The Unhealthy Dependency That Caused Demand Media To Lose Half Its Market Cap

I believe that investors have been seduced by commodity content and its siren, Demand Media (DMD). On March 1, Demand’s stock hit a new lifetime high, a week away from its peak market cap of $2.25 billion. Today, it is worth half that. The selloff comes after Google’s “Panda” algorithm update decimated Demand Media’s traffic from its #1 source by 40%, or more.  The financial pain is pervasive, and this appears to be a blood-bath.

Indeed, now that DMD has lost over a billion dollars of market cap, I thought it would be good to revisit what has happened – and why.

As my mother always taught me, let’s start with what I got wrong:  I have theorized that Google’s darkly aligned interest in Demand’s use of AdSense could prolong support of the publisher.  I hadn’t expected Google to wean itself off the addictive revenue and profit so quickly.  It turns out that Google is more disciplined about serving the customer than I had imagined (that would be a great sign for Google!), or else, it is under so much pressure for search quality that it had no choice but to forego the revenue.  Alas, the latter is more likely. 

And on what I got right:  I have written previously that “there’s no question that Demand will be successively punished as long as its model is garbage content at almost-free cost.  Bad content may be Google’s first choice now, but it’s not the audience’s, ever.”  More specifically (from my January blog post), I’ve said that “The big question is how long Google can hold on to its revenues at the expense of its consumer experience.  Demand Media’s new shareholders will want to be the first to know. That way, they can get out front and sell.” 

And sell they have. The stock is down almost 50 per cent since its 52-week high. And it has lost almost $700 million in the last two weeks alone!  

Why the shocker, Wall Street?  Consumers did not decide suddenly that they no longer find Demand Media’s content valuable. Demand Media did not suddenly lower its content quality.  And Google did not suddenly insert a new and surprising choke-hold over Demand Media’s distribution. 

Demand Media forgot who the customer is.  What’s really going on here is that Demand Media always had an isolated and single point of failure. It’s not just Demand Media’s issue: it’s an issue for every publisher that relies on Google for a fire-hose of traffic.

Google is not the audience.  Publishers make the mistake of thinking Google’s choices for search results represent the audience’s selections.  They don’t.  Audiences don’t care whether URL’s contain underscores or dashes.  Audiences don’t count inbound links to a page.  Audiences don’t think one page is good just because there are lots of links to another page on a site.  But Google does all these things.  No, audiences didn’t change their mind overnight. 

Wake-up call:  Google is not beneficent.  But two things did happen suddenly.  First, Google decided, this time, to put its customer satisfaction above its own business results and reorder its index. Second, investors suddenly woke up to the risk factor that they had previously ignored. It’s staggering that investors overlooked this flaw in the first place. 

Investors ignored what they didn’t want to hear. Back in early January 2010, when I had dinner with one of Demand Media’s eventual bankers, we discussed its dependency issue: Google holds all the traffic cards to Demand’s success.  At the time, the banker said he thought it was a major weakness in the offering. Two years later, nothing changed in Demand Media’s business, but something changed in the market. Over those two years, the phrase with the greatest per cent gain I heard from bankers was “There is pent-up demand for new product.”  It was code for “We want IPO’s and we don’t care much about what happens after.” 

Another sign of a bubble.  Today, there are many questions about whether we’re seeing a bubble in the public and private financing markets. When it’s clear investors neglected such a major strategic weakness in such a controversial company, it makes me put a tick-mark in the “yes” column. 

Don’t fall for the hype.  But those of us in the media business have a choice to make. We can either play to what’s trendy in financial markets, and in our media circles, or to what we know really matters when it comes to building valuable media properties. SEO businesses are perilous because they are so tightly connected to a distributor – and disconnected from their customer. Which is more than a little ironic, since media is all about connecting audience, content, and advertisers. 

The end of SEO. The Panda update represents a turning point, and Google can’t throw its consumers under the bus for the sake of its own revenues any longer. The pressure is mounting on Google to align its search results with what the audience really wants.  That’s what Facebook is doing; and Google knows that Facebook is becoming the #1 substitute for Google when audiences want to find content.  SEO strategies that inflate a site’s standing are unmistakably fizzling out.  And for publishers, the message is clear:  design for your target audience, not for an algorithm. 

So, as I update my perspective today, there’s one truth that I put forward in March that I stand by more than ever:  Truth #1:  In the end, there’s no one more important than the consumer.”