that were eviscerated amid high hopes and low revenue. Plus, there is the specter of impatient investors.

Some sites could draw millions of customers, but if they are short on funding there isn't much they can do, analysts say. "The clock is ticking," says Emily Riley, senior analyst at JupiterResearch. "If they don't have enough volume (users) to land premium ads and charge per page view, game over."