Making Social Networks Pay

Facebook and Twitter have millions of users who don't pay them a dime. For these companies to turn a profit, they'll have to cozy up and consolidate.

Over the past month, a new dawn has risen over social media. The protests following the Iranian elections serve as example – not long ago, protest organizers in Iran would have been confounded by government-jammed cellular communications, but now encouragement and logistics could be passed around on Twitter and Facebook, and government-sanctioned acts of violence uploaded to YouTube in no time. Even video of the recent Uighur uprising in Western China has found its way onto the internet.

That said, digital social networking has its problems. Even creative destructionists are struggling with the biggest one – how to make social networking applications profitable enough to survive.

Users inhabit the web in separate spaces, preventing any one social networking site from truly gaining scale (the key to the profit centre). I, for example, have four email accounts (three personal, one work), Facebook, Twitter, and Linkedin accounts, plus Yahoo, Google, RSSes, etc. Together, these make up my social web experience. As a consumer, I have a problem – I have too many egocentric outlets to manage, and still too many sources of content to surf. I want consolidation of my network experience. I want Search.

Mark Cuban, the dot-com billionaire and mercurial owner of the Dallas Mavericks basketball team, came up with a possible answer to the profit question. He hosts an extremely popular blog and recently posted a notable observation – his traffic is increasing, while the percentage of people who find him via Google is “significantly” declining. Twitter and Facebook referrals are now the most common route.

This doesn’t signal the demise of Google so much as suggest that Facebook could profit greatly from these referrals, were it to modify its model to operate beyond limited networks of friends and fans. Twitter, too, could be well served. Its more flexible form means that companies could very well pay for followers, perceived as de facto endorsements by trusted experts, companies, and/or celebrities.

This prompted Cuban to suggest that social networking sites charge advertisers “on a cost per referral click originating from their followers.” He goes on to say “as long as the cost per click is lower than competing options, why wouldn’t they do it?” Good question.

To take it a step further: link the ability to search within a social network with access to content outside that network. Now you have a one-stop shop – let's call it Search – for the entire user experience. Draw in ad revenue from pay-per-click as well as from companies competing for your attention through "legitimized" sources on Twitter/Facebook (call that one “the Cuban Corollary”), and suddenly you’ve got a viable business model.

As long as search engines, social networks, email servers, and the like are separated, there will be gaps in the social chain. Centralizing the network closes the gaps, and creates enough value for providers to profit. That said, because of the capital expenditures required for Search and an ever-expanding social network, Twitter and Facebook are going to need to join forces, shoring up their customer base.

Because of Facebook’s size (about 120 million users worldwide) and its debatable fiscal value, it is the most unlikely candidate to lead a consolidation charge. No one knows how much it’s worth. Microsoft’s 2007 decision to purchase a 1.7 per cent stake in Facebook valued them at $20 billion, but recently, a 2 per cent stake was sold to a Russian VC firm for $200 million, indicating a $15 billion value. A 2008 court filing by the company pegged it at $3.6 billion-ish.

With no long-term viable business model and an inability to use equity to consolidate even if they wanted to (Facebook was rebuffed last year while allegedly trying to buy Twitter for $500million – a function of the valuation question), Facebook and Twitter will continue to struggle for access to more working capital. Facebook may file for an IPO, but then it have to show us what’s behind the kimono, and it may not be pretty.

Earlier iterations of profit models for Facebook haven’t worked – selling user data didn’t fly with users and privacy advocates, and click-though ads haven’t gotten much traction. Charging users isn’t viable either – a [recent CNET poll] (http://reviews.cnet.com/8301-18438_7-10222191-82.html) had almost 90 per cent of Facebook users abandoning if they were asked to pay just $1 a month.

Microsoft and Google look like the answer. With tons of cash sitting on both balance sheets (over $22 billion and $9 billion respectively), the most viable web-enabled profit models, search dominance, and a great rivalry for the average eyeball, they appear to be the likeliest of consolidators and the most willing to pay for control over the web.

In this ongoing battle, Microsoft made an impressive advance this week, announcing a deal with Yahoo. The addition of a more formal link with a prominent social networking site would certainly make Microsoft an even larger rival to Google and its 65 per cent Search market share.

Even then, such an acquisition may not save the likes of Facebook or Twitter – after all, big companies can lose their nimbleness, and certain corporate structures can smother an innovative company (Newscorp and MySpace, for example). There could even be regulatory concerns if one or both were to be picked up by either company.

Most importantly, the “flat world” has empowered the masses, and they are inherently finicky – annoy them, even in the most seemingly innocuous ways, and you can kiss your investment goodbye.

Consolidation has to occur to keep the business of social networking alive, and the search model is the only thing that will keep the lights on at both companies.