Facebook And Twitter Will Always Be Crappy Businesses

Bo Peabody

Two weeks ago, we ran an excerpt from a piece the Village Ventures partner Bo Peabody wrote for the Washington Post about how Facebook, Twitter, and other social networks would always be lousy businesses. 

Bo brings an interesting perspective to this argument, given that he founded and ran community-site Tripod in the late 1990s.  Bo’s piece generated many questions, from us and others.  Happily, he had a more complete version on hand that answers many of them.

Bo answers some specific questions about Facebook and Twitter at the end.  But first, here’s his entire argument. 

I founded Tripod in 1992. It started as a plan to compete with America On-Line. While we were trying to build our own proprietary network, Marc Andreesen was writing the Mosaic browser. In 1994, Mosaic turned the text-based Internet into the graphical World Wide Web and “Tripod, the proprietary network” became “tripod.com, the website”. Rather than pouring $10MM into an X.25 network with modem racks strewn around the country, Tripod was served from one $10K computer that we shared with another start-up.  
Tripod was known then as a community site and at one point was the eighth largest destination on the Web. It is now known as a social network and is the eighth largest social network on the Web. The change in Tripod’s ranking is a testament to just how much the Web has grown. There are now millions of web sites and at least one for every category of human interest. Indeed, the Web’s vast network of linked documents is limited only by the world’s aggregate imagination. Social networks like Tripod have played an important role in enabling the Web’s massive growth by making public a full suite of publishing tools. What was once the domain of big media companies – publishing text, pictures, audio, and video at will – can now be accomplished by anyone with access to a computer and a connection to the Internet. Social networks have exploded recently and become much more sophisticated. MySpace, Facebook, and Twitter have replaced Tripod, Geocities and Angelfire. However, the raison d’être of all of these sites remains the same: allowing and encouraging people to find and connect with each other. Social networks are indeed all about being social. 
In 2003, I helped form another company called Everyday Health, now the Web’s largest health information property. Everyday Health is considered a content network as opposed to a social network. Through my investment firm Village Ventures, I’ve backed many other content networks including Daily Makeover in the beauty and fashion category, Top 10 Reviews in technology, and Babble in parenting. These networks are about finding information rather than finding people. They produce and organise professional information around a specific category. The goals of a content network are simple: first, make it easy for people to consume information on a particular topic and second, make it compelling and safe for advertisers to associate their messages with the information and the people consuming it.  
Through my experience building Tripod and Everyday Health I’ve concluded that individuals get on the Web for one of two reasons: to find people or to find information. I might end up receiving information from the people I find or finding people through the information I receive, but my dominant intention is either social or informational when I get on the Web. Tripod is social and Everyday Health is informational. Both companies are vitally important to the ecosystem of the Web and are equally valuable as consumer experiences. But as businesses, the value of Tripod and Everyday Health could not be more different. 
Tripod has never been a good business and I don’t believe it ever will be. Everyday Health is a fantastic business and gets more valuable as the Web grows and matures. To understand what plagues the social networking business models of Tripod, Facebook and Twitter and what buoys the content network business models of Everyday Health, Daily Makeover and Top 10 Reviews one has to understand the media business. To understand the media business, one has to understand advertising and this means understanding how the people that buy advertising – brand managers at companies and media planners at advertising agencies – think and feel.  

Brand managers are the parents of their brands, in the same way that a mother or father is the parent of their child. Brand managers are taught to think about their brands as children who must be protected and nurtured over long periods of time. This parental instinct lends itself to risk-adverse behaviour. Most people don’t let their kids take unnecessary risks and most brand managers don’t take unnecessary risks with their brands. Media planners work at advertising agencies and partner with brand managers to execute advertising campaigns. Media planners have roughly the same instincts as brand managers and in many cases are even more cautious. The production fees associated with building advertising campaigns drive the business model of an ad agency. The media planning and buying portion of the business is secondary. It therefore does not pay to take many risks when buying media. You want the campaign to be considered a success but more importantly you want to do no harm. When you put brand managers and media planners together, risks rarely get taken. A brand is a very hard thing to build and an incredibly easy thing to destroy.

The scariest thing about taking risks with a brand is that the risks are difficult to calculate. Network television is considered to be one of the safest and most controlled environments for advertisers. However, if you decide to advertise on a show like Two and Half Men, perhaps the most popular show on network television, people may associate your brand with sexual innuendo, which makes up about 90% of the dialogue. Despite the risks associated with Two and Half Men and other shows on television, brand managers and media planners feel comfortable because they know what’s going to come out of Charlie Sheen’s mouth. Brand managers and media planners can calculate the risks associated with the trade off between a large audience and sexual innuendo. They even know exactly what that innuendo is because they can read the scripts, in many cases before their advertisement runs. To be sure, there are risks associated with advertising on network television, but there are very few unknowns.  
Content networks on the Web present a similar environment for brands. The risks and rewards can be catalogued and weighed. There are very few unknowns associated with advertising on the Everyday Health Network. The vast majority of information is produced by professionals and whatever isn’t is walled off and clearly marked. On the other hand social networks such as Tripod, Facebook and Twitter have zero control over their environments. Indeed, that is what makes them so attractive and valuable to consumers. But it is also what makes them such a dangerous place for advertisers.  
To create a compelling and safe environment for an advertiser requires that content be controlled and organised so that the advertisement itself can be targeted properly and, perhaps more importantly, so there is no chance that the brand being advertised will be associated with something it did not intend to associate with. There is very little control or organisation on social networks; I can post whatever I want whenever I want, whether a written word, a spoken word, a picture, or a video. Only the most rudimentary restrictions apply to what content can be posted on a social network and even those are flouted all the time. This presents two problems for advertisers. First, it’s impossible to target an ad properly because it’s impossible to know with any specificity or certainty what content is on a social network. I could be talking about health one moment and NASCAR the next, or about Dale Earnhardt Junior’s health. Second, the content is amateurish at best and offensive at worst. There is no way a brand can be sure it’s going to be associated with content that is consistent with the message it wants to send to its audience.  
The most striking example of risk-adverse behaviour by brand managers and media planners is what has happened to advertising on network television over the last five years. No one will refute that network television audiences have shrunk; yet the ad dollars spent in this venue have not shrunk at nearly the same rate. The price that advertisers are willing to pay to reach the network television audience has gone up considerably. Why is that? One reason is that many of these viewers have gone to the Web and you could understand why brand managers might be hesitant to follow them there; the Web is a completely different medium requiring an entirely different superstructure of creative execution, campaign monitoring, and results reporting. However, many network television viewers haven’t gone to the Web at all. They’ve simply switched the channel to one of the hundreds of cable television stations started over the last two decades. While advertising on cable television has grown, the rates that media planners are willing to pay to reach a viewer on cable still pale in comparison to the rates paid to reach viewers on the networks. Network television is still viewed as safe whereas cable television is viewed as a den of inequity and amateurism, populated by astrologists and high school lacrosse games, not to mention sex and swear words. It’s not exactly the place that American Express and McDonalds want to pitch their professional and wholesome images. Cable television has been around for over 20 years and many brands still aren’t comfortable with it.  
Social networks face this same issue with an order of magnitude more complexity. Indeed, the Web as a whole makes cable television look like bible study. But within that complex environment, sites like WebMD, CNet, The Knot, and The Street present a clean and safe environment for advertisers to reach specific and large audiences. The content is professional and organised, and the companies are public. These two characteristics give brand mangers and media planners a tremendous amount of comfort. It is no coincidence that there is not one public social networking company. The risks associated with owning the stock of a social networking company are similar to the risks associated with advertising on its site. The unknowns far outnumber the knowns and therefore investors managing the pensions of public school teachers in Iowa would rather not subject themselves to the risks. 
So how did social networks become the darlings of the media business and the venture capital community? Let’s start with the media business. The most important thing to a media company is audience and social networks have huge audiences. Even the less sophisticated social networks like Tripod have enormously large audiences, which is very alluring to media companies. But a large audience does not necessarily make a good media business. Good media businesses are defined by also being good places to advertise. A visit from the Pope attracts a large audience, but it’s a complicated place to advertise. I spent five years trying to sell advertising on Tripod. Almost 20 years later and as the eight largest social network on the Web, Tripod does $350,000 per month of advertising revenue, about as much advertising revenue as Google generates in an afternoon.  
The venture capital community is enamoured because social networks grow fast and growing fast is a very difficult thing to do. Venture capitalists have never liked content networks because of the costs associated with creating the content. Social networks present the perfect solution to that problem. The content on social networks is created for free by people who derive some other psychic or social benefit from creating it. I raised $14MM of venture capital for Tripod based on millions of random people creating lots of content for free, and tens of millions of people looking at that content. But when random people create content for free and other people look at it is that a media business?  

The key to understanding the business model issues facing social networks, and indeed the source of the confusion for media companies and the venture capital community, is the recognition that social networks are not media businesses at all. They are communication businesses. This is why the venture capital community loves social networks and why media companies have struggled to make economic sense of them.

The confusion all started with the search engine businesses of Yahoo, Excite, Lycos, Alta Vista, Ask and Google. These technologies do an amazing job of organising the vast array of content on the Web. However, they are not media businesses. They hardly ever create content, and when they do investors and management lament it at best and disdain it at worst. During my two years working at Lycos (they bought Tripod in 1998) I witnessed this first hand. Search engines are technology products that happen to be supported by advertising, but they aren’t media businesses. Advertising works on search because people are looking for specific information and ads can be placed in an environment where the content is largely static. If a brand manager wants to buy the keyword “fruitcake” and is worried about what might show up on the results page he can just perform the search, peruse the results and provide himself with some measure of certainty that his advertisement for a food product won’t show up next to results for mental institutions. Still, search engines have had a hard time attracting large sums of advertising dollars from companies that depend on their brand for competitive differentiation. Search results pages and the “text link” advertising unit preferred by the search engines aren’t great tools for expressing the unique qualities of a brand.

Search engines are amazing businesses, much better than most media and communications businesses. However, they are an anomaly. Media companies and the venture capital community have been chasing the next “search engine” business model for over 10 years; this elusive creature that creates highly valuable advertising inventory without the costs associated with actually creating content, and has the financial and cultural profile befitting a public company. The chase first lead to email (Hotmail, 411, Mail.com); and then on to instant messaging (PowWow, ICQ, Ubique), personal homepages (Geocities, Tripod, Anglefire), blogging (Weblogs, Blogger, WordPress), video blogging (YouTube, Grouper, Blip.tv), social networking (MySpace, Facebook, Bebo), and is now focused on micro-blogging (Twitter, Tumblr, Pownce). Indeed, some media companies have paid a lot of money for businesses that provide these tools for free with the eventual promise of advertising support; and some venture capitalists (and entrepreneurs) have made a lot of money on those transactions. But in all cases profitable revenue never materialised. Or if it did, it materialised in “direct response advertising”: a short term maths game of buying low-priced ads to promote high volume, low margin businesses like debt consolidation and auto insurance where brand matters less, if at all. Witness the recent death of Geocities. Not even the traffic and sales heft of Yahoo could make the advertising inventory on Geocities attractive to brand managers and media planners.

What all these businesses have in common is that they are based on people communicating with each other. They are communications businesses. Communications businesses are very rarely, if ever, good places to advertise. However, they are really interesting and necessary products, and on the Web they may be the most interesting and necessary products. I can get health information on the Web from the Everyday Health Network, but I can also get it from many other venues in many other mediums. The freedom to express myself and communicate with others efficiently, privately, and in multiple formats is done far better on the Web than anywhere else. Social networks, and the other communications products of the Web, are the engines of that freedom.   

What about other forms of revenue beyond advertising?

Indeed, most communications businesses charge users for their services. Telephone companies have made a lot of money for a long time charging consumers to express themselves and communicate with each other efficiently, privately and in multiple formats. Does charging users make sense for Tripod, Facebook and Twitter, the communications businesses of the Web? We tried this at Tripod back in the mid-nineties and many others have tried it since then. It doesn’t work. The barriers to entry for Web-based communications businesses are so low and the switching costs for consumers so minute that charging uses will never amount to much revenue.  
What about direct to consumer revenue streams beyond subscriptions, like verified accounts, virtual goods, and commerce?

In the same way that the fundamental nature of social networks as communications products renders them subpar advertising venues, monetization schemes based on extracting money from the social networkers themselves faces yet another problem resident in the fabric of social networks: what I call the “ubiquity paradox”. The value of social networks is their ubiquity. What makes Facebook such an incredibly fun and useful experience is that virtually everyone is on it. Any monetization efforts are going to drive some users away and that will in turn erode value for the users that remain. Most of the moneymaking ideas contemplated by Facebook are good ones and I think many of them could work. But all of them require Facebook to get more commercial and more intrusive, and therefore less personal. This will result in a smaller Facebook.     

There are many small social networks that make money by focusing on a niche audience. SawxHeads, a social networking site for Red Sox fans, does not require ubiquity. Users only care that there are enough Red Sox fans on the site at any given time. Users can come and go and the quality of the site will not be affected drastically. The value of these niche social networks is not in ubiquity and general communication, but rather in exclusivity and focused communication around a specific topic. This allows for relatively aggressive monetization schemes around advertising, subscriptions and commerce that are much harder for larger social networking platforms to pursue.  

What about selling data from the “social graph” as Twitter recently did to Google and Microsoft? 

I don’t know a lot about the business of selling data, but I do know that there is a lot of valuable data created on social networks. But my hunch is that once users know revenue is being generated by selling their personal data or data associated with their actions, they aren’t likely to rejoice. If social networks can sell data in a way that feels harmless to users perhaps they can make some money, but not a lot of money and certainly not enough to justify the values placed on them today.  

I could be wrong about all of this of course. But what if I’m right and social networks are like the streets, roads and highways of the virtual world: lots of users but no profitable business model?

We have to solve this problem. We can’t let social networks wither and die as Geocities did. The socio-political value of Tripod, Facebook, and Twitter is just too great, far greater in fact than their economic value. Can you imagine a world without these sites…a world where the freedom to express yourself and communicate with others efficiently, privately, and in multiple formats does not exist? It would be a much worse world; a world where I could not easily share hundreds of pictures of my infant son with his grandparents or where it would take me days instead of minutes to find and connect with old friends. A world where bloggers in Rwanda could not use Tripod to tell of the atrocities faced in their nation, or teens in Cambodia could not use Facebook to befriend other teens who share their worldview, or the citizens of Iran could not use Twitter to challenge an outmoded way of thinking. This is not a world any of us want to live in.  

Perhaps there is no for-profit business model for social networking. It’s been nearly 20 years and a lot of impressive money and brainpower hasn’t figured it out. Does social networking need a for-profit business model? Perhaps the world would be better off if social networks were not-for-profit? The mandate of the entrepreneurial community is to find solutions to problems, not just to make money. Wikipedia has grown phenomenally with a not-for-profit business model, and has become one of the world’s most useful resources. Wikipedia has its problems for sure, but its fate is in the collective hands of its users and not in the hands of media companies or the venture capital community. Perhaps Tripod, Facebook and Twitter should enjoy the same comfort.  

Bo Peabody is co-founder and Managing General Partner of Village Ventures, an early stage venture capital firm with offices in Williamstown, MA and New York City. Bo wrote a book for entrepreneurs called Lucky or Smart? which was published by Random House in 2005.

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