The Social Network Valuation Equation
Posted by Nick O'Neill on June 24th, 2008 9:00 AMFor the past few days, there has been intense conversation surrounding the valuation of social networks. It began with Andrew Chen’s analysis of Facebook and MySpace which leveraged Google’s new Trends for Websites services.
Not only does Andrew suggest that, “social networks have weaker network effects than previously speculated” but he also suggests that not all social network users were created equal. His basis is that ad spending in the U.S. is quadruple the size of the next largest advertising market, the U.K. Yesterday, Mike Arrington furthered supported this argument by creating his own point based system which associates average valuation model which connects the average ad expenditure per person in each country and multiplying that into the size of each network.
I’ve done some research myself over the past 12 months and I’ve come up with my own equation:
Social Network Valuation (SNV)
=
(Repeat Monthly Visitors x Engagement x Virality) / Nobody Has Any Idea
As you can clearly see in my heavily researched equation, nobody has quite figured out the answer to how much a social network is worth. The biggest challenge is that nobody has yet to figure out how to effectively monetize these sites. If you’ve attended any of the industry events you’d also know that the primary reason is that advertisers have not figured out how to measure this yet.
While I believe exploring various metrics to determine more “accurate” valuations is an important exercise, I’m not sure that the models used so far are the most effective. What do you think are the most effective models for determining social network valuations?
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The first = number of impressions. This is the classic measure of most media (CPMs in print or online, GRPs in broadcast), and the potential "virality" of social media is what gets so much hype. The hope that a message will go viral and make millions of impressions at almost no incremental cost is what gets people so excited about social networks.
But the second measure = responsiveness of the audience. This is where social media falls down, because on a scale of 1 to 100, responsiveness is probably around a 1 or 2. A good example of responsiveness on the other end of the scale is Google search results, where a consumer is actively seeking a service, say "media planning," sees a text ad offer said service, and so is very likely to respond (or click). The "mode" of that user is active hunting.
In social media, however, people are doing something completely different: being social. Their responsiveness to any ad message is very low, because the message is peripheral to the dynamic at hand. People chatting on Facebook or Tweeting on Twitter are like close friends socializing in a bar. A widget or banner ad offering a service, even if targeted to the demo, is reaching people when they are not in the mode to respond.
This doesn't mean that social media can't have value. It does mean that the valuation of a social network must factor in both impressions (all that hype about virality) *and* the propensity of each impression to create a response.
A simple way to calculate value would be to examine the potential profit derived from ad sales in a social network, calculated as responses times profits. Or:
SNV = [(total users) * (total response rate)] * (close rate) * profit per sale
A social net with 1 million users that had a *total* 2% response rate among *all offers* extended to its customers annually (say, each campaign had a 0.10% response rate and customers were exposed to 20 such campaigns a year) would generate *20,000 total responses*. Then, at a 10% average close rate, and $100 average profit per sale, the net would thus be "worth" $200,000 ... or about 20 cents per user. You could extrapolate this to the lifetime value of users, but given the short trends of social media, that timeline might be just 1-2 years.
But hey. Who knows?
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