Social Networking May Not Be as Profitable as Many Think

The problem for social networking companies like Facebook and Twitter isn't growth: Facebook is about to register its 500 millionth user, and Twitter is now the world's fastest-growing search engine as well as the leader in "information networking."

The problem is how to monetize those enormous user bases into billions of dollars of annual profit.

Ironically, companies large and small are rapidly developing social media and networking-based marketing strategies to grow sales and profits, but these efforts don't directly enrich the social media companies. Indeed, corporate expansion into social media is one of the "hot" career opportunities in a generally stagnant job market.

Games Revenue Pales Next to Advertising

Facebook collects significant revenue from purveyors of online services and games such as Zynga's FarmVille, but the big money is in advertising -- a field that both Twitter and Facebook are still exploring.

Most Web users claim they generally disregard banner ads, and this poses a problem to both the social media companies and their potential advertisers: How can they break through the marketing clutter, which many users tune out? If social media companies fail to offer advertisements that actually work for their advertisers, then they won't be able to charge premium rates for ads.

Facebook is attempting to make use of its vast user base in tailoring ads that aren't just contextual to the content but to their social context.

When somebody writes about their mortgage on their blog or Facebook page, then search engines will place an ad for mortgage rates on that page. That's contextual placement.

Social-Context Ads and Word of Mouth

The social-context ads, which Facebook introduced about a year ago, are based on data it collects on the "likes" and networks of friends of its users. These social-context ads appear on the right side of a user's homepage, and along with the ads are the names of any of the user's friends who previously clicked that they like the brand or ad being displayed. Users can then click a button to add their "like" to the ad or brand.

The basic idea is to expand the gold standard of marketing: word of mouth. Despite all the studies, metrics and innovations, successful marketing campaigns are still largely based on good old word-of-mouth advertising. Thus the hope for social media companies and their advertisers alike is that the global networks of friends and colleagues assembled in Twitter, Facebook and other social media leaders can be used to spark successful word-of-mouth campaigns.

"Marketers have always known that the best way to sell something is to get your friends to sell it," says Sheryl Sandberg, Facebook's chief operating officer. "That is what people do all day on Facebook. We enable effective word-of-mouth
advertising at scale for the first time."

Two challenges have emerged to this "stimulate word-of-mouth" strategy. One is the inherent ambiguities in tracking the effectiveness of any such campaign, and the second is that marketers and promoters are busy exploiting the trust that is the foundation of social networks.

Lack of Reliable Metrics in Online Media

The metrics of online media is so important to the Web that an industry has arisen to fulfill that mission, and a professional conference, the International Conference on Online Media Measurement, was recently held in Lisbon, Spain.

One attendee was David Tiltman, a journalist who has covered the field for years. Tiltman concluded that the industry has no standard metric to measure "buzz" (word-of-mouth) or effectiveness, and thus advertisers are bombarded with loose terms such as "engagement" and "conversation" rather than meaningful metrics.

A number of companies have sprung up to measure the "buzz" created by ad campaigns on social networks. According to Tiltman, "When one delegate asked five different word-of-mouth measurement companies to track his Superbowl ad, he got five different responses. These services sell themselves as tracking tools, but actually they are hugely reliant on human input to categorize brand mentions on social media."

In other words, it isn't as simple as counting friends or clicks.

Canny marketers are also busy inserting counterfeit "friends" and product placement into social networks, undermining the very trust they seek to exploit.

Inflating Numbers of Friends and Followers

One way marketers seek to influence social network users is to inflate the number of "friends" and Twitter followers by purchasing thousands of friends and followers online.

They also deploy Sponsored Tweets and paid referrals -- users are paid to re-tweet Tweets promoting some brand or advertisement -- to create what is in effect a fake word-of-mouth campaign that will supposedly ignite real word-of-mouth buzz.

This dilution and exploitation of social networks may well cause users not to trust any marketing or branding they see on social networks, which would lower the value of social media to advertisers and marketers.

Tiltman described a conversation with a big-name advertising client who was wary of such a metric-free, easy-to-game environment: "Without a proper currency online that allows some sort of comparison between media, he cannot advise heavy spend in digital."

Companies deciding between traditional advertising campaigns that funnel revenue to the social media companies like Facebook, and "viral" word-of-mouth campaigns waged via Tweets and inserting product placement in conversations between online friends, have little to go on.

The People Aren't There for the Ads

"It fundamentally comes down to why people are there on social networks. They are not there to read our ads. They are there to talk to each other," says Scott Monty, the leader of social media at Ford Motor (F).

Rather than spend millions on traditional ad campaigns displayed on Facebook, Ford uses the site's free options to assemble networks of fans who share photos and stories about their Ford vehicles online.

The net result of these fast-moving trends is that social networking companies such as Facebook and Twitter might not reap the advertising revenue many expect. Rather, their potential advertisers will simply use the free tools these networks offer to market their products and services, leaving the actual media companies with little big-dollar advertising.

Bottom line: Social media may remain wildly popular but never be wildly profitable.