@andrewchen

Are the social networks making tons of money?
People have been very excited about the advertising prospects of social networks lately. First you have announcements from MySpace about an 80% rise in CTR through profile targeting, as well as some claims of Facebook’s going rate CPMs being $4. Furthermore, the recent gold rush in Facebook apps has led quite a few folks amassing large userbases with dreams of incredible monetization. It’s quite easy, with all the profile information that social networks have, to automatically assume that this information is the same type that drives Google-like revenue and monetization.

So let’s talk about this… Are social networks making money hand over fist? Why or why not?

To aid this discussion, I’ll go through a couple of the critical challenges that affect social network monetization:

1. Engagement is inversely correlated with CTRs
2. Inventory isn’t homogeneous, it’s a pyramid
3. Don’t confuse interest with intent
4. CPMs are driven by underlying value, not just targeting
5. Brands are a big wild-card

Understanding the CPM formula
Before we jump in, let’s talk about how CPMs are generated. For the purpose of this discussion, I’m going to focus on direct response advertising, rather than branding (which we’ll get into later).

Ultimately, CPM is a simple calculation that is determined by:

CPM = Clickthrough Rate * Price Per Click * 1000

For example:
1,000,000 impressions * 0.5% clickthrough * $0.25 PPC
= $1250 per 1 million impressions = $1.25 / 1000 impressions
= $1.25 CPM

This is from the publisher side – if you have a good CTR or PPC or Impressions, you make more money. Now from the advertiser side, you need to figure out what the underlying value is. After all, even if you get a ton of clicks, if you can’t convert them on your side and have a good transactional value at the end, you won’t want to pay a PPC.

CPM = Clickthrough Rate * (Value of Action * Conversion Rate) * 1000

Conversion rate means the percentage of people who do the desired “action” that drives value for you. That might mean the % of people who buy from your e-commerce store, or who fill out your mortgage lead form, or whatever. You could also substitute this for Lifetime Value for your social network, or LTV for your virtual goods-driven casual game, or whatever.

Now let’s jump into how different dynamics on your site drive these different variables…

1. Engagement is inversely correlated with CTRs
You know how MySpace and Facebook just encourage you to click-click-click and log in every day and are just incredibly sticky? That’s great engagement, and it helps with a lot of things, particularly growth and competing in strategic areas.

However, the drawback is that the more pageviews people have your site, the lower the clickthrough rate gets. Here’s a great diagram:

You should read the rest of the article on MikeOnAds, it has some other great data on there. This issue of engagement negatively correlating with clickthrough rate is well-documented, and happens at every network.

So how bad are the clickthrough rates, exactly? I’d guess that across all the social networks, something from 0.01% to 0.05% is pretty standard. You might have some higher CTRs in some very specific areas, for example right after a user completes an action (composes an email, friends a person, etc) but in general, they will be quite low.

There’s some evidence for Facebook’s CTRs being about 0.04%, documented here:

2. Inventory isn’t homogeneous, it’s a pyramid
Sometimes you might hear the CPMs for one of these social networks is X dollars. And that’s true, it’s exactly the price that SOME people are paying for the inventory. But in general, that’s not how publishers end up managing their inventory. Instead, if you take the impressions for a user across their session, you’ll instead get something like this:

• The first US impression in a session has the most value ($10)
• Then impressions 2-5 have some level of brand value or high CTR value ($3-5)
• Then after that, you’re hitting ad networks selling on category ($1)
• Then eventually, you hit remnant ad networks ($0.50)
• Finally, you hit pure CPA remnant networks ($0.10)

These are just example numbers. Now the problem is that while people often quote the premium numbers, the majority of the impressions happen in the low CPM remnant numbers. The premium ads happen on the homepage, major channel pages (like Music, Games, etc), but not in the most popular pages like forums, profile pages, etc.

I’d expect the top inventory (let’s say 5-10%) end up generating 50% of the overall revenues.

So in your financial forecasting, don’t expect to be able to multiply a big CPM against your ad inventory. Instead, you need to be nuanced about the different sections of your site, and how they sit relative to the ad inventory pyramid.

3. Don’t confuse interest with intent
Now to the profile data – how much is this worth? You might expect that by looking at profile keywords like “skiing” or “travel” or topics like that, you could make a ton of money on social networking sites.

Every page should be like Google, right? Wrong. (unfortunately)

The reason is that interest in a topic is different than having intent. Having “skiing” on your profile is completely different than searching for “ski tickets.” The latter means you’re ready to buy, whereas the former simply means that you sometimes buy. This is GREAT for brand advertising, but really doesn’t help on the direct response CPM formula.

Having high intent typically drives a higher conversion rate (driving up the PPC) as well as driving up the CTR. Having interest but not intent should theoretically be better than nothing, but there might be other effects, like having more “looky-loos” click on your ad just out of interest, but not actually buy the product there.

4. CPMs are driven by underlying value, not just targeting
Furthermore, you really have to look at the underlying value of the transaction to figure out how the CPMs will turn out. After all, the underlying value drives the PPC, which then drives the overall CPM. In order words:

Mortgage leads trump contextually relevant ads because Mortgage leads can be worth 50X more than a non-transactional site.

This is how a mortgage lead generation site might work: Person enters their contact info, which then gets sold to 4 lenders, which then call the person to work out the loan. Each lead might be worth $10, but because it’s sold to 4 different companies, it’s worth $40 total.

Now a ski ticket might be more contextually relevant service. Or maybe a music subscription service. Or some other mass consumer good. But the increase in clickthrough rate COMPLETELY offsets the powerful value of the mortgage lead, all you will see is LowerMyBills psychedelic peacock ads.

Now targeting really does help advertisements, but the problem with display advertising which shows as you are using a site is that the effects are not going to be as strong as high-intent areas.

In this case, targeting might increase CTRs and conversion rates, but it’s unlikely that it’s so powerful it’ll completely offset the value decrease. People are mostly interested in things that don’t generate lots of money, and because of that, you have to compensate.

5. Brands are a big wild-card
Of course, the real wild-card is brand advertising, because it really follow the CPM formula. Brand advertising is really not priced based on any logical way that follows a formula like that. Instead, it’s based on relationships, prestige, audience metrics, and other intangibles. So as the audiences for brand advertisers migrate from TV to the internet, you will see a tremendous amount of brand dollars move as well. These brand dollars will simply follow whatever’s “hot” – thus, because the major portals seem to be growing pretty slowly and/or actually losing engagement, you’ll see brand dollars chase the social networking sites.

However, unless your name is Tom or Mark, you’re unlikely to get your hands on too many of these dollars. And the reason is that brand advertising is sort of a “winner take all” game, where only the largest sites can afford large sales teams that can develop the deep relationships required to sell to Madison Avenue brand ad agencies.

The current hurdle is that advertisers don’t like UGC (er, CGM content) because it requires them to let go of their brand. So until that changes, through technological means or an attitudinal change, the brands are preferring buying video on mainstream media sites.

What’s next?
Now, it’s not all bad for social network ad monetization. The place in the CPM formula that’s really driving revenue is that impressions are getting bigger and bigger. What these sites can’t make up via advertising efficiency, they are making up through pure bulk. That’s why you can build sites with 100s of million in revenue, and it’s growing every day. The brand shift is also going in their favor.

More interestingly, I’m looking for native ad units to develop on the site which do work for advertisers. Months ago, I had written about “tag along widgets” which has quickly materialized as the Cost Per Install ecosystem on Facebook. Here’s the excerpt from “What’s a Facebook user worth, anyway?”

Another option would be for some sort of deeper integration to happen
as hooks to another widget. For example, I could imagine a company
(let’s say Apple) creating their own widget. If you as Mr. Travel
Widget, when installed, would try to convince the user to also install
an Apple widget, I think that’d be an interesting model. Basically
tag-along widgets which advertisers pay some amount for every user that
is brought along.

As these native ad units mature, I’d expect some new revenue opportunities to be built from scratch. Let’s see how it goes – it can’t be worse than display

UPDATE: Fixed CPM formula.. note to self: never add changes at 6AM when your brain is asleep!

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