A recent edition of Bloomberg Business week (31 Jan – 6 Feb) ran an interesting article on Demand Media and its Chief Innovation Officer Byron Reese. The recent Demand Media IPO has been a significant success and to be clear I wish the Company a successful future. In reading the article however I found myself reflecting on why investors are so bullish about the company? Is the real story Excellence or Exuberence?
Demand Media’s business model is simple but effective. Through a network of over 13,000 contributors they create content (subjects are specified by Demand Media) which focuses on attracting advertising and therefore revenues. Their contributors are not paid highly. The model depends on volume rather than quality and their USP on the company’s ability to identify profitable subjects and niches.
I have identified six weaknesses in this model which give me cause for concern in the long term.
1. Google’s Search Algorithm
Media farm’s such as Demand Media are effectively gaming the Google Search system to find profitable and attractive niches. At present Google does not differentiate or adjust its search results to take account of this. In the event that Google decide to change their algorithm, Demand Media would either need to respond or suffer a fall in revenues from this source.
2. Barriers to Entry
While Demand Media may have developed a clever way to identify profitable subjects, with the plethora of web analytical tools available, most of them for free, this does not strike me as a significant barrier to entry. I grant that Demand Media is ahead of the game – Comscore data rate it the 17th largest web property in the US – first mover advantage is not always enough.
3. Content Quality
The business model is predicated on smart SEO and quantity rather than quality. In contrast the AOL acquisition of the Huffington Post last week was all about acquiring quality content. In the long term I do not feel that quantity will win out over quality.
4. Page Metrics
According to Alexa the average visitor to eHow – Demand Media’s most visited site – spends only 2.3 minutes and clicks on 1.7 pages. Facebook’s comparative metrics are 31.9 minutes and 12.7 pages. This raises the question of the value of the brand and brand loyalty.
5. ARPU – Average Revenue Per User
This metric measures the value of each user and is a useful metric for assessing the quality of the digital enterprise and its business model. Amazon makes on average $189 per unique user, Google about $24 but Demand Media currently makes only $1.6o per unique user
6. IPO Metrics
The historic financial statements of the company show that the company is yet to make a profit. In 2009 the company lost $22.4 million on turnover of $198.4m. In the first nine months of 2010 the company lost $6.3m on revenues of $179.3m. Now I understand that companies grow and some take time to move from loss to profit but my concerns about the business model lead me to question whether this is really a $200m company.
On 10 February 2011, the New York Times had the following quotation from Matt Cutts from Google:
““We definitely have heard feedback in the last two weeks that people are concerned about the low-quality content farms in Google, and we’re working on a variety of algorithms to try to address that,” Matt Cutts, a principal engineer at Google who leads the Web spam team, said in an interview. He declined to single out any specific sites.”
In summary, I am concerned that we are once again in a technology ferment, with investors starting to chase ever more extravagant valuations and business models. Certainly web 2.0 is much more soundly based than the .com boom ever was but I would strike a note of caution when looking for the next big thing and go back to some fundamental business analysis before rushing out to make bets on the market.
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