When Users Don't Mean Profits

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There's an inherent belief held by many Internet companies, or at least their investors, that users equals future profits. The more users, the greater the future profits. This belief leads to investors valuing the ephemeral photo-sharing application Snapchat at $3.5 billion, although the company makes no profit and only recently began attempts to make any revenue. This notion is also responsible for the high multiples of Facebook (FB 2.33%), because surely its 1-billion-plus users must mean some fantastic future windfalls.

But what if users just aren't worth that much?

Value of users
While advertisers have paid for eyeballs for centuries, the price and value of each ad is falling, especially because of the rise of mobile devices where converting from ad to sale is more difficult. For example, Google's (GOOG 0.75%) cost-per-click that advertisers pay each time someone clicks on an ad fell 8% in the most recent quarter, making it the eighth quarter in a row of declines. It's difficult to grasp exactly what a user is worth across the industry, especially because the services companies offer differ so much.

Sources: Latest quarterly filings, Pew Research, and comScore.

Users aren't always the same
An upstart like Snapchat, or even a company that has yet to prove profitability, rides on the success of its predecessors. However, just as there is a difference in delivering ads around Google searches and ads around friends' photos on Facebook, there is a difference in posting ads on Twitter feeds or with self-destructing photos. It's conceivable that advertising won't work at all for some services, yet investors slap on the old business model to have at least some idea of future profits.

And even those who seemingly have proven the advertising model can work may have long-term issues. A recent report from Forrester notes that "Facebook creates less business value than any other digital marketing opportunity." As businesses dip their toes in the world of social media marketing, making a good first impression will mean a lot to win repeat business.

Mobile ad in Facebook's iPhone application. Source: Facebook.com.

Diverging from the ad model
This is why finding novel methods of monetization outside of advertising can greatly help out a company's fortune. LinkedIn's business segment that handles advertising accounted for only $88 million of the most recent quarter's $393 million in revenue. It made the bulk of revenue, $225 million, from Talent Solutions, which includes its Talent Finder and Job Seeker services that help companies recruit and potential employees find jobs.

Slapping on the easy monetization trick of selling ads fails to take advantage of the specific qualities of these services. Facebook, as Forrester suggests, could "fully leverage social affinity data within [its] ad targeting products." Facebook knows so much about its users, but has failed to capitalize on this database beyond targeting demographics already available with other online advertising networks.

Looking at Twitter's future, it could have great success at enabling users to quickly make impulse buys, recently showcased with Starbucks' "Tweet-a-Coffee" program. Twitter is a low-friction service, full of users looking to kill some time -- and possibly spend some money.

A user can be worthless
Simply serving up advertising can help a business survive for quite a while. But to be a truly long-term company, it needs to offer and deliver value beyond what any other company or start-up can offer. Users are never guaranteed to come with value; they're only worth what a company is able to extract.