July/August 2008

Part II: The Business of Social Networks

Can social-networking sites ever make money?

By Bryant Urstadt

Bad Neighbors
Another problem that targeting may not be able to solve is the one posed by what advertisers call "content adjacency."

Unlike a newspaper or television show, social networking is a medium whose content is deeply unpredictable. In the sports pages of a newspaper, an advertiser knows roughly what kind of material its ads will be running next to. But an enormous, highly visible brand may not want to risk seeing its ad wind up on a page such as that run by the actual Facebook group "I've Had Sex with Someone on Facebook," which at press time had 59,353 members. Or consider the MySpace profile (turned up after about two minutes on the site) of 18-year-old "Nikki AKA Death Angel!," which is adorned with the motto "Don't fuckin fuck with ninjette bitch we'll cut ur fuckin head off an give it to ur momma."

This is not content that commands high rates, although certain buyers mind less. "Right now, the low-hanging fruit is entertainment, because they're agnostic about content adjacency," says Goldstein. Indeed, Nikki's badass profile features an ad for the Warner Bros. film Get Smart. But even entertainment companies are steering clear of the user-generated communities offered by Ning and KickApps. "It's not a controllable universe right now, with the porn sites and such," Ruxin says. "It's a blind buy."

Not everyone is so pessimistic. Andrew Braccia, a partner at Accel, one of Facebook's early investors, thinks advertisers will eventually become more accepting of the "breathing, dynamic" nature of social networking and grow to understand that its unpredictability is part of its allure. And Facebook's Palihapitiya, perhaps naively, doesn't seem to think the adjacency problem will arise much on his site; Facebook, he says, has "a tremendous amount of user content moderation, with a very simple mechanism for flagging inappropriate material."

Fancy, this: In spring 2007, artist David Choe painted the walls at Facebook’s Palo Alto offices. Credit: Jamie Kripke

Multimedia Timeline of key events in the rise of social-networking sites. See a comparison of Myspace and Facebook’s traffic and advertising growth. View a graph on U.S. ad spending on social networking sites relative to U.S. online ad spending. • View a graph on worldwide online social-networking advertising spending.

Users' ideas of what's appropriate are hardly the same as advertisers', though. Such arguments may not be enough to sway the enormous, image-conscious brands that drive the majority of the advertising market. And Palihapitiya, deliberately or otherwise, may be missing the point: advertisers dislike rude content not merely because it might reflect badly on their brands, but because people reading such stuff are probably not thinking about buying many things that advertisers are selling.

Still, backers of social networking feel strongly that so many eyeballs must have value. Braccia points out that while more than 6 percent of advertising dollars are spent online, 20 percent of media consumption now happens there. "It's a significant opportunity," he says. "We're so young, so in our infancy here."

"These sites are no different from traditional media properties," says Paul Kedrosky, who writes Infectious Greed, a much-read blog on venture capital and the Internet. "We're holding these sites to an absurd standard. The advertising allocations will follow the consumer, and right now they're badly out of whack."

Roger McNamee remains convinced that Facebook is too alluring, too useful, and too established not to be profitable somehow. The answer is out there, even if he doesn't have it. "Someone," says McNamee, "is going to have to get creative. I take it on faith that it will emerge. After all, I'm an investor. I'm hopelessly biased."

Marc Canter has a few ideas. Canter, who cofounded ­MacroMedia, is now CEO of the company that produces the social-networking tool PeopleAggregator, which aims to allow communities, tools, search engines, and the rest of Web 2.0 to interconnect in one giant open mesh. He imagines ads of all kinds making up only about a third of revenue, with profits coming from a "long tail" of sources--from Craig's List-style marketplaces to on-demand music downloads to branded apparel to ad-free premium services.

Chamath Palihapitiya expects Facebook to generate revenue by selling a variety of such services to users. The site has rolled out a "gift" program, in which friends spend real money to "give" friends virtual items, such as an image of a box of tissues with a get-well note. He also suggests that Facebook may at some point see reve­nue from ads served through applications on its site, a growing and potentially major source of income from which it currently gets nothing.

Perhaps most optimistic of all is venture capitalist Ron ­Conway, the subject of the book The Godfather of Silicon Valley, who has invested in Google, PayPal, and dozens of Web 2.0 companies. "MySpace projected it would do a billion dollars' worth of reve­nue this year. They came up short and did $800 million," he says. "Rupert Murdoch only paid $570 million for the whole thing. It's been called the best acquisition of all time. I think Facebook is a couple of years behind MySpace but on the same trajectory. It's a hugely monetizable business. I think it's a slam dunk."

A GLOOMY FORECAST
Can social-networking sites continue to make significant inroads into the U.S. online advertising market? The outlook is uncertain. A shaky economy and setbacks in ­targeted-advertising initiatives have caused leading online marketing research firm eMarketer to project more modest revenue growth for social-networking sites over the next four years than it had previously predicted.

THE GLOBAL VIEW
Social networking is a global phenomenon, and reaching users outside the United States will become increasingly important as advertising dollars flow to Western Europe, Asia, and beyond.

Things Fall Apart
The ghosts of vanished giants haunt social networking. So many formerly great Internet companies are struggling or dead. Consider CompuServe, AOL, Netscape, Napster--even Yahoo. Lycos, a search engine that was sold to Terra Networks in 2000 for $12.5 billion, was sold to a Korean firm for $95 million four years later.

What CompuServe and many of the others have in common is that they were portals: gateways to the Web. Facebook wants to be something similar: more than just a useful and fun social tool but the first page people open on the Web, and the platform they use for all their other communication on the Internet.

As would-be portals, however, social-networking sites are vulnerable to one of the problems that brought down those earlier Internet businesses. The portals were "walled gardens" where inexperienced Internet users congregated for a time but where they became restless at last--leaving for the wider, wilder Web. Facebook and MySpace understand this and are now struggling to achieve an appropriate balance between openness and control.

They're also struggling with faddishness. Danah Boyd, a doctoral candidate at the University of California, Berkeley, studies social networking as a cultural phenomenon. She describes online hot spots as though they were popular pubs. "It's supercool when all of your friends go there," she says. "Then all sorts of other people come in. Even if the pub doesn't start feeling physically crowded, it starts feeling socially crowded when your ex is at the other end of the bar talking to some creep who brought his fellow gang members. How long until you say, 'Enough--I'm outta here'?"

Home Page
Several attendees at EconSM took the same flight home, and anyone paying attention on that red-eye from Los Angeles to New York got a lesson on social networking's place in modern life.

Just before the plane began its descent, a 28-year-old woman named Erin fainted on the way to the bathroom. She was possibly overtired, or maybe weirded out by the inhumane crush of economy class. Even she didn't really know what happened. By the time we were on the runway, she had regained her senses. Her first question to the flight attendant was, "Did anyone get my phone?"

As soon as the attendant handed her her iPhone, she opened it up and went right to her Facebook account. She wasn't looking for ads and she wouldn't have noticed one, unless it annoyed her by getting in the way. She wanted to reach her friends, and that was all.

Bryant Urstadt has written for Rolling Stone and Harper's.