The Challenge of Social Networking
Jay is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
While people can use LinkedIn (NYSE: LNKD) as a free social networking service to build professional connections, the company must link marketers and recruiters to its network of professionals in order to generate revenue. For LinkedIn investors, the company not only operates a social networking site for individual professionals, but also provides marketing and recruiting services to enterprises and organizations. Similar to how services are offered by other social network companies, LinkedIn’s free social networking service by itself doesn’t earn the company a profit. But unlike others that have become primarily reliant on ad spending by marketers for revenues, LinkedIn has found another revenue source by leveraging the site’s massive professional profile data to offer fee-based recruiting assistance to hiring managers.
Effective user monetization has long been a challenging issue for online companies whose business model is based on providing free services to site users and making money by selling something else to a different constituent, mostly advertisers. With the exception of Google (NASDAQ: GOOG) and to a lesser extent, other online search engines, companies using such a business model have yet to prove the value of their revenue generation. Search engines generally can better attract marketers as it’s easier to pair ad displays with specific, relevant search terms. On the other hand, companies such as LinkedIn and Facebook (NASDAQ: FB) offer users free access to their online applications and have to really convince marketers that their ad displays can also be tailored to particular users’ interests. For social network companies, there can potentially be a disconnect between the quality of a site’s service for users and the flow of ad traffic for advertisers. LinkedIn in 2011 generated less than 30 percent of total revenue from its marketing solutions, a decrease from 2010. Also, Facebook lately admitted its ineffectiveness in translating its fast user growth to a comparable increase in ad revenue.
Getting users to subscribe to a Website’s service is always a hard sell, largely because the Internet started as a free information medium. Most Internet users expect non-restricted browsing of Web pages and likely resist paying for viewing and using Web content. The Internet is particularly effective when used as a means to facilitate the running of a business of a traditional nature. Yes, Amazon (NASDAQ: AMZN) is considered an Internet company, but it uses the Internet mostly as an online channel to sell physical goods. In contrast, social network companies, like LinkedIn and Facebook, use the Internet as a destination for their services that cannot be replicated offline. Here the Internet is effective as the online application platform, almost an impediment to generating direct service revenue without user purchases.
It may become a common practice someday that non-public and proprietary online applications all demand subscription-based access. LinkedIn for now offers certain enhanced services to paying subscribers only, but this is not a significant part of the company’s revenue. LinkedIn’s total revenue is about $500 million annually, only around five percent of its market capitalization of almost $10 billion, illustrating the difficulty for a social network company to bring in revenue.
One revenue source that LinkedIn investors may want to pay attention to is the company’s recruiting service. The company charges enterprises and organizations for using LinkedIn to locate new hires. Operating in the recruiting segment, LinkedIn faces competition from other more established recruiting agencies such as Monster Worldwide (NYSE: MWW), which offers recruiters access to a pool of job seekers’ resumes on its Website. But LinkedIn apparently compiles richer data profiles of its site users, given the additional information it has about users’ professional connections and their activities in participating professional groups. Offering recruiters highly relevant information will give LinkedIn a competitive edge over its rivals. In fact, there has been reports about Monster considering to sell itself amid the current dismal hiring environment. Monster stock is now trading at a discount of abut 85% to its book value. Still, only half the size of Monster in equity value and annual revenue, LinkedIn may not have the financial resource for a Monster deal.
Unless they can somehow switch to a fee-for-service business model, social network companies like LinkedIn will have to rely on other lines of services to target paying corporate customers. It’s challenging for a social network company to develop and run different lines of unlike services in order to be profitable. The same also goes for investors: when investing in a social network company, investors are also investing in something else that also holds the key to both the company and investors‘ financial success.
JJtheArdent has no positions in the stocks mentioned above. The Motley Fool owns shares of Amazon.com, Facebook, Google, and LinkedIn. Motley Fool newsletter services recommend Amazon.com, Google, and LinkedIn. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.If you have questions about this post or the Fool’s blog network, click here for information.