Wednesday, December 3, 2008

Feeling social?

With all the talk about declining CPM's (and related metrics)... and a son who is taking High School economics, where he's been exposed to the dreaded supply/demand curve, I decided to look at the deal flow we have seen over the past 18 months (nearly 600 companies) and look at the % that were intending to build/grow companies that had banner/social advertising (supply of pages) at the core of their business models. With the sector's torrid growth, I suppose it was no surprise that nearly 60% of these reviewed companies had advertising based models that were reliant on CPM's or similar variants for revenues.

The industry has seen a massive expansion of inventory (pages) available for advertising, with some estimates touting that, in a scant 3 years, social pages now account for nearly 50% of all ad based inventory. With signs that, in a general sense, social inventory reached equilibrium with advertising spending sometime in late '07-early '08, it's not surprising that the unabated growth in pages, coupled with a stagnation (decline) in spending has shifted the CPM pricing curve for many of these firms in a negative way.

This is a natural supply/demand ebb and flow. But what I am watching is the impact the funding environment has on the success of these entrepreneurial ventures. Building social networks is a bit like building a proprietary information database where it often takes 2x the planned time and money to critical mass, but when you do, it's like owning gold mining rights into perpetuity. Today, building companies, such as Twitter, is akin to flying a plane and adding components in mid-air. You must have great faith, leading-edge innovation, or a serious safety net (capital) to achieve a critical mass substantially larger than originally planned to reach self-sufficiency or to build meaningful shareholder value. I think at least two of the above conditions are necessary for survival...three to prosper.

The natural outcome of this rationalization will be a reduction of inventory, via shuttering companies, to a level where we have market forces again in alignment with demand. From what I have seen, it will be a tall order for many companies to cross today's economic chasm. I am afraid the outcome for these businesses will be akin to the cold freeze when the 'dot bomb' imbroglio was mostly confined to the Internet. True the burn rates are lower, and management is more focused on sober business metrics, but it's a tall order to fight the broad economic tape.

M&A activity will not alone solve the economic equation shareholders find themselves in today, where they have the option to fund companies with declining asset values, hoping for a greater payback tomorrow. Chris DeWolfe, of MySpace, was quoted here that they are being approached by companies willing to sell themselves at a fraction of the value of a scant few months ago as capital to fund loss making operations is now scarce.

If past is prologue, many entrepreneurs are already making a 'left turn' and are busy building companies that leverage areas (like where end-user prices are inflated to support brick 'n mortar sales/marketing) where a great price reduction will encourage demand to outstrip available supply.

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