Hidden Business Models

Two factors helped Google become the dominant search engine on the Internet in the early 00s:

1. It provided better search results than any other search engine at the time
2. It came up with a business model that helped fund the search engine without detracting from it

When the advertising world began to inhabit the Internet in the late 90s, we all suffered the sparkly annoying banner ads that literally popped up everywhere. Google avoided that route by placing only small text ads around the search results. When it came to figuring out what ads to place next to what results and in what order, well there had to be an algorithm for that… Auctioning keywords became a billion dollar revenue generator. And the model scaled beyond the search engine, as web sites began to include ads managed by Google for a slice of the keyword revenue.

Since then, as new technologies gain mainstream awareness if not adoption, the question always being asked is: What’s the business model? For many, the answer is advertising. It’s the wrong answer.

Facebook is rumoured to be finally in profit. Revenue is claimed to exceed $1 billion this year, up from $700 million-ish last year but the infrastructure to support a 500 million user social network costs a fair bit. The assumption has always been that Facebook needs to find an advertising method that works for social networks the way auctioning keywords works for search and web sites. In the meantime, another company has found a better way to make money from Facebook’s social network.

Zynga creates games for social networks. If you’ve got any friends on Facebook, at least some will have tried to recruit you to join their gang to start a Mafia war, or will be seeking chicken food for their farm in Farmville… simple games can be very addictive and people will pay small amounts of money at regular intervals to keep at the top of the game. Zynga has tapped into that ego/ addiction and is estimated to be earning revenues of $50 million per month with a potential profit margin of 30%.

Google started out as a search technology but the money is made by owning the advertising channel – be it next to search results or on web sites. Facebook started out as a social network but the money needs to be made by owning the transaction channel – Facebook should be an online bank.

…and it looks like that small point hasn’t gone unnoticed. Facebook is planning to introduce credits with a view to taking a 30% cut from applications that use its social network. Not as strong an approach as Google’s auction method, they seem to be looking more to Apple’s model (which takes a 30% cut from all sales on the App store). Time will tell.

Apple’s approach is niche, albeit a big market – they own the devices and developers can only sell apps for the devices through the single App store. With strong market share and a strong brand, Apple have a loyal and large customer base for developers to sell to. Facebook’s network is certainly large but is it loyal to Facebook? Enough to pay artificially high prices that a 30% tax on Facebook apps will create… I’m not so sure. A better approach would be the flexibility of an auction that enables application providers to determine how much of their profit margin they are prepared to lose for access to Facebook’s network. And that approach would scale beyond the Facebook web site, just as Google’s auction scaled beyond the search web site.

References

• Zuckerberg: Facebook revenue estimates of $1.1 Billion “Not so far off..” – TechCrunch, June 2010
• Facebook could surpass $1 Billion in revenue this year – Mashable, March 2010
• Facebook doubles its server count to 60,000 in six months – Download Squad, June 2010
• Is Zynga’s headcount already bigger than Facebook? – CNET, September 2010
• Zynga revenue estimated at $50m per month – Virtual Goods News, May 2010