Facebook's business problems are symptomatic of many large digital firms

Facebook is wrestling with a business challenge more traditionally found in legacy media: how do you translate consumers that don’t think they have a commercial relationship with you into relationships that that other firms will pay for?

Despite 955 million active users and increasing revenues, the company has lost a third of its share value since its IPO in the spring.  The exuberance that surrounded its IPO and overpriced its shares has worn off and investors are realizing that being big isn’t enough to ensure business success. Its latest earnings reports show the firm lost money, $157 million, in the second quarter on income of $1.18 billion.

Facebook’s challenges are symptomatic of a long line of “successful” digital firms that are experiencing monetization problems, including Yahoo, You Tube, AOL, and Twitter. Despite large numbers of users globally, they still lack effective business models to generate revenue levels congruous with their size. They may provide great communication functions for users, but they are not transforming very well from innovative users of technologies to highly profitable commercial enterprises.

Part of their challenge is that they have to focus so much effort on non-paying customers and those customers think of the services as personal communications—making them resistant to many efforts to monetize them. This problem has long plagued traditional media, but they are conceived as mass rather than personal media and have been around so long that many people are now used to a certain level of commercial exploitation. They also have a proven track record of return on advertisers’ investments that digital media have not yet been able to deliver for many types of advertisers.

Large digital players will continue to evolve and can be expected to improve their financial performance over time, but it will take a good deal of innovative thinking about the business rather than about the technologies and social value of their services.

Digital journalism reaches sustainability, but transitional business problems interfere

The income streams of digital news providers continue to grow and many have now reached the point of sustainability. Fundamental financial and business problems, however, are keeping publishers from moving out of print and becoming digital-only operators.

This leads many publishers and journalists to continue bemoaning the fact that digital media do not provide as much income as print and many still argue that organized, regular newsgathering and distribution cannot survive in a digital-only environment. They point to the fact that digital advertising produces only about 15 percent the income of print advertising—largely because it does not appeal to retail, display advertisers--and that paid circulation for digital products is growing slowly.

Their analysis is flawed, however, because publishers do not require as much revenue online as offline because the costs of digital operation are so different.

Editorial operations account for only about 10-15 percent of total costs of operation of print newspapers, but they are the primary cost for digital operations. About half of the costs of print are taking up by printing and expenses for getting papers to readers; when the costs of paying for and maintaining buildings and land used to house presses and circulation equipment are factored in, those costs rise to about 60 percent of total costs. Expenses to maintain the large advertising operations found in print newspapers add another 10 percent to overall costs and the managerial costs due to the large number of personnel and functions in non-editorial activities add about another 5 percent. Thus, switching to digital operations can take out at least three-quarters of the costs of print newspaper operation, making the lower revenue of digital operation sustainable.

A growing number of newspaper companies are already generating 15-20 percent of their total revenue from digital operations, making nearly enough money to sustain the kinds of journalism practiced by legacy news media. So why does negativity about the future of journalism remain so high and why are newspapers not yet moving to digital-only operation?

There are three primary reasons:

1. Print newspapers still continue producing above average returns compared to all industries. No publisher is willing to throw away those operating profits even if the costs of print operation are higher than digital.
2. Retail advertisers get more return on investment from newspaper advertising than any other form of advertising, including digital. As long as they remain willing to advertise in newspapers, no publisher is willing to give up the revenue stream and operating profits that they now provide.
3. Owners of print newspapers have a great deal of capital tied up in facilities, printing and distribution equipment that cannot be withdrawn because few buyers want to acquire the used equipment today.

The fundamental challenge today isn’t that digital journalism has not reached sustainability; its how does a publisher transition from the print to digital-only operation in a way that is financially feasible and desirable.

The transition is critical for society because it will bring with it the reportorial strength and organization that exists in newspapers. That is something that digital startups do not provide because they generally lack the capital to build and sustain staffs as large as those of print newspapers and because they lack the reputations and brand identity of established papers.

Newspaper owners, publishers, and journalists then need to stop decrying the digital revenue problem and start focusing on solutions to the business challenges of when and how to realistically reduce and end the print operations. It will happen at some point in the future; the problem is how to plan and manage the switchover.

Is the future of digital journalism an outside job?

Making small digital news providers sustainable has become the holy grail of journalists and the search continues for workable business models and revenue streams.

Advertising may produce some revenue, but it will never generate sufficient resources to support digital journalism because so little advertising money is available for sites with small audiences. About three-quarters of all online advertising goes to the top 10 sites and Google, Facebook, Microsoft, and Yahoo account for about 60 percent of all online revenue. This leaves very little advertising expenditures to be contested among all other players--of which news providers are only a small fraction. At the same time, the prices paid for online advertising are falling because there are so many sites offering advertising, the advertising inventory is nearly infinite, and audiences continue fragmenting.

This means the majority of funding for start-up digital journalism must come from elsewhere and online news sites—especially start-ups—are having mixed success trying to construct multiple revenue streams from philanthropy, memberships, events, consulting services, and payment systems. Both large legacy news organizations that dominate provision of news in the digital space and free automated aggregators are hampering efforts of small sites to develop audiences. The primary successes that can be observed have been for start-ups carrying out special forms of journalism or concentrating on highly specific topics.

The answer to sustainability may not lie in the business creation and business operational approach. The key to making emergent digital news providers sustainable may lie in the 18th and 19th century approaches to journalism, in which journalism was an avocation and not a profession (or at least only a part-time profession).

If one reviews the history of newspaper start-ups around the world, one finds that the bases of journalistic compensation were not journalism itself. It many cases it was funded by public employment—serving as postmasters, teachers, or other civil servants—or by operating commercial endeavours—such as printing firms, taverns, and retail shops (Even brothels funded the costs of newspapers in some towns in the Western U.S. during the nineteenth century).

The current inability to effectively fund small-scale digital journalism means that we all need to be thinking more broadly about how we can support the functions and people involved in them. If the past is a guide, we may need to return to provision of local journalism as community activism, political activity, or business support service—all of which played significant roles in establishment of news provision in years past.

How to Destroy Your Customer Base and Investor Confidence

Netflix used to have a charmed life.

This year, however, poorly thought out strategy and lurching decisions are stripping away many of its advantages and making it vulnerable to competitors.

Established in 1997, its founders saw opportunities in creating an Internet-based DVD-by-mail distribution system. It was designed to be a competitor to physical video stores, making it more attractive by offering a larger selection and using a unique IT driven distribution system that combined distribution centers across the country to serve customers within 24 hours at highly attractive prices.

The DVD-by-mail service became a hit, ultimately devastating the market of physical stores such as Blockbuster. By 2007 it had delivered more than 1 billion DVDs to customers. That same year it launched on-demand video streaming service so customers could also select a video and stream it to a PC (and later other platforms) for immediate viewing. The company allowed viewers a highly popular choice of physical DVDs or streamed video for the same price.

Effective marketing and the enviable distribution system led the company to became the largest video subscription service in the U.S., with 24 million customers

Despite--and because of the investments required for--its growth, the company was losing money on its $10 per month price for the joint service, so it suddenly increased it price to $16 dollars (a 60% increase) in July. That significant price change and the poor way it was introduced to customers—especially in the midst of poor economic times, angered customers and created price resistance that led a least a half million to drop the service.

Then, in September, the firm announced it would spin off its DVD-by-mail service and rebrand it Qwickster, leaving Netflix with the digital streaming business. Customers were furious to learn they would now have to pay separately for both services. By downplaying its DVD-by-mail business, the company hopes to reduce distirbution costs and its costs for content by moving content from a per rental basis to per subscriber basis that is more beneficial for the firm.

Netflix's decisions were not made with a customer focus, but a focus on stemming losses that worried some investors. That strategy is dubious, however, and share prices have fallen from nearly $300 per share in mid-summer to $140 per share.

The lurching changes have also made the company’s position seem vulnerable, leading to new competitors to enter the market. Dish Network, which bought Blockbuster out of bankruptcy, is now using it to introduce a competing DVD-by-mail and digital delivery services at competitive prices and Hula and Amazon are reportedly looking a ways to exploit consumer dissatisfaction.

The entire episode is a classic example of why companies should never take customers for granted and why company decisions need to be driven by creating--rather than subtracting--value for consumers.

What Legacy Media Can Learn from Eastman Kodak

What do you do when your industry is changing? What do you do when your innovations are fueling the changes? Those problems have plagued Eastman Kodak Co. for three decades and the company’s experience provides some lessons for those running legacy media businesses.

Eastman Kodak’s success began when it introduced the first effective camera for non-professionals in the late 19^th century and in continual improvements to cameras and black and white and color films throughout the twentieth century. Its products became iconic global brands.

The company’s maintained its position through enviable research and development activities, which in 1975 created the first digital camera. Since that time it has amassed more than 1,100 patents involving electronic sensing, digital imaging, electronic photo processing, and digital printing. These developments, however, continually created innovations damaging to its core film-based business.

Digital photography created a strategic dilemma for the company. It could move into digital photography and destroy the highly profitable film-based business or it could exploit the film-based business while it slowly declined and then--when it was no longer profitable--try to leap out of the business into digital world. It was an ugly choice and the company chose the latter.

Today, the company has just 15% of the employees it once had and its stock prices are about 15% of what they were before it finally stripped out its production capacity and distribution systems. An enduring benefit of its research and development activities is that the company now owns patents on much of the underlying technology used in all digital cameras including those in mobile phones. It is building a new digital revenue stream on licenses and infringement payments for use of those technologies. Those alone now account for 10% of its turnover.

Eastman Kodak’s situation is not unlike that of legacy media firms, especially those in print, whose uses of digital technologies two decades before the arrival Internet and whose experiments with teletext and other telecommunication based information distribution systems foreshadowed the arrival of the Internet.

Today, newspapers and magazines—and increasingly broadcasters—are faced with dilemma of whether to keep exploiting their base legacy product or to dump the old business and jump fully into digital. It is as ugly a choice as that faced by Eastman Kodak in the 1980s and 1990s. So, what lessons can be learned from its experience?

1)      Don’t try to fight change

You may not like its direction and may understand how it will affect your current business, but you will not be able to stop its momentum and trajectory if it is beneficial to many customers. In such conditions you can only protect your existing product by making it as productive and competitive as possible, by adjusting its strategies to better serve those who are most loyal and resist change, and by carefully monitoring the pace of change and the investments you make in the existing product. Simultaneously, existing companies that want to benefit from the change need to be creating new products for the new markets and allow them to develop and mature with the pace of change even though they may be compounding the challenges in the pre-existing product.

2)      Don’t wait too long to change

Waiting to move into new markets with new products gives upstart companies and other competitors opportunities to become players with better products and larger market shares once you decide to enter. Although there are sometimes reasons not to be first movers, you should not wait too long because it is very difficult and expensive to enter and become a major player once a new market moves into its maturation phase.

3)      Be willing to sacrifice some short-term profit for long-term gain and sustainability

Careful strategic consideration must be given profits during transitional periods and managers needs to make the strategy clear to the company and its investors. It may be desirable to boost research and development costs even though there is no guarantee they may produce results; it may be necessary to harm the profits of the existing product by building up its replacement and cannibalizing some of its market; it may be appropriate to make investments in the new product that may not pay off in the short-term. Whatever the strategy, it should be the result of clear and deliberate choices and managers need to ensure that investors and entire company understand the reasons for it.

4)      Own the rights to technologies and services your competitors will employ

Use your R&D efforts and make strategic acquisitions to acquire the technologies and services that competitors will need to employ in the new market so they must turn to you and share the benefits of their growth. Unfortunately, few legacy media companies invested in research and development to early exploit opportunities in digital media by creating the underlying hardware and software for content control and distribution online and in phones, tablets, and computers. Thus, they own few intellectual property rights other than trademarks to their legacy media names and most are not benefiting as Eastman Kodak from patents being used by those eroding the business base. However, the new products still need content products and content management services that legacy media have long produced and companies need to be open to cooperating with the new competitors rather than giving them incentives to go elsewhere or to develop their own content capabilities.

These are turbulent times for legacy media and they require making choices and positioning firms for the future. It is no time for timidity or keeping on with business as usual.

MySpace Sale Underscores the Risks of Exuberant Digital Investments

The decision by News Corp. to dump MySpace once again reveals the risks of over exuberance toward digital companies that do not have a proven business model or long-term customer loyalty.

There are plenty of digital investments that meet those requirements, but a number of the most hyped firms moving toward IPOs and acquisitions do not. They need to be considered with hard headed pragmatism.

MySpace was launched 2003 and rapidly became the toast of the digital world as a social networking site and “the place” for musical stars and fans to connect. By 2005 it was the fifth most visited site on the Internet.

New Corp., which was anxious to benefit from growth in digital media, jumped at the opportunity to acquire the service and paid $580 million in 2005. It was an enormous price for a company with an unclear revenue potential.

Within two years MySpace had grown to be the world’s number one social networking site and was receiving 100 million unique monthly visitors. But it still had revenue problems; its visitors weren't paying customers and advertising wasn't paying its costs.

Despite landing a $900 million ad deal with Google, MySpace reported just one period of profitability. On top of that, it lost its cache with users and its leading position was soon eclipsed by Facebook.

Overall, it is estimated that the MySpace lost at least $1.5 billion under News Corp. and those losses dragged down the News Corp.’s overall earnings. The extent of its losses has never been completely clear because its results were not transparently presented in News Corp. financial reports.

After desperately trying to revive MySpace, News Corp. put it up for sale with an asking price was $100 million. It was sold in June to the online advertising network Specific Media for $35 million (about 6% of what News Corp paid for it), but the company was really just giving it away to get it off its books. As part of the deal, News Corp. took a minority equity stake in Specific Media.

Investing in emerging industries is always more risky than investing in established ones, so it requires a good deal of realism and clear headedness about the opportunities and their potential. It is not good enough merely to throw money on the table in hopes of drawing a winning hand or because the crowd is encouraging you on. A solid business plan that it is already working and producing financial growth and a user model based on more than popularity and status are required unless you investing high-risk capital you can afford to lose, as well as other opportunities it might have funded.

Google, Newspaper Archives, and the Business of Cultural Heritage

Google announced this month that it is ending its ambitious project to digitally archive newspapers. The project to scan the archives of the nation’s newspapers and make them available online as a searchable historical record was announced in 2008 with the level of hubris only found in online enterprises.

"Our objective is to bring all the world's historical newspaper information online,” said Adam Smith, director of product management at Google, announcing the project. Those lofty aims were echoed by Punit Soni, manager of the newspaper initiative: “As we work with more and more publishers, we'll move closer towards our goal of making those billions of pages of newsprint from around the world searchable, discoverable, and accessible online…."Over time, as we scan more articles and our index grows, we'll also start blending these archives into our main search results so that when you search Google.com, you'll be searching the full text of these newspapers as well.”

After scanning about 60 million pages and beginning to make them available as full page shots--because costs of disaggregating and indexing were too high and copyright clearances were difficult to obtain for older material—the company announced that it will quit scanning pages, but continue offering the existing pages available on it Google News Archive site. It said it would not invest any new effort to improve indexing or add tools to better search and manage the archive.

The project may have been well-intentioned, but it was not well thought out. It was a free service designed to use the search traffic at the site to raise revenue through advertising Google would put on the site. The scale of the project was enormous and requiring finding, scanning, and indexing thousands of daily and weekly newspapers--many no longer in existence. It would require a long-term commitment of funds, personnel and server capacity to catalogue and scan the material and provide and maintain search functions. The project ultimately incorporated on a fraction of the papers it had hoped to scan, did so spottily in many cases, and its usability was poor because it never mastered the problems of handling so much content. Worse yet, it discovered that history was not a money making business.

The exit announcement is not a surprise and is another sign that players the virtual world are stopping deluding themselves that they are replacing the entire world and that the laws of economics and finance to not apply to them.

As laudable the preservation of newspaper archives might be, expecting it to be completed and maintained by a commercial firm defied sense and historical experience. For centuries, the most important historical records, books, art have been maintain in governmentally and charitably funded collections because commercial enterprises were either unwilling to bear the costs or to allow the large scale efforts required to preserve, catalogue, index, and make available cultural heritage materials distract them from their business activities.

Why would anyone expect Google to act otherwise?

As Google increasingly acts as a mature business it will increasingly shed activities that were launched as goodwill gestures because the costs of their operations reduces the company’s financial performance and will diminish the value of its stock compared to other tech firms. Over time it will be harder for the firm to maintain the stance that it is not self-interested and motivated only by the opportunities to improve the lives of the public by providing access to all the world’s information.

The tentacles of its operations that have reached out into to many fields will increasingly be pulled back if they do not yield financial results. And fears that Google will rule the world will diminish. Google, Microsoft, Amazon and other big players of the digital world all have limits, just as did the handful of firms that once controlled steel, oil, and shipping through cartels. At some point even mammoth, wealthy companies do not have the resources and capabilities to keep expanding endlessly and their performance declines, leading shareholders to rein them in and competitors to find opportunities.

International Protection for Broadcasts Gaining New Momentum

The proposed international treaty on the protection of broadcasters is inching forward after nearly 10 years of consideration and member states of the World Intellectual Property Organization and other stakeholders are moving toward consensus on the central elements of what it is to do and what is the object of the protection.

Much of the rhetoric of stakeholders—particularly pay TV channels and sports rights organisations—has led many to believe it is about protecting their business models and revenue. They have done the proposed treaty a disservice.

It is about protecting the value creating activities of broadcasters in content selection, packaging and distribution—something that is not protected by copyrights, but can be protected with a neighboring right. What the treaty is intent on doing is protecting the broadcast—in a signal and derivative of the signal—which embodies the broadcasters value creation activities and is the object of the proposed protection.

The result may assist revenue generation and strengthen the business model of rights holders, licensers, and broadcasters, but it does not directly protect those.

What it will do is provide a streamlined mechanism for broadcasters to enforce their rights internationally when unauthorised reception, decryption, and retransmission and rebroadcast of their signals are done by other broadcasters and cablecasters. Such practices regularly occur in some countries and sometimes involve the second broadcaster substituting their own advertising and charging fees to obtain the broadcast.

The treaty essentially gives broadcasters the right to license other uses of their broadcasts and halt uses they have not licensed, but does not give them rights to the content in the broadcasts that they do not own.

The proposed treaty includes some protection of public interests, by permitting national limitations and exceptions for clearly public purposes such as education, service to visually or hearing impaired persons, etc.

Some scepticism about the proposals exists in developing nations, because most of the benefits will occur to broadcasters in high income and upper middle income nations and only limited benefits will occur in other states.

The thorns on the rose bush, however, involve the fact that many of the nations where egregious reuses of broadcasts have occurred have never well enforced copyright, so one must be highly optimistic to believe that passage of the treaty will solve the problem.

Content Farms and the Exploitation of Information

A growing number of firms are aggressively pursuing the market for information by providing material that answers online searches and employing strategies so their material appears high in search results.

These enterprises are providing high quantity, low quality material on topics designed to produce many search hits and driven by the desire to make money from advertising received as high traffic sites. Some are proving quite successful.

Demand Media, for example, uses about 13,000 freelance writers to produce about 4000 articles a day for which it gains about 95 million unique visitors with more than 620 million page views monthly. Its eHow.com site alone gets about 50 million users. Ask.com, Yahoo and AOL are also engaging in the market.

When you make a search and are taken to answer.com, dictionary.com, wikianswers.com or hundreds of other sites providing such information to the public, you encounter this mass produced content. The business strategy is working and many of the sites are among the top 25 sites in the U.S.

These producers and a whole range of similar organizations are producing material in content farms that rely on freelancers who are paid as little as $1 an article or get no payment except for number of page views for their specific work. It is a throwback to the penny-a-word days of journalism in the 19th century. The firms are increasingly seeking video producers, photographers, and graphic artists to provide similar material at similar levels of compensation.

Even established news organizations and other enterprises are starting to use the syndicated material produced by such content farms. Organizations such as Hearst publications and National Football League are relying on them for some content that appears on their sites, for example.

The implications of these developments on the quality of Internet information and the prospects for professional writers are clear and hardly encouraging.

Digital Media Require New Pricing Methods

Newspaper publishers need to explore new methods of pricing content as they expand their digital portfolios because merely transferring the methods used in print can never bring the success publishers desire.

Print newspaper publishers have traditionally tended to set prices based on production and distribution costs and not on value created. Unfortunately, this has made it impossible to possible to obtain a price premium for factors such as prestige, service, experience, and convenience.

New digital operations, however, provide significant other pricing options because they differ in terms of whether they maintain the existing content bundle, whether non-payers can be excluded from use, the types of experience they deliver and how they are used.

Digital media require significant new thinking because they tend to be joint and complementary products with print. These lend themselves to selling strategies of bundling and versioning that permit uses of bundle pricing, option pricing, multiple purchase pricing, differential access pricing, and inventory based pricing that have not typically been used in the newspaper industry.

Pricing is particularly complex in the digital environment because the number of price choices grow exponentially. In the print product managers price advertising and the circulation, but when they add an online product they have to make 8 choices because they are shifting to a multisided platform operation. If mobile, social media and other print products are added to the portfolio, one must give significant thought to the roles each plays in the portfolio and the interactions of pricing choices among them.

Although digital media use is growing significantly, companies need to be pragmatic in their investments and operations and their hopes for new revenue. Online consumption is still only about 10 percent of all media use and online advertising is still only about 13% of offline advertising. Those numbers are significant and rising so companies needs to seek and exploit opportunities in digital spaces, but managers cannot expect those to immediately replace the contributions of their legacy operations.