The problem with online “local” businesses

One of the most popular areas for startups today is “local.”  I probably see a couple of business plans a week that involve local search, local news, local online advertising, etc.

Here’s the biggest challenge with local.  Let’s say you create a great service that users love and it gets popular.  Yelp has done this. Maybe Foursquare, Loopt etc. will do this.  Now you want to make money. It’s very hard to charge users so you want to charge local businesses instead.

The problem is that, for the most part, these local business either don’t think of the web as an important medium or don’t understand how to use it.  Ask you nearest restaurant owner or dry cleaner about online advertising.  They don’t see it as critical and/or are confused about it.  Even Google has barely monetized local.

People who have been successful monetizing local have done it with outbound call centers.   The problem with that approach is it’s expensive.  Even if you succeed in getting local businesses to pay you, it often costs you more to acquire them than you earn over the lifetime of the relationship.

To add insult to injury, local businesses often have very high churn rates.  I have heard that the average is as high as 40%.  Anyone who has done “lifetime customer value analysis” can tell you how that ruins the economics of recurring revenue businesses.

Hopefully this will change in time as local businesses come to see the web as a critical advertising medium and understand how to make it work for them.  But for now, monetizing local is a really tough slog.

* This is what I hear from industry sources.  If readers have better numbers or sources I’d love to hear them.

The new economy

According to the Business Insider, Facebook is “‘Beating The S— Out Of Its Numbers’ Thanks To Zynga’s Virtual Goods.”  I wanted to try to understand this new, emerging economy.

It all starts when a user sees an ad on Facebook:

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After clicking and installing the app, she gets a little farm where she can grow tomatoes and such.

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Game seems pretty fun.  But she runs out of seeds, and wants more.  So she goes shopping for virtual goods.

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Let’s say our protagonist is too young to have a credit card, so she decides instead to buy coins by signing up for a free offer.

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She decides to download a toolbar.  Free greeting cards seem like fun.

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The download puts an Ask.com search toolbar in the user’s browser.  Ask.com makes money off search ads.  Ask probably paid $1 to $2 for the install.  Some portion of that goes to Zynga, and then back to Facebook when Zynga advertises.

Farmville apparently does not advertise on Ask.com:

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Thereby preventing the entire new internet economy from imploding in an endless cycle of circularity.

Google and newspapers: the false choice of opting out

First let me say I love Google.  I think Google created one of the greatest inventions of the past century and continues to give back much more value to the world than they “capture” in revenue.

Secondly, I think Google itself has almost nothing to do with the decline of newspapers.  That is due to, among other things, 1) the newspapers losing their classified business to Craigslist and others, 2) the internet making geography irrelevant and hence causing newspaper competition go from 1 or 2 papers per market to thousands.

That said, I am bothered by the arguments I hear in internet circles of the form:

Premise 1:  X can stop working with Y at anytime.  (NYTimes could opt out of Google search results / Google news at any time)

Premise 2:  X would lose out if it did that (NYTimes would lose traffic and revenue if they opted out of Google).

Conclusion:   Hence Y is helping X.  (Google is helping the NYTimes and the NYTimes should stop whining.)

The conclusion doesn’t follow from the premises.  The NYTimes might in fact be better off in a world without Google.  More specifically, they would be better off if the search engine market were genuinely competitive.

The power dynamics between Google and the newspapers has the same dynamics of any buyer-supplier market.

Newspapers, like all websites, are suppliers of content to Google.  In most markets, with genuinely competitive buyers and suppliers, the revenues are shared between buyers and suppliers in proportion to their relative bargaining power.  Their bargaining power depends on how fragmented each side of the market is – how many genuine alternatives each company has.

Normally there is some reasonable level of interdependence between buyers and suppliers, hence the revenue split is positive and non-negligible. Pepsi and Coke are always jostling with their bottlers about the percentage split but in the end each side usually makes a profit.

And in situations where the relative bargaining power is severely imbalanced, there are normally business mechanisms for correcting the imbalance.   For example, before Staples was founded, office supply stores were mostly mom-and-pop shops that were tiny relative to their suppliers, and hence had very little bargaining power.  The central business concept behind creating Staples was to “roll up” these shops and thereby increase their bargaining power with their suppliers.  In doing so, they were able lower their costs and increase their margins even while lowering their prices.   One of the primary reasons companies merge is to increase bargaining power with respect to buyers and suppliers.

As a “buyer” of web content, Google has incredible dominance, so much so that the price they pay for that content is zero.  If the NYTimes decided to opt out of Google tomorrow, Google users would barely notice.  (Perhaps the only content site that would matter and hence in theory could bargain with Google would be Wikipedia – but even Wikipedia only accounts for ~2% of Google click throughs).  On the flip side, the NYTimes would see a massive decrease in traffic and hence ad revenues.  Google has so much power they can split 0% of the revenue for organic traffic (and of course charge for paid links).

Now imagine a world where search engines are truly competitive.  I know it’s hard – but imagine there are say 20 search engines, each with 5% market share.  And suppose they differ primarily according to which content sites they index.  (I am not saying I’d prefer this world – I’d actually hate it – but please bear with me for the sake of argument).   On the content side, suppose there are only a couple of newspapers left – maybe the NYTimes, WSJ, USA Today, and the Financial Times (which, btw, will probably be the case in a few years).  In this situation the newspapers would have enough leverage to get the search engines to pay them for inclusion in their organic listings.  I know that in my own case if two search engines were nearly identical except one included my favorite newspaper and the other didn’t, I’d use the one that did.  I suspect a lot of other people would make the same decision.

There is nothing inherently un-monetizable about newspaper content.  Like all goods and services, if newspaper content has value to people and is scarce (it’s not scarce today but as more newspapers go out of business will become increasingly so), they can eventually generate sustainable revenue (albeit probably operating at a much smaller scale).  The revenue can come either through consumers paying directly or buyers like Google sharing revenues, or some combination thereof.

For the moment, and for the foreseeable future, newspapers (and all content sites) just happen to be in a dreadful bargaining position with respect to Google.