On Social Media and SAAS

[jschembs]

Revolutionary industry creations (railroads, automobiles, telecommunications, PCs, the internet, et cetera) create new markets and consumers that never previously existed. Railroads, for example, required massive labor and capital, building a tangible infrastructure that fundamentally altered commerce and transportation. There was some displacement of horse-based and other travel options, of course, but largely this new industry created its own customers. The personal computer, similarly, created consumers out of thin air, with obvious gains in productivity, efficiency, and spillover effects into other industries.

 

Social media and software as a service, on the other hand, largely are just rearranging the deck chairs of the economy. Social media companies competes for existing ad dollars. There is no incremental consumer being created. Similarly with SAAS. These upstart software companies are essentially stealing market share from entrenched software vendors.

 

Are there vast new, incremental markets and consumers being created by social media and SAAS that my myopia can't see? I'm not saying some of these companies do not have interesting business models or will not create substantial cash flows in the future. Something just seems awry in the last 5-10 years of capitalism, whereby the notion of creative destruction appears to be more zero sum than it has been in the past.

[youngMC]

There are probably lots of ways to slim down new market and technology advancements - "a railroad is just another way to get from A to B!" or a "telephone is just another way to talk to your mom!"  However, both inventions had the effect of opening up transportation and communications to new people and new niches.

 

In the cases of SAAS and Social Media:

SAAS is meant to make the capital costs of running and supporting software (for the end customer and client) much cheaper, thereby opening up the possibility for many more users to use it than before.  Your average employee at a large enterprise isn't going to be very capable of learning a new desktop software like Word (think about how early children are started now on Word/Excel, given the complexity of those packages!) but they may stand a chance at accessing software that's presented simply with no complex installation required.  The delivery model for Salesforce is so much more efficient than some complex installation that it affords a larger client base actually able to see and spend time with it.  I'd argue that more people in the enterprise are aware of the company's sales pipeline, forecast, and client base as a result - opening up the number of seats to be sold, creating a more sticky product, and so on.

 

Social Media opens up another previously untapped avenue of attention.  Before Twitter, Facebook and the like, advertising didn't really have much of a chance of being there at the point of connection and 1-on-1 or 1-on-many personal interaction.  With new supply of attention available for corporate sponsorship, it's easy to then presume a global increase in ad spend might follow, instead of a simple reshuffling.

 

There's a lot of writing out there about the "attention economy" which is really something that ties under both of these trends.  An interesting example under this model is Google's investment in self driving cars.  Google is really a media and advertising company, not a car company.  What they've done that's so smart is make an investment in one of the few remaining pockets of untapped attention in America - your morning and evening commute.  It's Google's secret vision that in the future you'll spend that time doing email and surfing the web on Google properties.

 

All of these are examples of investment areas in an information and knowledge worker type economy, versus the commodities and materials markets like railroads or automobile manufacturing you mention.

 

[ItsAValueTrap]

SAAS is just another way of delivering software.  I don't think that it's some seismic shift in the software industry.

Outlook is application-based.

Hotmail is SAAS.

 

Both are legitimate ways of delivering software.  And if you look at Hotmail, SAAS has been around for a long time (even before Hotmail).

 

2- I think that online advertising does create value.  The targeting on search ads is pretty amazing.  It has opened up niche markets that would not otherwise bother with advertising on radio or TV.  Lawyers for abestos-related lawsuits pay very high CPCs (e.g. several dollars for a click) for online search advertising.  I don't believe they would advertise in mass media because their audience is so narrow.

 

The other aspect of online advertising that does create value is advertisers' ability to track their campaigns.  We already had that with direct response television (infomercials, home shopping channels, etc.) and most forms of traditional advertising.  But companies advertising toothpaste in branding campaigns couldn't track their ads.  With search advertising, most advertisers do track their ads / aren't running branding campaigns.  Being able to track ads allows them to bid aggressively on clicks, which means that Google makes more money.

 

That being said, there are a lot of online services that haven't yet been profitable.  Major companies have shut down popular services such as:

DivX: Stage6

Google:  Reader, Checkout

I'm sure you can find more examples yourself.  I think a lot of the Web 2.0 IPOs will flop (with the exception of Facebook, which is highly profitable).  Like the original Dot-Com bubble, a lot of these companies have monetization problems.

 

3- Online advertising facilitates online shopping.  The ads help you find obscure items that would be difficult or impossible to buy locally.  I definitely think that there is real value creation going on.

 

I clicked on Google ads to buy a Halloween costume online.  The ads were actually helpful.

 

The delivery model for Salesforce is so much more efficient than some complex installation that it affords a larger client base actually able to see and spend time with it.

I believe installing Salesforce can be ridiculously complicated, like all of the CRM software on the market.  Companies will hire consultants to help them implement a CRM system.

[jschembs]

Good points by both of you. I certainly see benefit in social media and SAAS (our company shifted to Google as our email host a few years ago and would never consider going back to on premise), but nothing seems revolutionary. Having better-targeted ads improves the efficiency of advertising, which actually might argue companies would be able to decrease their ad/marketing expenses.

 

I think the thrust of my original point remains, however. Except for the marginal software seat or incremental ad sale, social media and SAAS don't create new markets or new customers en masse. Both are much more zero sum in their economic impact than the railroads, autos, PCs, etc.

 

For investors, I think what this means is that because the circumstances are more zero sum, these companies will face much more significant competitive dynamics than people envision. For example, if in fact Facebook is largely stealing ad dollars from more traditional advertising channels, one would expect those venues to compete much more aggressively on price. Facebook appears to have a phenomenal business model (high network effects, minimal capital requirements to grow, effectively free content), but their ability to grow revenue without facing significant downward pressure on ad rates (not just from newspapers, television, and radio, but from every other social media platform) is difficult to envision. Facebook has not magically created some new set of circumstances whereby businesses will allocate "new" dollars to a brand new expense line in their P&L. Those Facebook dollars come out of the pockets of Viacom, the Washington Post, et al, who will aggressively fight to recapture those dollars.

[Palantir]

Two words - Lower cost. When you slowly, step by step remove impediments, people can create new markets. By the way, whether railroads were that instrumental in promoting growth has also been questioned, see RW Fogel.

[ItsAValueTrap]

For example, if in fact Facebook is largely stealing ad dollars from more traditional advertising channels, one would expect those venues to compete much more aggressively on price. Facebook appears to have a phenomenal business model (high network effects, minimal capital requirements to grow, effectively free content), but their ability to grow revenue without facing significant downward pressure on ad rates (not just from newspapers, television, and radio, but from every other social media platform) is difficult to envision. Facebook has not magically created some new set of circumstances whereby businesses will allocate "new" dollars to a brand new expense line in their P&L. Those Facebook dollars come out of the pockets of Viacom, the Washington Post, et al, who will aggressively fight to recapture those dollars.

I don't think that's the case.

 

There are:

1- Advertisers who track their clicks down to a sale.

2- Advertisers who are trying to build their brand and can't track their advertising that well.

 

For group #1, you increase your advertising spend until your profits stop going up.  It's not that complicated.  When determining your Facebook budget, you don't care about how much you are spending on Google.  Facebook and Google only compete for the marketer's time.  Because Google tends to drive more traffic, marketers tend to put more time into optimizing their Google campaigns (especially over Bing/Yahoo).  Because Google is the most competitive ad marketplace, its rates are a little higher.  The largest ad platform will enjoy higher rates than everybody else.

 

Group #2 might be different.  I don't really understand that type of advertising.  It's not very empirical/scientific.  Facebook has exposure to that type of advertising.

 

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Google and Facebook and Bing do not set pricing.  Rates are based on a bidding process. 

 

The more complicated answer:

On Google, the highest bidder doesn't always win.

- If the bid is extremely low, Google won't show any ads at all.  Google doesn't want its search results cluttered with low-revenue ads.

- Google has a quality score (which is sometimes frustrating to marketers).  Google doesn't want all of its ads to be the same.  It also wants the ads to be relevant to the search result.  A high quality score will improve ad position.

- The click-through rate on the ad will improve ad position.  That sometimes means that the marketer with the #1 spot gets an advantage, as the #1 spot will naturally have a higher click-through rate.  So sometimes there is a game where you will overspend in the beginning to secure the top spot.

 

On Facebook, certain types of ads are disallowed.  This largely prevents abuse.

 

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*Disclosure:  I'm long GOOG, short CRM TRLA WDAY KUTV

[Guest valueInv]

Good points by both of you. I certainly see benefit in social media and SAAS (our company shifted to Google as our email host a few years ago and would never consider going back to on premise), but nothing seems revolutionary. Having better-targeted ads improves the efficiency of advertising, which actually might argue companies would be able to decrease their ad/marketing expenses.

 

I think the thrust of my original point remains, however. Except for the marginal software seat or incremental ad sale, social media and SAAS don't create new markets or new customers en masse. Both are much more zero sum in their economic impact than the railroads, autos, PCs, etc.

 

For investors, I think what this means is that because the circumstances are more zero sum, these companies will face much more significant competitive dynamics than people envision. For example, if in fact Facebook is largely stealing ad dollars from more traditional advertising channels, one would expect those venues to compete much more aggressively on price. Facebook appears to have a phenomenal business model (high network effects, minimal capital requirements to grow, effectively free content), but their ability to grow revenue without facing significant downward pressure on ad rates (not just from newspapers, television, and radio, but from every other social media platform) is difficult to envision. Facebook has not magically created some new set of circumstances whereby businesses will allocate "new" dollars to a brand new expense line in their P&L. Those Facebook dollars come out of the pockets of Viacom, the Washington Post, et al, who will aggressively fight to recapture those dollars.

Yes, this is the argument I have been making for a while. You are seeing the price competition on the CPCs. There is a limited set of ad budget that is allocated every year. Google has been taking a huge chunk of that with limited competition in the online space. Well, that has begun to change. There are more ad channels coming up and the ad dollars are going to be distributed among them.