The Amazing Business Model of Web 2.0

Today's internet is an amazing thing:

This blog contains no advertising, and yet it is totally free, including an archive of all previous posts. I have a free Yahoo e-mail account with unlimited storage. A free Flickr account. A free Facebook account (which I never use). I can use an endless number of free forums, where archived discussions dating back 5 years or more are still fully available. I hardly use YouTube and never used Twitter, but lots of other people do, and for free as well.

So what, you might say: After all, how much can it cost to run a highly-automated website?

Quite a bit of money, as it turns out:

According to this article, YouTube is burning money like crazy:

Despite a 41% share of the video market, Credit Suisse analysts Spencer Wang and Kenneth Sena project YouTube will only pull in $240 million in revenue this year. That's up 20% from 2008. But ... the costs of running YouTube are astronomical: About $711 million, with $360 million in bandwidth charges alone.

How come a successful business is losing so much money? Can't they simply run more ads? This article thinks they have no chance:

This half-billion dollar loss comes after more than a year of feverish experimentation in various forms of advertising, cross-product embedding, licensing and partnership deals. YouTube is adamant that ultimately they’ll find an advertising solution ... to reach profitability. Looking at the math, it doesn’t seem likely ... Presumably, the videos YouTube is already monetizing represent the best content available, with diminishing returns as they reach deeper and deeper into a repository rife with copyright violation, the indecent, the uninteresting, and the unwatchable .. It seems safe to assume that YouTube’s traffic will continue to grow, with no clear ceiling in sight. Since the majority of Google’s costs for the service are pure variable costs of bandwidth and storage, and since ... no greater economies of scale remain, the costs of the business will continue to grow on a linear basis. Unfortunately, far more user-generated content than professional content makes its way onto the site, which means ... non-monetizable content is growing geometrically as compared against the monetizable content that YouTube really wants and needs to survive. ... less and less of YouTube’s library will be revenue-contributing, while the costs of delivering that library will continue to grow.

YouTube is owned by Google, which so far picks up the tab. And while Google can in principle afford it (Q1 2009 financials seem as healthy as ever), shareholders won't be thrilled to keep subsidizing a business that loses so much money.

And it's not just YouTube: According to The Guardian, US data centers accounted for 1.5 % of total US electricity use in 2005 (that doesn't include end-user PC electricity use). Due to rapid annual growth of 10 % and more, the figure is projected to reach nearly 2.5 % by 2010. 2.5 % of all the electricity used in the US - that must certainly cost a bundle. Not to mention the cost of all that hardware.

Meanwhile, even some former stock-market darlings are beginning to struggle: Yahoo's Q1 2009 revenues were down 13 % yoy, and profits were down 78 % (to a mere 118 m US$).

Remember GeoCities? Yahoo paid 3.5 bn $ for it in 1999, and is unceremoniously closing it down now, says this article.

Then there is MySpace, currently owned by Rupert Murdoch. According to this NYT article, MySpace has made a profit of 200 m $ in 2008. Sounds good. Unfortunately, the profit is due to 900 m $ guaranteed revenues from Google. The contract is up for renewal next year, and Google is apparently quite unhappy with the revenue generated from MySpace. So the odds are the contract will be cancelled or renewed at much less favorable terms.

And Facebook? Nobody know how much money it is losing, but it is definitely burning money.

This NYT article argues that Facebook is currently taking off in the third world. User numbers (and therefore costs) are increasing very fast. Unfortunately, most of those third world customers are not particularly interesting for advertisers, so revenues can't keep up. A snippet from the article:

Facebook said last month that it was on track to become profitable next year. But as it did, Gideon Yu, Facebook’s experienced chief financial officer, left the company. Three people familiar with the internal maneuverings at Facebook said Mr. Yu objected to such a rosy projection as the company was struggling to finance its expensive global growth.

It may well turn out that the days of ever-expanding free web-applications are numbered. Except, of course, for the solidly profitable Google search...