Twitter, Skype, And The Trouble With Free Internet Services

Twitter has just raised capital at price that values the company at about $1 billion. A collection of private investors have agreed to buy two-thirds of Skype from eBay (EBAY), a process complicated by a patent suit by Skype’s founders. Even with the threat of that suit, eBay managed to fetch nearly $2 billion for the VoIP company.

Facebook recently announced that it was cash flow positive and has reached 300 million users. By most accounts, its revenue is approximately $300 million.

The grand old man of social networks is MySpace, now owned by News Corp (NWS). When Mr. Murdoch bought the company in 2005 for $580 million, analysts viewed it as a stoke of genius. He was able to get one of the most visited websites in the world for a modest price. As time marches on, the growth of MySpace has stopped. It apparently losses money now on revenue of well under $1 billion.

All four of these companies share one very important property which is that they started as free services. That was one of the reasons, if not the major reason, that they attracted tens of millions of members. Each has a special utility and attraction to users, but that was reinforced by the fact that they cost nothing to use.

Now that each of these businesses has become very large, at least as measure by the visitors, they are struggling with how to make money, Skype is trying to convert some of its 400 million subscribers to paid services. MySpace, Facebook, and Twitter are attempting to get marketers to spend money to reach their audiences which are ill-defined pools or people who may have very limited common interests. Certainly sorting out the demographics of the sites is difficult. Isolating sets of users who may be interested in  finance, games, news, or sports which are fairly standard targets for advertisers, is nearly impossible.

Social networks carry about 20% of the display advertising placed in the US. The revenue that they derive from this is very small. That is because the sites have to offer huge discounts due to their inability to offer targeted audiences. Until that changes, which it may not ever, social networks will never get the premium for advertising that large portals like Yahoo! (YHOO) and AOL ,which have idenfiable audiences, do.

“Free” may be a good way to build an audience but it is an awful way to make money off one.

Douglas A. McIntyre