Thursday, January 3, 2008

Internet's next big wave

David George-Cosh, Financial Post Published: Monday, December 31, 2007

Microsoft chief executive Steve Ballmer says online advertising will become 25% of the company's business within a few years.Christian Hartmann/ReutersMicrosoft chief executive Steve Ballmer says online advertising will become 25% of the company's business within a few years.

TORONTO - Inside a cramped conference room at Toronto's MaRS Discovery Centre, angel investors listened closely as Nussar Ahmad pitched the future of the Internet.

Equipped with just a cellphone and a laptop connected to the Web, Mr. Ahmad, director of Addictive Mobility, demonstrates how his company's latest software application has the ability to cash in on the world of social networking - the Web's latest gold mine.

Using code supplied by Facebook, Mr. Ahmad's software can take pictures snapped on a camera phone and instantly send them to a Facebook profile page.

While the software is in its early stages, Mr. Ahmad plans to launch the program to the public free and introduce pay structures after enough early adopters make it "go viral."

Although the PowerPoint presentation was technical, Mr. Ahmad's audience was sold long before the pitch was complete.

"They didn't ask many questions; they were already sold," Mr. Ahmad said. "They all want to help me out and introduce me to potential investors."

Addictive Mobility is seeing clients from Mazda and Brisk Iced Tea knocking on his door. "I couldn't have done this six months ago," he said. "Social networking has given me an opportunity I could only dream of."

Today, there are hundreds of thousands of new application developers and content generators being created for sites like Facebook, MySpace and a slew of other social networking sites fueled by money being poured into the industry by the demand to advertise as much as possible online.

According to online market research firm eMarketer Inc., worldwide advertising spending at social networking sites jumped from US$480-million in 2006 to US$1.2-billion this year. By 2011, that number is expected to grow to US$4-billion.

Those numbers are backed up by British online advertising trade group, the Internet Advertising Bureau. In October, the IAB reported Internet marketing had grown 41.3% in the first half of 2007 and now accounts for 14.7% of the British ad market.

No other Web site has taken advantage of the online advertising cash windfall more than MySpace. After Rupert Murdoch's News Corp, purchased MySpace for US$580-million in July 2005, analysts questioned the hefty price tag for what was then a crowded online hangout for kids. But as the Web site boasts more than 220 million registered users and is finally turning a profit, that price seems a bargain now.

According to News Corp. officials, MySpace exceeded US$500-million in revenues in the 2007 fiscal year. While News Corp. doesn't release specific numbers on its subsidiaries, its Fox Interactive Media unit, which largely consists of MySpace, turned a profit of US$10-million. And with last year's US$900-million contract with Google to provide the back-end for the search engine's online advertising network, those profits should continue to grow.

Facebook, MySpace's closest competitor, grew from a Harvard University dormitory experiment to the darling of Silicon Valley in only two years. With 47 million users around the world and growing at a rate of 200% per year, Facebook made headlines last month after Microsoft Corp. purchased a 1.6% stake in the company worth US$240-million, thus indcating Facebook had a value of US$15-billion.

The temptation to target Facebook users with specifically tailored ads using information the users reveal is in line with Microsoft's long-term plan to be a heavyweight in the online ad world. Chief executive Steve Ballmer told a consortium of European ad agencies in October that online advertising would become 25% of the company's business within a few years.

But perhaps the surest sign that social networking has become the Web's next big profit centre was Google's announcement last month that it plans to dive headlong into this sector by uniting the fractious world of social networking Web sites with one standardized set of programming code.

It's a dramatic change in direction for the Internet's 600-pound gorilla, which currently receives 99% of its revenues from online advertising. The "OpenSocial" application platform exists in a pre-beta format with selected developers and is expected to be released early next year.

"We want to help build the fundamental social infrastructure for the Web," David Glazer, an engineering director at Google responsible for OpenSocial, says. More to the point: "More people spending more time on the Web is good for Google's core business."

Indeed, there hasn't been this much optimism in the tech world since before the dot-com bubble burst several years ago.

"You're finally seeing an industry mature. In 2000, it was a very immature industry where dreams and candy were being sold and bought by the financial community," says Tera Capital president Howard Sutton, a Toronto-based hedge fund manager. "Now, we've got more stable platforms and sophisticated investors."

In the 1990s, any company with a .com suffix garnered hype and valuations in the millions. "[Today], bad companies aren't being financed; bad companies in 1999 were being finance," Mr. Sutton said.

One thing that hasn't changed much from the early dot-com days, however, is how quickly the latest Internet gold rush has formed.

"You've got these young companies coming up with ideas, and the pervasiveness of how quickly these companies can catch the wave," he said. "It's just a different business and moves at an entirely different speed."

Today's online communities rose from the ashes of the poorly designed, circa-1999 dot-com sites when users began offering up detailed information about their daily activities. The sites became sophisticated enough to translate that data into a marketer's dream scenario.

But it wasn't until recently, when broadband speeds became affordable for consumers, that the social Web phenomenon took off.

"When you have a big innovation, like electrical power or the telephone, you always get a similar set of activities," said Don Tapscott, author of Wikinomics: How Mass Collaboration Changes Everything. "First off, you get experimentation, then investment, excitement, speculation and a bubble," he added.

"The bubble always bursts, as it did with dot-com, but after that you get decades of long-term deployment where the real impact of the technology becomes understood on business models, economy and society," Mr. Tapscott said.

"Having the bubble burst in people's faces set people in the mindset to create businesses that provided something material for users," said Amit Kapur, MySpace's vice-president of business development. "[With MySpace], everything fell together at the right time and created this innovative product combining all these other user experiences from other sites on the Web that weren't making the most of their technology."

Matt Cohler, a Facebook vice-president and one of the site's first employees, says the online advertising business model is still a very narrow slice of a marketer's budget, and it's up to sites like Facebook to innovate and create new revenue streams.

Still, there is no sure bet on the Web, even for Facebook. The site's drive to appease marketers with its most recent advertising platform, dubbed Beacon, has failed. The site partnered with third-party Web sites that place unauthorized messages in users' news feeds. It infuriated the Facebook community, who said the practice was a blatant invasion of their privacy.

"We moved too quickly when it came to Beacon," Mr. Cohler admits.

Duncan Stewart, director at Deloitte Canada Research, agrees. "The lesson of Beacon is not that it can't be done or even if it was done wrong, but it must be done cautiously," Mr. Stewart said.

But try telling that to social networking phenoms like California-based software company RockYou, developers of Super Wall, which has more than 2.6 million subscribers, as well as about 400 other Facebook applications. A new advertising platform geared towards Facebook developers - with more than 10,000 already signed up - it will drive revenues into the "tens of millions or higher," said Lance Tokuda, RockYou's chief executive and founder.

"The space we're shooting for is bigger than Yahoo's presence on the Web," Mr. Tokuda said. "Four of the top 10 sites in the world are social networks and we're looking to expand into e-mail and instant messaging."

Financial Post