A recent piece in  the Economist raises a provocative question: social networking sites such as Facebook, MySpace, and Bebo have grown tremendously in usage, but are they viable businesses? In other words, is it possible to monetize these services in an effective fashion? To answer this question, it helps to take a step back and look at the monetizability of social media as a whole.

Since most social media sites rely on advertising revenues, let us restrict ourselves to advertising as the monetization mechanism. Regardless of the ad model used --cost per impression (CPM), cost per click (CPC), or cost per action (CPA) -- advertisers value three key measures: reach, frequency, and targeting. Many social media sites certainly score high on reach and frequency, but how do they fare on targeting? Targeting is key, because it determines the CPM rates advertisers are willing to pay. And CPM rates vary very widely: from $16-20 for TripAdvisor to $0.10 for Facebook and MySpace.

What drives such a wide divergence in CPM rates among social media sites? Are the low rates at social networking sites a transient aberration, with higher rates around the corner?

Is there a simple model to predict the targetability of different forms of social media?

Remarkably, there appears to be a single factor that explains a great deal of the available data. Consider the difference between a Facebook profile and a TripAdvisor travel review. A typical pageview on the former is by someone known very well to the creator of the profile -- a close friend or acquaintance. On the other hand, a TripAdvisor travel review is seen by people completely unrelated in any way to the person or persons who wrote the reviews on the page.

We quantify this distinction with a measure called “affinity.” The affinity of a social media service is the average closeness of relationship between a content creator and someone who views that content.  The affinity of Facebook is very high, while the affinity of TripAdvisor is very low.

Now for the key observation: There is an inverse relationship between the affinity of a social media service and its targetability. Why is this true? The act of viewing a Facebook profile gives us very little information about the viewer, other than the fact that she is friends with the profile creator; when someone views a TripAdvisor travel review, she is definitely interested in traveling to that location.

There is a strong inverse proportionality between the affinity and the targetability for several forms of social media, with a couple of outliers. We’ll get to the outliers in a moment; for now, note that social networks and photo-sharing sites have even higher affinity (and therefore lower targetability) than e-mail. This is because we often e-mail people we don’t know or know only in passing. Instant messaging (IM) has the very highest of affinities: my IM buddy list includes only my very closest friends, who I trust with the ability to interrupt me any time of the day.  (See graphic at my blog.)

What about the outliers? Video sharing sites, such as YouTube, have low affinity, because the majority of people see videos posted by people they don’t know. However, the targetability is lower than we would expect, because of a compensating factor: herding. Most people see videos featured on lists such as “Most Popular,” which reduces the targeting value of such videos. This is also true of social news sites, such as Slashdot and Digg.

A  couple of caveats:

  • This is a broad brush-stroke, and individual services might well differ from the overall category. For example, popular blogs have much lower affinity and therefore much higher CPMs than the typical blog.
  • Targetability is not the only factor determining CPM; there are others. For example, certain viewer intents are inherently more valuable than others.

But with these caveats, this simple model is highly instructive. We may conclude that the CPM rates of IM services will not exceed those of social networks, which will not exceed those of e-mail. These are inherently low CPM businesses.

What can social media sites do to increase their CPMs? There appear to be two options:

  1. Create sections of the network that are more topic-oriented, and less about individuals. For example, band pages and groups on MySpace, and Facebook groups.
  2. Mine individuals’ profiles, or their off-site behaviors, to target them behaviorally rather than contextually. This approach carries with it dangers of privacy violations, as the Facebook Beacon fiasco demonstrates.

If social networks are to become a viable business, and therefore a viable advertising medium for businesses, particularly small and mid-sized companies, they need to aggressively pursue one or both of these approaches. Of course, it may be possible for some services to sidestep this question entirely and develop business models that don’t depend on advertising. We haven’t seen such a model emerge yet, but there is so much creativity and ferment in this space that it might just happen.

Anand Rajaraman is co-founder of the search engine Kosmix. He also sits on the board of several technology companies and currently teaches at the Computer Science department of Stanford University.