A few relevant scenes from the recent blockbuster Moneyball:
Peter Brand: Billy, Pena is an All Star. Okay? And if you dump him and this Hatteberg thing doesn’t work out the way that we want it to, you know, this is…this is the kind of decision that gets you fired. It is!
Billy Beane: Yes, you’re right. I may lose my job, in which case I’m a forty four year old guy with a high school diploma and a daughter I’d like to be able to send to college. You’re twenty five years old with a degree from Yale and a pretty impressive apprenticeship. I don’t think we’re asking the right question. I think the question we should be asking is, do you believe in this thing or not?
Peter Brand: I do.
Billy Beane: It’s a problem you think we need to explain ourselves. Don’t. To anyone.
Peter Brand: Okay.
Grady Fuson: No. Baseball isn’t just numbers, it’s not science. If it was then anybody could do what we’re doing, but they can’t because they don’t know what we know. They don’t have our experience and they don’t have our intuition.
Billy Beane: Okay.
Grady Fuson: Billy, you got a kid in there that’s got a degree in Economics from Yale. You got a scout here with twenty nine years of baseball experience. You’re listening to the wrong one. Now there are intangibles that only baseball people understand. You’re discounting what scouts have done for a hundred and fifty years, even yourself!
These two scenes from Moneyball illustrate something that may be essential to modern business: the incredible value of youth and innovative thinking relative to traditional experience. It turns out that the Moneyball character Peter Brand’s real name is not Peter Brand (played by Jonah Hill), but rather Paul DePodesta. And he didn’t go to Yale, but instead Harvard. He was indeed young – twenty-seven when he went to work for Billy Beane – and he did have an actual degree in Economics. What’s more, as you can see in the interaction above, Billy valued Paul’s (Peter Brand’s) opinions and decisions – despite the fact that he was a complete novice with respect to baseball operations.
A month or two ago, I had the unique opportunity to share the stage with Billy Beane at a management offsite for one of the leading companies in the Fortune 500. We were both fielding questions about innovation, and what one can do to keep their organization innovative. I talked about how many of the partners that have joined Benchmark Capital have been extremely young when they joined, including our most recent partner Matt Cohler who joined us at the age of 31. At Benchmark, we believe that young partners have many compelling differentiators. First, they will ideally have strong connections and compatibility with young entrepreneurs, who are frequently the founders of the largest breakout companies. They are also likely to be frequent users of the latest and greatest technologies (all the more important with today’s consumer Internet market). Like the “Moneyball” situation described herein, young VCs are open to new ways of doing things. This form of “rule-breaking,” or intentionally ignoring yesterday’s doctrine, may in fact be a requirement for successful venture capital investing.
When I mentioned this intentional bias towards youth, Billy Beane abruptly concurred. He noted that injecting youth into the A’s organization is also a key philosophy of his. Paul DePodesta may have been the first young gun that Billy hired, but he was far from the last. Billy continues to recruit young, bright, talented people right out of college to help shake up the closed-minded thinking that can develop with an “experience only” staff. Also noted was the fact that if a certain “experience” is shared by all teams in the league, then it is no longer a strategic weapon. You can only win with a unique advantage.
The impact of youth on the technology scene is undeniable. The included table lists the founding age of some of the most prominent founders of our time. The facts are humbling and intimidating, especially for someone who is no longer in their twenties or early thirties. Can someone in their forties be innovative? Or, do the same things that produce “experience” constrain you from the creativity and perspective needed to innovate?
Lets look at some of the specific advantages of youth. First, as mentioned before, without the blinders of past experience, you don’t know what not to try, and therefore, you are willing to attempt things that experienced executives will not consider. Second, you are quick to leverage new technologies and tools way before the incumbent will see an opportunity or a need to pay attention. For me this may be the bigger issue. The rate of change on the Internet is extremely high. If the weapon du jour is constantly changing, being nimble and open-minded far outweighs being experienced. Blink and you are behind. Youth is a competitive weapon.
The point Billy raised regarding the fleeting value of experience is also important to consider. As the world becomes more and more aware of a trick or a skill, the value of that experience begins to decay. If word travels fast, the value of the skill diminishes quickly. Best practice becomes table stakes to stay-afloat, but not to get ahead. We see examples of this every day with Facebook application user acquisition techniques. Companies find a seam or arbitrage that creates a small window of opportunity in the market, but quickly others mimic the same technique and the advantage proves fleeting.
Back before the Yahoo BOD hired Carol Bartz, there was much speculation about the important traits for Yahoo’s next CEO. Most of the analysis honed in on two key traits for the company’s next leader – the ability to lead and the ability to innovate. I remember trying to think about leaders that I thought would have a chance at having a measurable impact. On one hand, you could put a very young innovative executive into the role, but it is hard to imagine handing a $15B public company over to someone remarkably inexperienced. The other side of the coin is equally difficult – thinking of a seasoned executive who has the ability to dramatically innovate Yahoo’s products and business model.
There were only a handful of people (as few as three) that I could think of at the time that fit this second profile. Thinking back now, they all shared the following characteristic: despite being experienced CEOs, these individuals all “thought young” i.e. they were open-minded and curious. And they did not believe that experience gave them all the answers. These type of executives love diving head-first into the latest and greatest technologies as soon as they become available.
If you want to stay “young” and innovative, you have no choice but to immerse yourself in the emerging tools of the current and next generation. You MUST stay current, as it is illusionary to imagine being innovative without being current. Also realize that the generational shifts are much shorter than they were in the past. If you were an innovative Internet company five short years ago, you might have learned about SEM and SEO. Most of the newly disruptive companies are no longer using these tools as paths to success – they have moved on to social/viral techniques. The game keeps changing, and if you are not “all-in” in terms of learning what’s new, than you may be falling rapidly behind.
Consider these questions:
- When a new device or operating system comes out do you rush out to get it as soon as possible – just because you want to play with the new features? Or do you wait for the dust to settle so that you don’t make a mistaken purchase. Or because you don’t want to waste your time.
- Do you use LinkedIn for all of your recruiting, or do you mistakenly think that LinkedIn is only for job seekers? How many connections do you have? Is your profile up to date? (When Yahoo announced Carol Bartz as CEO, I did a quick search on LinkedIn. She was not a registered user.)
- When you heard that Zynga’s Farmville had over 80MM monthly users, did you immediately launch the game to see what it was all about, or do you make comments about how mindless it is to play such a game? Have you ever launched a single Facebook game?
- Do you have an Android phone or do you still use a Blackberry because your Chief Security Officer says you have to? I know many “innovators” who carry an iPhone and an Android, simply because they know these are the smartphones that customers use. And they want exposure to both platforms – at a tactile level.
- Do you use the internal camera app on your iPhone because it’s easy, or have you downloaded Instgram to find out why 27mm other people use that instead?
- Do you leverage Twitter to improve your influence and position in your industry or is it more comfortable for you to declare, “why would I tweet?,” before you even fully understand the product or why people in similar roles are leveraging the medium? Do you follow the industry leaders in your field on Twitter? Do you follow your competitors and customers? Do you track your company’s products and reputation?
- How many apps are on your smart phone? Do you have well over 50, or even 100, because you are routinely downloading each and every app from each peer and competitor you can to see how others are exploiting the environment? Do you know how WhatsApp, Voxer, and Path leveraged the iphone contact list for viral distribution?
- Do you know what Github is and why most startups rely on it as the key center of their engineering effort?
- Have you ever mounted an AWS server at Amazon? Do you know how AWS pricing works?
- Does it make sense to you to use HTML5 as your mobile solution so that you don’t have to code for multiple platforms? Does it bother you that none of the leading smartphone app vendors take this approach?
- When you are on the road on business, do you let your assistant book the same old car service, or do you tell them, “I want to use Uber just to see how it works?”
- When Facebook launched the new timeline feature did you immediately build one to see what the company was up to, or did you dismiss this as something you shouldn’t waste your time on?
- Have you been to Glassdoor.com to see what employees are saying about your company? Or have you rationalized why it’s not important, the way the way the old-school small business owner formerly dismissed his/her Yelp review.
The really great news is that being a “learn-it-all” has never been easier. With the Internet, high-speed broadband, SAAS, Cloud-services, 4G, and smart-phones, you can learn about new things, 24 hours a day, no matter where you are or what you do. All you need is the internal drive and insatiable curiosity to understand why the world is evolving the way it is. It is all out there for you to touch and feel. None of it is hidden.
There are in fact many “over 30” executives who can go toe-to-toe with these young entrepreneurs, precisely because they keep themselves youthful by leaning-in and understanding the constantly evolving frontier. My favorite “youthful” CEOs are people like Marc Benioff and Michael Dell, who frequently can be found signing up for brand new social networking tools and applications. Reed Hastings has more than once answered Netflix questions directly in Quora. Jason Kilar frequently communicates directly with his customers through Hulu’s blog. Rich Barton, the co-founder of Expedia and Zillow is one of those people carrying both an Iphone and an Android, and is constant learning mode. I would also include Mark Cuban, whose curiosity is voracious. The other NBA owners never saw him coming. And lastly, there is Jeff Bezos, who seems to live beyond the edge, imagining the future as it unfolds. Watch the launch of Kindle Fire in NYC, and you will have no doubt that Jeff plays with these products directly and frequently.
Our last table highlights the stats from the Twitter account of some of these “youthful,” learn-it-all executives (sans Mr. Bezos – we all wish he tweeted). If you don’t find this list interesting, think about the thousands and thousands of executives out there who are nowhere to be found with respect to social media. They take the easy way out, likely blaming their legal department. They intentionally choose not to learn and not to be innovative. And they refuse to indoctrinate themselves to the very tools that the disrupters will use to attack their incumbency. That may in fact be the most dangerous path of all.Read Full Post | Make a Comment ( 41 so far )
Posted on November 15, 2011. Filed under: advertising, Facebook, Internet, IPO, social networking, Twitter, Uncategorized, Venture Capital, Web/Tech | Tags: Facebook, Google, Internet, Twitter, Venture Capital |
Frequent comparisons to Facebook leave many confused about the true value of Twitter.
“In a brand new direction
A change of perception
On a brand new trajection”
[Disclosure: Benchmark Capital is a major investor in Twitter, and my partner Peter Fenton sits on the Twitter BOD.]
Twitter is having a remarkable year. Active users have soared to over 100 million per month, with daily actives now above 50 million. Tweets per day are over 250 million. Most top actors, athletes, and artists are all active on Twitter. Every news and sports program proudly advertises its Twitter account handle. No one would consider running for public office without a strong Twitter presence. Global news in any region breaks first and spreads fast on Twitter. Even uber-socialist Hugo Chavez of Venezuela has 2.24 million followers (which puts him slightly behind Mandy Moore, but just ahead of Queen Latifah).
So, Twitter’s traffic has been growing in leaps and bounds. It has become an indispensable tool for managing personal and corporate brands. And Twitter, along with its verb form “tweet”, have become words in everyday usage all over the world. Yet despite these impressive strides, Twitter’s upside is far, far greater and its user base will expand by an order of magnitude – as soon as the service can overcome a major perception problem.
Twitter suffers from two key misperceptions that need to be resolved before the business can reach its true potential. The first misperception is that Twitter is simply another social network, like Facebook. People commonly think of Twitter as a variant of Facebook. The press frequently positions the two together as “leaders in social networking.” This pairing erroneously implies that the two services are used for the exact same thing, even though the two platforms are very different. Facebook is a few-to-few communication network designed for sharing information and life events with friends. Twitter, on the other hand, is a one-to-many information broadcast network. The only way magic happens on Facebook is through reciprocity: I friend you and you friend me back – then information flows. But on Twitter, I can get something out of following Shaquile O’Neil who has no social obligation to follow me back.
As its roots are in communication, a key part of the Facebook value proposition is sharing information. Any potential anxiety with regards to Facebook sharing is reduced by the fact that these communications are generally seen only by one’s friends. In fact, users react quite negatively when this information is unknowingly shared more broadly. For the people who view Twitter as a Facebook variant, they immediately assume the platform’s core purpose is for the user to broadcast his or her own thoughts and personal information (like Facebook), but to a much broader public audience. For those with this perception, the notion of potentially exposing their own private thoughts to the broad public Internet is overwhelming and uninteresting.
The second, and more critical, Twitter misperception is that you need to tweet, to have something to say and broadcast, for the service to be meaningful to you. For many non-Twitter users, Twitter is an intimidating proposition. “Why would I tweet?,” and “…but I don’t want to tweet” are two common refrains from the non-adopter that highlight this key misperception. But this completely misses the point as to why Twitter has become such an amazingly powerful Internet destination for 100 million others. For the vast majority of Twitter’s next 900 million users, the core usage modality will have very little to do with “tweeting,” and everything to do with “listening” or “hearing.”
Twitter is an innovative and remarkable information service. While it is amazingly democratic and allows literally anyone to broadcast publicly as a “tweeter,” the core value in today’s Twitter is the amazing flow of curated and customized information that emanates from its crowd-sourced user feeds. Other Internet networks like to keep the user “inside.” Much like Google, Twitter points out to the world. It’s a “discovery engine” and an “information utility” rolled into one. With Twitter, you get news faster, you see updates from your favorite artists, you hear directly from key politicians, and gain insights from influencers in a wide variety of specializations. Just as Facebook is symmetric in terms of its poster-reader relationship, Twitter is highly asymmetric. The majority of the tweets on Twitter are posted by a small sub-set of the users. And the majority of the users get value from “reading” or “listening” to the tweets from these core influencers. Once again, for most users it’s more about what you hear, learn, and find than the fact that you can tweet.
In many ways, Twitter is much more of a competitor to other “discovery tools” and “information sources” than it is to Facebook. Facebook is unquestionably the number one resource for “sharing with the people in your life.” From this perspective, Facebook competes (extremely well) with email, instant messengers, and certainly other symmetric social networks like MySpace. Twitter, on the other hand, competes most directly with other tools that help you find important links, news, and information. It is in this broad, non-friend based crowd-sourcing and speed of discovery where Twitter truly shines. A recent Tweet by famed sci-fi author William Gibson highlights this point. Having become accustomed to the non-linear speed of information flow on Twitter, Gibson grew frustrated watching news of the Osama bin Laden killing on TV: “Network news feels like trying to suck cold tar through a milkshake straw.”
Some who understand this point have suggested that Twitter is merely a “Better RSS reader.” While this analogy is directionally more accurate than the Facebook comparison, it greatly underestimates the power and value of Twitter. RSS feeds are simply computerized information “routers” that require complex setup, initialization, and maintenance. Twitter has three breakthroughs that make it dramatically more powerful than simple RSS. First and foremost, your personalized Twitter feed is human-curated by a potential universe of millions of curators. When you “check Twitter” you are looking at the specific articles and links purposefully chosen by people you have chosen to follow. That is powerful leverage. Second, it is easily extensible. Due primarily to the concept of “retweeting,” the simple act of using Twitter exposes you to new and interesting sources to follow. It evolves into a richer and more customized offering over time. You discover new people as well as new information. Lastly, Twitter’s unique handles and follower networks create a strong-form network effect that has high lock-in and high switching costs. Twitter and its top tweeters have a deeply symbiotic relationship.
So what can Twitter do to solve this misperception problem? The first thing they can fix is the new user registration flow, a process that has already begun. Earlier this year, a new user would be encouraged to “tweet” very early in the registration process, basically reinforcing the perception problem. Today’s “first 60-second” Twitter experience is quite different and revolves around choosing the influencers you will follow. You should expect even more evolution in this direction in the future. Next, Twitter must make it crystal clear to the press and prospective user that there is an amazingly powerful value proposition for non-broadcasting users. This will not be easy, as it requires a reprogramming of perception across a broad audience. Not only will this aid in incremental adoption, but it will also help subdue the confusion with respect to Facebook.
Twitter is on an amazing trajectory and will continue to increase in usage and influence. However, the power of this discovery platform is much more about the tweets themselves, and not simply about every single user having the ability to tweet.Read Full Post | Make a Comment ( 51 so far )
American journalists and corporate executives have been slow to appreciate the beauty, brilliance, and consumer allure of the virtual goods business model.It’s not that they did not have data points – China is chock full of multi-US$billion market capitalization companies that are based on this business model. That said, many luddites predicted it was an “Eastern” fascination that would never spread to the West. They never fully understood it.
As a result of this headstrong denial, I have often wondered what data point would finally convince me that the West had fully accepted the reality of the virtual goods business model. Last week I received my answer. Jeff Grabow from Ernst and Young asked my partner Mitch Lasky and I to sit down with Mick Bobroff, an audit partner developing an expertise in virtual item based revenue recognition. Now I wasn’t exactly waiting for a sign from God or anything – rather just a small signal that confirmed this new model was legit. Having an audit partner at a top three accounting firm become an expert certainly qualifies as a step in the right direction.
Mick had prepared a remarkably succinct and information rich presentation (here is a link to their PDF on the subject). I was fairly excited to go through it – at least as excited as anyone should get when discussing accounting principles. Here is a summary of what Mick had to say in his presentation titled “Revenue Recognition Considerations for the Sale of Virtual Goods”. [If you want to reach Mick, his contact info: 415-894-8205, email@example.com]
- [Legal Point First] Michael made it clear that this document represented general observations and should not be used specifically as accounting advice. I understand and concur with regards to this post also. For your own books verify with your own accountant.
- There are already a ton of companies that trade on American stock exchanges (NYSE, NASDAQ) that use virtual goods models and adhere to GAAP. To the point above, they are all in China. Examples: ChangYou (CYOU), Giant (GA), NetEase (NTES), Perfect World (PWRD), The 9 (NCTY), Shanda Games (GAME). [For the record, TenCent is Hong Kong listed.] The current GAAP revenue recognition policies were honed with these companies.
- When a company sells virtual currency, this is not a revenue event (even though it may clearly be a cash event). When purchased but not yet used, virtual currency sits on the balance sheet as a customer deposit or deferred revenue (i.e. a liability).
- Revenue recognition commences when virtual goods are bought with virtual currency by the consumer. Exactly how it “commences” depends on the following.
- There are two categories of virtual goods – (1) consumable items that are used once and gone, and (2) durable items that “work” over an extended period of time.
- For “consumable items” you can recognize revenue when it is consumed.
- For durable items (which many are), things are much trickier. You need to amortize the revenue (linearly) over the useful life of the good, or the average life of the actual user (i.e. – what is the average customer life of your customer?). This is a messy problem, especially when you understand how difficult it is to measure “customer life” when some customers never pay and others come and go in fairly random patterns. Also, your “average customer life” may change over time creating very complex accruals.
- The bottom line: getting this right requires quite a few database entries for tracking the sale and usage of every single virtual good sold in your digital world, in addition to the supply and usage of each virtual currency account, and the activity levels of each user (to estimate average life).
These policies were not particularly surprising. That said, when I was listening to the complications of the “durable item” revenue accounting, it reminded me of something I learned for the early leaders in the virtual items space — innovative Korean companies such as Nexon.
About four to five years ago, the team at LindenLab (SecondLife) held a pizza night at their offices with the goal of learning more about the virtual item games that were wildly popular in Korea. We invited two bilingual gamers to install and play Audition, Kartrider, and FreeStyle. My big takeaway from that night was that not one of these titles actual allowed for the “sale” of virtual goods. Rather, each virtual item could only be “rented.” In each case, the user was given the option of one, seven, or thirty-day rental. I assumed this was Darwinian, and immediately began to wonder why “renting” might be better than outright ownership when it comes to virtual goods.
- In world inventory gluts. As virtual worlds mature, they often suffer from game-wide inventory glut. Items that were once useful to newbies become throw-aways for the more advanced user, and can literally pollute the world and compromise the in-world economy. Allowing rental is like having free garbage collection. Everything eventually goes away.
- User inventory clutter. More advanced users typically have a huge problem managing large inventories of items. Also, many items are trend-oriented and trends change. With the rental model, no user sits around thinking “wow, why did I really buy that two months ago and what do I do with it now?,” and “why am I buying all this stuff?” The rental model simplifies inventory management for the user.
- More marketing opportunities. When an item expires, it offers a unique time to re-market to the user for either an extension of the current good, to a trade to a newer, fresher, and perhaps more interesting item.
- Price segmentation. By offering 1, 7, and 30 day rentals, the merchant has basically price-segmented the market. This theoretically allows more users to experience the good than may have with a single, and arguably higher, price point.
- Good business. Why sell something that lasts forever if you can sell something that has to be naturally repurchased?
- Simpler accounting. I didn’t think of this sixth point until my meeting last week. The rental model does away with the notion of a “durable” virtual good, as they all expire. What’s more the time frame over which you recognize the revenue is now fixed at 1, 7, or 30 days. This dramatically reduces the accounting complexity.
Thanks again to Michael and Jeff at E&Y for reaching out and setting up the meeting. It’s great to recognize that virtual goods businesses are finally mainstream here in North America, and that they even have their own appropriate accounting policies. I also appreciate having one more reason to favor “rentals” vs “sales” when it comes to virtual items.
[I have received several comments that concern this post and how it relates to SecondLife. For those of you that don’t know, SecondLife doesn’t actually sell virtual items, its residents do. As such, this post does not relate to SecondLife at all. It pertains to the 98% of virtual worlds where the hosting companies ALSO is in the digital goods business. Nothing would stop SL from offering rental as a choice to its developers, but the main message is that this post does not pertain to SL (which has a different business model altogether.)]Read Full Post | Make a Comment ( 44 so far )
Posted on March 9, 2009. Filed under: advertising, casual games, Internet, social networking, Uncategorized, video, Virtual Goods | Tags: advertising, Avatars, casual games, Digital Items, Facebook, MySpace, social network, social networking, Virtual Goods |
“Little Joe never once gave it away
Everybody had to pay and pay”
— Lou Reed, Walk on the Wild Side
The consensus seems to be that social networks have a monetization problem. On this topic, both the leading technology industry blogs and the world’s top news organizations agree. The problem is not that these sites have no revenue. I “guesstimate” that MySpace and Facebook have annual revenue run-rates of approximately $650mm and $450mm respectively – highly reputable numbers. The perceived problem relates directly to revenue per user or page view, as these are two of the most heavily trafficked sites on the Internet. As a comparison, other companies with similar usage, like Yahoo, are doing $7.2B in annual revenues. When reporting earnings from Q4 of 2007, Google also opined on the difficulty in monetizing social networking sites. Sergey Brin noted, “I don’t think we have the killer best way to monetize social networks yet.”
There is ample historical data that proves web sites like these are inherently difficult to monetize. Most other online communication products have had similar struggles. Two great examples of this: the many leading players in the Instant Messaging (IM) space (AIM, ICQ, Yahoo Messenger) and the leading free email sites (Hotmail, Yahoo Mail). These products/sites have always had some of the lowest eCPMs on the Internet. Many speculate that this is because the user is so heavily engaged in using the product (i.e. communicating) that they are unlikely to be distracted by or engaged in an advertising message. Another corollary to this point is that other Internet properties offer more direct purchasing intent based on the way they aggregate users. Example here include TheKnot for brides, TripAdvisor for travelers, and even Google, where the search query highly delineates the direct intent of the user, allowing the advertiser to find users already in the purchasing funnel. All of these properties have incredibly high eCPMs.
Despite this conundrum, there is a solution. Luckily for these U.S. based companies, a Chinese company named TenCent has already paved the way by identifying the optimal way to monetize this type of product. For those that don’t know, TenCent is the owner of the leading IM franchise in China – a product known affectionately as “QQ”. TenCent was founded in 1998, has 355 million users, US$1.2B in annual revenues, and a US$11.2B market capitalization. The stock chart for the past 5 years is included in the adjacent graphic. The two primary drivers of revenue for TenCent are digital items and casual game packages and upgrades. Advertising, which doesn’t work well on U.S. products like IM, doesn’t work well in China either. Advertising revenues for TenCent represent only 12% of total revenues. Recently, I asked a leading Internet analyst which company in China is best positioned above all others? He quickly replied “TenCent”.
The spreadsheet below tries to highlight the monetization differences between TenCent, Facebook, and MySpace. For each we have taken our best guess at monthly unique users, monthly page views, monthly revenues, and advertising as a percentage of revenue. For TenCent, these numbers are published. For MySpace and Facebook we used the best information we could find and/or infer. We then calculated effective CPM (eCPM), revenue/user, and advertising revenue per user. Lastly, we show these same numbers for TenCent with a cost of living adjustment. In China the cell-phone ARPU (average revenue per user) is about 1/5th of that here in the U.S., so adjusting these numbers up by 5X gives you a much better number for comparing directly with the U.S. properties.
The takeaways are quite straightforward. The amount of advertising revenue on an adjusted basis at TenCent ($2.08) is quite similar to Facebook ($2.44) and MySpace ($5.85) (some may wonder why MySpace ad revenue per user is higher than Facebook – many believe they are more aggressive with ad placement and insertion). The key difference in this comparison is obviously the revenue TenCent generates with business models that are largely absent on both Facebook and MySpace — digital items and casual game revenue. For every $2 of adjusted advertising revenue TenCent has per user per year, they generate $17 in other revenue streams. Benchmark Capital has invested in two private companies in the social/virtual world space – SecondLife and Gaia Online. In both cases, the company revenues are significant, and in both cases advertising is not the leading business model.
At a recent public investor conference in San Francisco, Alexander Tamas, an executive associated with the leading free email service in Russia (Mail.ru), noted that his company felt that the U.S. companies have little understanding on how to monetize a product like Mail.ru, and that they were taking their clues from TenCent in China. Most of the public market investors in the audience, who have witnessed TenCent, DENA, and GREE’s remarkable success, nodded in agreement. Gaia also presented at this conference and the crowd was standing-room only. The questions from the audience made it even more apparent that the buy-side investors have a strong appreciation for the digital item business model.
It is peculiar to have a situation where the NY-centric public market investors are more open minded to a new business model prior to the entrepreneurial executives on the west coast, but that is clearly the case here. It is not hard to see why investors like this model. When Pony Ma, the founder of TenCent, first described the digital item model to me five years ago I was blown away. He was selling virtual clothes and accessories for digital avatars that represented his users online. Think about it; this is a beautifully high gross margin business with very low marginal costs. He even told me he thought digital shirts should deteriorate over time like real ones. Pure genius.
It is my perception that most U.S. executives have trouble conceiving and believing in the digital item model. For starters, they simply think it’s strange. “Why would someone buy clothes for their virtual avatar? That’s weird.” What they fail to realize is that U.S. consumers pay for “virtual” things all the time. In the attached picture you see a pair of expensive Chanel sunglasses that retail for $329. If you removed the Chanel logo from them, and offered them for $50 cheaper, you could not sell a pair. Not one. Why? People are buying an image that they want to project about themselves. Without the logo, they fail to make that statement. The same is true for watches, clothes, cars, sodas, beers, cell phones, and many more items. People care greatly about how they are perceived, and are willing to part with big bucks to achieve it. Digital items are merely the same phenomenon online.
Another reason that digital items are a great monetization model for a social network is congruence of fit with the core activity of the site. We already discussed how for TheKnot, the decision to come to the site is very consistent with identifying exactly “who” the advertiser is trying to reach and at “what time”. For social networking sites, one of the key “experiences” of users is self-expression. Think about it: is the Facebook news feed more about the reader or the poster? Isn’t someone’s MySpace page all about self-expression? If people are there to represent and express themselves, shouldn’t you build a business model that charges for the ability to better differentiate oneself? Shouldn’t you also charge for ego-gratification on a sliding scale (the bigger the ego, the more the charge)?
These same executives like to believe that digital items are distinctly an Asian phenomenon – a convenient theory will prove to be a dangerous rationalization over time. Here are some numbers from a U.S. corporation. As I mentioned we are investors in LindenLab and their leading vitual world, SecondLife. In SecondLife, the users are the ones that get to sell digital goods (rather than the company as in TenCent’s case). Linden makes its money providing the platform services underneath this powerful economy. At this moment in time, the economy inside of SecondLife – the amount of digital goods and services – sold each year between SecondLife users, is over a US$450mm annual run rate. Of this, developers are realizing over $100MM in real profits extracted from Linden’s in-world to real-world currency exchange. And keep in mind that SecondLife has much fewer users than either Facebook or MySpace.
Another interesting data point exists in the Facebook and MySpace application developer programs. Best I can tell, the startups that are generating the most revenue on top of either platform are either selling digital items/avatars, or providing casual game packages — the exact two business models that are the drivers at TenCent, DENA, and GREE. This is hardly a coincidence.
Despite these arguments and the fact that others have also been arguing this same point, it would be surprising if either MySpace or Facebook move in this direction. First, they would need to have executive buy-in, which is not obvious at this point. Second, they would need to hire people with experience in executing against this model. Like any other endeavor in life, there are right ways and wrong ways to exploit these models, and there are already many experts in the field of digital items and casual games. Lastly, they would need to prioritize this direction over other programs. Currently, MySpace seems extremely focused on music, and Facebook on user-based communications.
The good news is that if they ever get around to deploying these models, they will not have trouble convincing Wall Street it’s a good idea – Wall Street is already there.
Wikipedia on TenCent
TenCent IR About Page
TenCent IR Investor Intro
Stock Information and Company Financials on Mixi
Stock Information and Company Financials on DENA
Stock Information and Company Financials on GREE
In addition to these, most of the large US investment banks are covering TenCent, DENA, and GREE with English based research. If you have a relationship with one of these banks, you can likely ask for their reports.
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