Betting on Betas: How Internet Entrepreneurs Are Creating New Paths to Online Revenue

Americans bought more than $127 billion worth of goods and services in 2007 from huge online retailers such as Amazon, Staples and Dell Computer as well as a host of smaller ones offering everything from dating services (eHarmony) to virtual pets (Marapets). In fact, consumers piled so much into online shopping carts that they spent about 25% more than they did in 2006, according to data from the U.S. Department of Commerce. But that figure still represents less than four percent of overall U.S. retail sales. 

And it doesn’t even begin to account for the revenues of those companies (so-called intermediaries) who don’t directly sell goods and services but instead use the Internet to link customers with content, products and services, and collect advertising and other fees for doing so. Think Google, which made $16.5 billion last year, nearly all of it from advertising revenues.

Still, despite the huge potential of the Internet market, few companies have been successful in developing effective new modes of generating revenue online, according to Eric Clemons, Wharton professor of operations and information management. Instead they have viewed the web as just another media outlet for traditional advertising, which, said Clemons, is forcing “the new into old models…a shotgun wedding at best.” Clemons spoke at the recent Supernova conference, an annual technology event in San Francisco organized by Wharton legal studies and business ethics professor Kevin Werbach. Clemons argued that there are numerous possible sources of value from the Internet that have yet to be converted to revenue, particularly in the area of online services.

Uncovering these new sources of value are executives such as Craig Sherman, CEO of San Jose, Calif.-based Gaia Online, and Doug Mack, vice president of creative solutions services for Adobe, also in San Jose. They participated in the Supernova event to discuss how they are developing alternative business models on the Internet.

Getting Them in the Door

At Gaia Online, more than 300,000 users participate each day in massively multiplayer role-playing games, creating their own avatars and interacting within the virtual world of Gaia. They pay nothing to participate, but buy nearly $1 million a month in virtual goods. Adobe, a long-time leader in software and technologies that allow content to be displayed on a variety of digital devices, just introduced Photoshop Express, an online tool for uploading, sorting and editing digital photos as well as sending them to friends or embedding them on blogs. The price? Zero. The potential payoff? A mass of first-time Adobe users, a percentage of whom will decide to buy other Adobe software or services. As with these examples, the most effective online business models “tend to be longer-term, more about developing a two-way relationship than a single transaction,” said Clemons. “They provide high information content, and seek to alter the user’s perceptions.”

Craig Sherman would undoubtedly agree. Gaia attracts five million users a month to its virtual world, making it one of the largest such sites in the real world. Users, mostly teens and young adults, discuss issues in active forums and participate in multiplayer online role-playing games with avatars they create. The site was launched in 2003 by a group of comic book artists who were fans of Japanese anime. They initially asked for donations from users to keep the site going, and “got three times more than they requested,” said Sherman. Out of that strong user involvement came the firm’s idea that diehard Gaia fans might also buy virtual goods. “We really got the audience and then stumbled onto the idea for the business model.”

Today Gaia makes most of its revenue from selling two or three limited-edition virtual items each month, at $2.50 each — gear such as a black ops function to help an avatar move undetected at night. As the collectibles get older, scarcer and more valuable, their owners can sell them later in Gaia’s marketplace in exchange for the site’s virtual money, Gaia Gold. Another, much smaller source of revenue is physical merchandise, such as caps and t-shirts, based on some of the most popular virtual items. Only in the last 12 to 18 months has Gaia experimented with advertising on the site, mainly sponsorships, which are intended to create experiences that are “fun and meaningful to the Gaia community as well as beneficial to sponsors,” said Sherman. In a recent example, Gaia partnered with New Line Cinema to promote the 2007 sci-fi film The Last Mimzy. Gaians could conduct a short quest that led them to preview the film’s trailer and then retrieve a virtual Mimzy plushy toy to pair with their avatars.

Adobe is out to create an experience of a different sort. Photoshop Express gives the amateur photographer a slick, easy-to-use version of the company’s industry-leading Photoshop graphics software for professionals. Express allows a digital camera user to upload, edit, store and share photos — as well as integrate with other services like Facebook, Photobucket and Picasa. From the outset Adobe treated Photoshop Express as a nontraditional product. The company held a virtual press conference to announce the service’s Beta launch in March, focusing much of its communication on bloggers rather than traditional analysts. It continues to gather data from users of what Adobe’s Mack called “a living Beta,” asking them to “help us get this right.” With Photoshop Express, said Mack, Adobe’s goal is to “focus on making the user experience great, making it so good that people will want it. If you can do that, you’ll acquire an audience. If you can attract a really big audience, that unlocks every business model.”

The value from Photoshop Express will presumably come in the form of opportunities to sell additional premium services, other products and potential advertising, as well as deals in which computer manufacturers would buy licenses to preinstall components of the Photoshop Express software. All of that will be needed to offset the undoubtedly large cost of building the hosting infrastructure to support the new service — and presumably others to come.

But, said Mack, “You don’t have to think about every application making money. You also have to ask: ‘What’s the value to the rest of the business’” if even a small percentage of a huge consumer market decides to trade up to more expensive software?

Monetize ASAP

Another way to “monetize” the Internet is to provide services to the many companies using the web as an advertising medium. That’s the niche that Clickable has chosen to exploit, explained Supernova speaker David Kidder, co-founder and CEO of the New York start-up company, which launched its first product in February. Kidder also spoke at the Supernova conference. Clickable’s new software-as-a-service gives small and mid-size companies the ability to easily create and manage Internet advertising. Any company hoping to succeed at e-commerce, he said, needs to master the often complex process of search engine marketing: understanding how search engines work, how much to bid for key words and ad placement on a search page and how to analyze ad performance data.

Clickable provides marketers with an interface that they can use to manage their advertising across multiple search engines. The tool also automatically retrieves campaign data, analyzes it and makes recommendations to improve ad performance. It runs on Clickable’s servers and displays in a browser. According to Kidder, the company got a clear message about market demand for the service when 3,000 applicants signed up for 500 slots after a September 2007 call for beta testers. Clickable had decided to “push the product early, so we could test and be realistic about what customers really wanted,” noted Kidder. In the process of developing and building such a product, “there’s usually a point where you face a courage and esteem crisis as to whether the product is really good enough to ask someone to pay for it. But, when it comes to monetization, I’d advise doing it early.”

Whether monetization comes early or late, experimentation with new and interesting variations of business models on the web is likely to continue, added Wharton’s Clemons. “Watch for companies that will monetize experiences, community content, social search, augmented reality and mobile advertising. But beware of investments that are tailored spam or an invasion of privacy — or the monetization of snooping in general.” The challenge is not only to think creatively about alternate revenue models, Clemons added, but also to meet the challenges these new models may pose for overall strategy, management and systems.

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