2011 Consumer Internet Predictions December 3, 2010

Once again Lightspeed is going on the record with some prognostications for what the future holds. Before I try gazing into my crystal ball to see what 2011 will bring for the consumer internet industry, let me first see how I did on last years predictions:

1. Social games overflow out of Facebook

Grade: C+. While the amount of social gaming on other social networks, especially the Asian networks, has significantly increased over the course of the year, the vast majority of social gaming still takes place on Facebook. While Farmville.com now has 6M UU/month, this is still only 10% of the number playing Farmville on Facebook.

2. Brand advertising starts to move online, boosting premium display, video and social media

Grade: A. The recovering economy has really boosted brand ad budgets in 2010, with online ad spend back to setting records again. Automotive and CPG in particular are both seeing significantly increased online budgets. The online video networks are doing terrific business, and even Yahoo is benefiting from increased brand spend, seeing revenue growth for the first time in a while. Many brand advertisers are spending their experimental budgets widely in social media as they attempt to figure out how to promote themselves through Facebook, Twitter, Foursquare and other platforms. The key driver of this renewed confidence from brand advertisers is better measurement of brand metrics that can show the impact of online advertising beyond clickthrough.

3. Direct Response Advertising becomes ever more efficient

Grade: A. According to Adsafe, approximately half of display advertising inventory is now moving through exchanges, Demand Side Platforms (DSPs) and realtime bidding platforms, with another 23% moving through Facebook’s self service ads. These platforms are rapidly commodifying a lot of “low quality” ad inventory, enabling the use of data and targeting to find the best use of this inventory, and thereby creating a very efficient marketplace. Direct response advertisers have benefited the most from this transparency.

4. Finding money and saving money online

Grade: B-. Saving money online has been a real driver of ecommerce growth in 2010. The breakout categories of 2010 are Local Deals (Groupon, Living Social* etc), and Flash Sales (Gilt, RueLaLa, HauteLook, Ideeli etc), and both are squarely aimed at helping consumers save money. Finding money online (principally online lending) has not seen the same level of explosive growth in the US, although in Europe and India there has been real growth in microlending (including “pay day loans”) from companies ranging from Wonga to SKS Finance. I think we’ll see more from the online lending space in 2011, so I may just have been too early on that part of the prediction!

5. Real time web usage outpaces business models

Grade: B-. Twitter continues to grow in usage, overtaking Myspace to become the third largest social network in the world. Foursquare and Gowalla have grown too, but off of much lower bases, such that only 4% of internet users currently use a check-in service. Facebook also joined the Location Based Services (LBS) party this year, enabling Facebook places, which some speculate is getting 30M users already. Last year I speculated that monetization would be hard for these businesses since CPM models have traditionally been hostile to user generated content, and local ad sales is an expensive and difficult proposition. But these companies have innovated new monetization models. Twitter, through its Promoted Tweets, Promoted Trends and Promoted Accounts, is not selling media on a CPM basis, but rather selling attention, and the early returns suggest that brands are willing to pay for more attention. Similarly, the check-in services are attracting experimental budgets from national retailers as well as forward thinking small businesses who are eager to attract new customers into their stores, and reward regular customers. While the revenue numbers may not be huge in 2010, there is certainly promise to the business models that are developing on these platforms.

Overall for 2010, I figure a B average, a little worse than last year. But there is always grade inflation when you grade yourself, so let me know what you think. Now, on to my predictions for 2011:

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1. Putting fun into ecommerce

In 1995, when Amazon was founded, e-commerce was like the proverbial talking dog. It wasn’t about how well the dog could talk, it was amazing that the dog could talk at all. The first generation of ecommerce sites were focused on functionality, getting the dog to talk better. We got everything from price comparison engines to aggregated user reviews to one-click checkout. These early innovations were focused on optimizing the “workflow” of shopping to get users into the checkout as quickly as possible.

This worked great for most internet users at that time because back then most internet users were men, and in general, men do not like to shop. They treat it like a chore, a necessary evil that would ideally be minimized and optimized to take the least amount of time possible. Then they could get back to doing something they enjoyed, perhaps playing video games, or watching football!

But a few years ago, that changed. There are now (a few) more women online than men. And in general, women tend to enjoy shopping more than men. Certainly more than playing video games, or watching football! If you enjoy shopping, you don’t want your “workflow optimized”. You don’t want to be rushed to the checkout as quickly as possible. Instead, you want to linger, to be delighted, to discover new things, to find great deals. You want shopping to be fun.

The Flash Sales sites and Local Deals sites both make shopping fun by offering deep discounts. This is the mechanism that they use to entice shoppers to buy something, even when they are not looking for anything specific. But discounts are not the only way to make shopping fun.

Sites like Modcloth make shopping fun through discovery. Modcloth highlights women’s clothes from modern, indie and retro designers. Because each item has limited supply, and selections are constantly changing, Modcloth builds an urgency that has users coming back frequently to see what’s new and to make sure that they don’t miss out.

Shoedazzle* makes shopping fun by democratizing the personal stylist experience. After users take a style quiz to assess their profile, they are shown a selection of shoes, bags and accessories that have been specifically chosen to match their taste. Each month they get a new selection of on-trend pieces that fit their profile. JustFab and JewelMint have subsequently launched with similar models.

More models keep popping up. Recently launched Birchbox focuses on sending cosmetic samples to its users to help them discover the perfect eyeliner or blush. Pennydrop is a Facebook app that lets users peek at discounted and constantly dropping prices on items and jump in to buy when the price is low enough.

All these sites play to the idea of making shopping fun. I expect to see more applications of these formats, as well as more new formats, all under this overarching theme. A little social shopping anyone?

2. Self-service ad platforms find their ceiling, and brand advertisers seek other avenues

As noted above, about half of display advertising inventory is now moving through exchanges, DSPs and realtime bidding platforms. Yet these platforms are only two to three years old. While perhaps only 10% of online ad revenue is currently flowing through these channels, the trend here is clear. Today, two thirds of online ad spending comes from direct response advertisers, and soon the bulk of these budgets will likely flow through bidded platforms such as these, including Facebook ads. Direct response advertisers move their budgets quickly to follow results, so this could happen within the next year or two.

Brand advertisers are also experimenting with bidded platforms. Each of the big ad agencies have their own trading desks. However, adoption on the brand side will likely be slower and far from complete. Many of the exchanges, DSPs and RTB platforms allow for bidding strategies that are easily optimized for click-through rates, but optimizing for brand metrics is much harder. Brands also care more about content adjacency and brand safe content, and these are harder to guarantee on an exchange type platform, where in some cases, ad impressions are traded several times before finding their final buyer.

In addition, exchanges by definition can only support standard ad units. Many brand campaigns incorporate custom elements, ranging from social media and other earned media components to custom microsites, site takeovers, roadblocks and other high impact units. These are often tied to specific publishers, and bundled into a broader media buy including standard ad units. Premium publishers depend on this sort of creative advertising to maintain the ad rates required to support the creation of high-quality content, and I think it is likely that this symbiosis between brands and premium publishers will continue to capture a large chunk of the brand ad budget. In fact, I expect to see a proliferation in custom ad units from the biggest and most premium publishers as they work to capture a greater share of brand budgets. Non-premium publishers that have reached the scale to become “must buys” are doing exactly the same thing. Twitter’s Promoted Tweets, Promoted Trends and Promoted Accounts, and Facebook’s Social Ads and Likes are all great examples of this trend.

3. Competition shifts from user acquisition to user retention

Today many e-commerce and subscription companies are growing very quickly through smart marketing. They are taking advantage of cheap media to cost effectively acquire new customers. As I’ve mentioned above, I think the exchanges will continue to make it easier for direct marketers to reach their customers. Facebook’s self service platform is still a relatively inefficient market, allowing savvy, analytical marketers to quickly and cheaply gain market share. However, in some categories (e.g. Local Deals) Facebook has quickly become efficient and there is already a “market price” for a new Local Deals subscriber. As more marketers take the plunge into Facebook’s platform, more categories will become efficient, just as Google became an efficient market over time for almost all keywords. Once this happens there will be a market clearing price for new customer acquisition across almost all categories, and smart marketing will no longer be as much of a differentiator.

On what basis then will winners pull away from the rest? Companies who are able to derive the highest lifetime value (LTV) from their users will squeeze out their competitors with a lower lifetime value. How can you improve LTV? There are three key factors:

• average revenue per user
• gross margin
• average lifetime.

The e-commerce and subscription based companies that pull away from their competitors in 2011 will find a way to differentiate themselves from their competitors on one or more of these dimensions.

4. Social games chase hardcore gamers

Notwithstanding Disney buying Playdom* this year and EA buying Playfish last year, Zynga is still the market leader in social gaming. Their enormous installed user base gives them a real advantage in customer acquisition cost over their competitors; their ability to cross-sell installs to their new games at zero cost allows them to get a new game to scale with much lower marketing spend then smaller competitors.

To combat Zynga’s might, the other social game publishers have to focus on games with a very high LTV. High enough that the publisher can afford to rely on paid customer acquisition alone to build a user base, and still make money. Kabam (once know as Watercooler) pioneered this approach with Kingdoms of Camelot, a relatively hardcore social game that is reputed to be doing low to mid single digit millions in monthly revenue from  about 750k Daily Acitve Users (DAUs) – a monetization rate that is dramatically higher than the norm for social games. Other publishers have taken note, and I would expect more games aimed at the hardcore gamer market to emerge over 2011.

5. Year of the tablet

Smartphones transformed the mobile internet. Apps will drive $5bn in revenue in 2010. Mary Meeker presents some great insight into the future growth potential of mobile in her Web 2.0 Summit presentation, Ten Questions Internet Execs Should Ask and Answer.

The same thing will happen with tablets. While the iPad has the tablet market largely to itself this year, that will change dramatically in 2011 and beyond, just as Apple’s iPhone had the truly web-capable smartphone market to itself in 2008, but is now a minority as competition emerged from Android, WinMo7 and the modern Blackberry.

The key difference between these new platforms and the PC web isn’t mobility (although that is part of it), but rather that these devices are always on and always with you. However, use cases differ between the phone and the tablet.

Phones are with you all the time, in particular when you are out of the house and out of the office. The most popular genres of app fit well with this “on the go” usecase. Local information, “snacky” entertainment, music, games have all been killer apps on smartphones. Some web incumbents made the transition well, including Yelp, Flixster*and Pandora. Many new companies also gained ground on the phone through this disruption.

Tablets tend to live in the living room. They lend themselves more to leisure than PCs, and to more protracted content consumption than phones. Killer apps might include, video, music, games, and “reading”, broadly defined. Again, some web incumbents will make the transition well, but once again I expect to see new companies gain ground through this disruption.

What do you think will happen in 2011? This time next year ,I’ll look back to see how accurate I was. In the interim, stay tuned for more Lightspeed predictions in other tech sectors over the next few days.

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* A Lightspeed Portfolio company