Deloitte predicts that in 2011 social networks are likely to surpass the breathtaking milestone of one billion unique members. Also, they may deliver over 2 trillion advertisements. Yet the advertising revenues directly attributable to social networks may remain relatively modest compared to other media, at least in the short term. With per member annual advertising revenue of about $4, that implies total 2011 advertising revenues of about $5 billion (see Figure 1). Despite social media’s large and growing audience, its advertising revenues still represent less than one percent of the worldwide advertising spend total. Other sources of social network revenues, such as payments systems and e-commerce, might exhibit faster growth.

Figure 1: Social networks Average Revenue Per User (ARPU) in $

In 2011, it is likely that social networks’ long-term market value will continue to polarize opinions. Some view social networking as the technology sector’s “next big thing”, promising even greater rewards than the decade-old phenomenon of search advertising. Others compare social networks to the dot com bubble and argue that monetizing their users at dollar levels similar to online search has not yet been demonstrated.

Deloitte’s view is that the advertising revenues from social networks in 2011 are likely to be very significant in absolute terms: total industry revenues of$ 5 billion dollars and year-over-year growth of 40 percent are impressive numbers; individual companies may experience even higher growth rates. Yet revenues on a per-subscriber basis are unlikely to match search or traditional media in the next year or two. Also, advertising rates, measured on a CPM (cost per thousand impressions) basis, are likely to remain low compared to other forms of online advertising as well as traditional media.

Nevertheless, thanks to a low cost base, social networks might still achieve impressive gross margins despite their relatively low revenues-per-user — particularly when compared to the traditional media companies they are competing against. A social network’s cost of content is close to zero since it merely provides the infrastructure, while its users and third party app developers provide all the content.

An assessment of social networks’ potential hinges on three metrics: subscriber growth, time spent on the network, and CPMs. Many social networking companies have been recording impressive gains in some of these metrics, but it is worth examining how much additional growth they can achieve.

When social networks attain the billion unique user milestone, nearly half of one global user base – computer-based Internet users – may be signed up by year-end 2011. This could put a ceiling on future growth if global Internet adoption continues to expand at the pace that consensus analysts expect. it might be increasingly difficult for social networks to sustain their impressive subscriber growth trajectories.

Mobile data might offer a better opportunity, particularly in developing countries where mobile penetration continues to rise steadily: there are far more global mobile users than those with access to computers. However, delivering display advertising to mobile phones at volumes and prices sufficient to create a significant multi-billion dollar business may not be likely in 2011. In 2010, mobile advertising revenues for the UK – the largest market in Europe – were only about $40 million. As smart phones and 3G networks become more widespread, the base of active social network users should rise accordingly.

Social networks’ growth trajectory is often compared to that of paid-for search, which in just 15 years grew from almost nothing into a $30 billion plus market that continues to expand. However, a decade ago broadband penetration in most countries was still in the single digits and some markets had no broadband service at all. The growth of search was at least partly fueled by significant growth in online use – a trend that social media has already capitalized on.

If social networks’ advertising revenues are only worth $4 billion in 2011 with half the potential user base already signed up, or if future growth is largely restricted to the low-value mobile ad market, most of the upside for social networks would need to come from increased time spent on the network, or from improved CPM metrics.

The amount of time spent on social networks rose sharply in 2010. In fact, according to one analysis, a popular social network enjoyed a 66 percent increase between Q3 2009 and Q3 2010. Yet even if the time spent on social networks grows by a factor of three, that might not necessarily translate into a threefold increase in advertising revenue. Increasing inventory could cause CPMs to fall even further.

If there are limits to audience growth and time spent, then the burden would primarily fall on CPM to drive revenue growth. Social networks’ understanding of individuals’ backgrounds, preferences, social groups, activities, and behaviors are without equal. There have been hopes that this would enable social networks to deliver superior advertising results: but paradoxically, social network CPMs remained among the lowest of all forms of online advertising. That could well change, as the ability to mine the myriad data or social networks may find new business models that allow for much higher advertising revenues, but for 2011 it is difficult to find the levers that would cause social network ad revenues to accelerate from their already rapid pace.

Perhaps the vastness of social networks’ repository of user information is itself a limiting factor; as of 2011, it remains a challenge to economically extract useful insights from the volumes of user data that social networks generate. The billions of stated “likes” may not all necessarily signal an intent to purchase. Also, in 2011, as in previous years, privacy concerns may constrain the ability to collect the most valuable data. Nevertheless, once social networks figure out how to rapidly and economically analyze their data, and to monetize the billions of recommendations made, a new seam of valuable customer insights will be available to mine and exploit.

Conclusion

In 2011, the story of social networks will continue to be written with no clear conclusion in sight. Social networks remain an emerging business founded on innovation; yet they have already achieved levels of market acceptance that might have seemed inconceivable just a few years ago. The question now is whether social networks can sustain their growth trajectory and find better ways to monetize value.

Even if social networks 2011 ad revenues only meet industry forecasts, they may still have other valuable ways to generate revenue. For example, they could serve as a payment platform for the hundreds of thousands of application providers in their ecosystem. Or they could adopt a blended e-commerce department store model, where they charge for online floor space and earn a commission on any sales. Yet in 2011 these additional revenue streams, although very profitable, are unlikely to surpass advertising in importance to social networks (see Figure 2).

Figure 2: Global Social network revenues

If low CPMs are expected to be the norm, social networks should consider how media agencies — particularly those paid by commission — are likely to respond. Agencies might conclude that commissions based on modest CPMs are less attractive than other potential clients, and could begin pushing other forms of advertising. Or they might decide to sell high value advisory services, such as public relations and reputation management, to help a brand manage its presence on social networks.

Advertising firms and their clients will likely need to expand their use of social media to protect their image and reputation in a world increasingly influenced by personal opinions and grassroots communications. Studies have shown that word-of-mouth feedback and peer reviews exert tremendous influence on purchasing decisions; in fact, one survey found that up to 78 percent of people trust peer recommendations, compared to just 14 percent who trust advertisements.

Throughout 2011, it seems likely that the forecast for the social network sector will continue to be promising, but unclear. As more information is released and as business models become more developed, all of advertisers, competitors and analysts will get a better picture of the future potential of this industry.

Source: http://www.deloitte.com/view/en_GX/global/industries/technology-media-telecommunications/tmt-predictions-2011/media-2011/eab5bcd1ed47d210VgnVCM2000001b56f00aRCRD.htm

TechCrunch has written a great article on Social Networks’ Valuation. Although it was written in 2008, the principles used are still applicable, only the valuation figures are higher now

Is MySpace worth $3 billion, or $20 billion? It depends on how you value a user.

It’s time to start comparing the big global social networks on something other than unique visitors and page views. I believe an effective way to value a particular user is based on the average Internet advertising spend per person in the country they live in. The higher the spend, the more value the social network can get out of the user by serving them advertising and other products. That means that, for now, users in a handful of key countries are worth far more in terms of revenue potential than those in the rest of the world.

We’ve begun to build out a model that looks at social network usage by country/region and compares that to available data on total Internet advertising spend in each of those countries. The model is then able to turn an apples-to-oranges comparison into an apples-to-apples comparison. The early results are surprising.

The ultimate financial value of any asset is, ultimately, what the market will pay for it. We have only a few data points to help us: Facebook, Bebo and LinkedIn are worth $15 billion, $850 million and $1 billion, respectively, based on relatively recent valuations (although only Bebo was actually sold completely; Facebook and LinkedIn raised investments at those valuations). The last valuation of MySpace was just $580 million, back in 2005 when it was acquired by News Corp.

Which valuation is most “correct?” It’s hard to say based on the data that’s been available to date, which is mostly just aggregate page view and unique visitor numbers from Comscore and other services. Based on worldwide unique visitors, for example, Facebook overtook MySpace to become the “largest” social network.

According to raw worldwide user number, the biggest social networks are Facebook, Myspace, Hi5, Friendster, Orkut and Bebo, in that order. But when you apply the model that we’ve created below, which takes into account where users live, the rankings change substantially. MySpace is by far the most valuable social network based on available data. A competitor like Orkut is worth only 1/20th of MySpace, even though it has nearly 1/4 the number of users.

Properly Ranking Social Networks

The model takes Comscore data for available countries and regions. Each of 26 well known social networks were graphed with the data we have been able to collect. We’ve then calculated the average advertising spend (estimated by PriceWaterhouseCoopers in a recent report) for each person online in each of those countries. For example, in the U.S., the total 2008 estimated Internet advertising spend is $25.2 billion. We’ve divided that by the number of people online in the U.S. according to Comscore (191 million), to get an average Internet spend per person of $132. View the raw data and calculations here.

The U.S., by the way, is only the 4th most valuable market per Internet user, trailing The UK ($213), Australia ($148) and Denmark ($144).

We’ve then multiplied the average Internet spend per user in each market with the number of unique users each social network has in that market, essentially creating a “weighted average” based on the advertising dollars chasing users. If a social network has more users in the U.S., Japan, the UK, Germany, Australia, and other bigger advertising networks, they will have a higher weighted average valuation.

We believe this model is an effective way to rank various competing social networks. It bumps down networks like Orkut and Friendster who have tens of millions of users in markets with very little advertising spend, and bumps up networks with lots of users in higher value markets.

Based on this model, MySpace is by far the most valuable social network. Second place Facebook has just 75% of the value of MySpace (even though it now has more users), followed by Bebo (26% of MySpace value), Hi5 and Amebio. LinkedIn comes in at no. 11, at 6% of MySpace’s value.

Valuation Ranges

The real-world revenue numbers being reported for the big networks supports this approach to valuation and shows a direct tie between monetization efforts and where a network’s users are. MySpace is estimated to have generated $755 million in revenue over the last year. The (now) larger Facebook, with a far higher percentage of users in less lucrative markets, will generate just $255 million this year:

EMarketer estimates that MySpace will post $755 million in revenue in the fiscal year ending June 30 2008. MySpace would not comment on the estimate. About a third of the revenue is expected to come from the Google ad pact. For the year, Facebook is estimated to earn $265 million in ad revenue.

Based on these three publicly available data points we’ve created value ranges for each of the top 25 worldwide social networks. There is a very wide disparity (MySpace, for example, is worth between $3.3 billion and $20 billion, based on which comparable you look at). But it does yield very interesting data. For example, If Facebook and LinkedIn were valued similarly to Bebo, they would be worth just $2.5 billion and $182 million, respectively, far less than what their investors recently paid for a piece of them.

Interestingly, the recent sale of Polish social network Nasza-klasa for $92 million appears to be right in sync with Bebo’s price. The model estimates its value at $91 million based on Bebo’s valuation metrics.

There are some big flaws with the model and analysis in its current state. First, LinkedIn may be in a different class of network, given that all of its users are business focused (no super-poking going on there). As a result, it may be able to monetize users far better than its competitors, no matter what geographic market is being looked at. Still, we’ve decided to leave it in as a data point, with that caveat.

The model itself needs more data. The user numbers are based on April Comscore. We will shortly revise it with the May numbers, although the absolute rankings probably won’t change. More importantly, some big markets are not included yet. The Chinese Internet advertising market, for example, is estimated to be $2 billion in 2008, yet they are not included (mostly because I can’t find data on user numbers for the networks). Also, the Philippines isn’t broken out separately, again due to data availability issues (although the total Internet advertising market in the Philippines is just $3 million this year, so it won’t affect the rankings materially even though Friendster is so strong there). Finally, Russia is currently grouped with “the rest of Europe,” and needs to be separately broken out – it has a large and growing online advertising market and lots of users, so that update may affect the mid-level network rankings.

The advertising spend model is just an estimate and from a single source. I’m less concerned with this data since it doesn’t matter to the model if the estimates are absolutely correct. If the estimates are wrong by different rates in different countries, however, the model will break. If we find better relative data between countries, we’ll update the model with that data. But for now, the PriceWaterhouseCoopers data seems to be pretty good.

Finally, this model doesn’t take into account execution at the company level. Two very similar networks may monetize vastly differently based on methods of advertising and even the brute effort and passion of the employees. This model obviously doesn’t take that into account.

I also note Andrew Chen’s analysis last week which takes a similar approach to this using Google Trends data instead of Comscore. The Google data isn’t granular enough to really dig in to relative values, however, and he was lacking current and deep data on average Internet spend. Still, I agree with his methodology.

As I wrote at the very end of this post, you have to consider the current monetization value of users when comparing social networks. Raw user numbers are pointless without it.

Written by: Michael Arrington
Source: http://techcrunch.com/2008/06/23/modeling-the-real-market-value-of-social-networks/