My last TechCrunch Teardown outlined the multi-billion dollar online brand advertising opportunity. As part of that research, I looked at the top Facebook brand pages to see how some brands were successfully using social media to connect with their consumers. With soaring Facebook revenues, a significant share of which comes from brand advertising, I went back again to look at how the top 165 brand pages performed in Q1 2011 to get a sense for which firms continue to get the most out of Facebook. And to see if some brands are showing signs of slowing growth.

For instance, here is how the 10 largest brands on Facebook are doing:

As you can see in the longer table below, which ranks the top 165 Facebook brand pages by growth, many of the top brands on Facebook continue to experience strong fan growth, even with bases of multi-million fans. For this research, I specifically looked at those brand pages that had an installed “fan base” of 500,000 users and above in December in order to get the best measurement of the health of the platform.

Facebook itself grew it’s users by 13.7% (from 585 million to 665 million, in terms of raw number of accounts) so I would expect to see the top brands seeing a multiple of this considering the nascent stage and untapped potential of commerce on Facebook. Conversely, if a brand page’s growth lags that of Facebook’s in general, it may be an early indicator of a stalled social media strategy.

Top 10 Takeaways

1. Only 10 top brand pages grew their audience 100%+ last quarter and only three (Hollister, Sour Patch Kids, Trident Chewing Gum) saw 200% or more growth.
2. 31 brand pages (19% of the total) grew less than the overall Facebook growth rate of 14%. Starbucks, the 2nd largest brand page on Facebook, was the largest brand in the bottom 31. By contrast, Coca-Cola, Facebook’s largest brand, grew 26%, and Disney, the new No. 3 most popular brand, grew its fans by 42%.
3. Food and apparel retail are two categories of note that appear to be among the fastest growth areas. This is interesting considering consumption for these products mostly occur offline.
4. Apparel retailers, specifically, seem to be doing a better job of tying their retail store promotions to their Facebook presence. Interesting to note that Hollister and Abercrombie are No. 1 and No. 4, respectively, and are owned by the same company. American Eagle, Forever 21, H&M, and Zara are all doing something right.
5. Walmart was the No. 12 fastest-growing fan page, adding 2.5 million fans. Along with its recent acquisition of Kosmix, I believe Walmart will continue to invest heavily in social, commerce, and campaigns.
6. In the next decile, quick-serve restaurants such as Domino’s, Pizza Hut, In-N-Out Burger, and Wendy’s appear to signal another trend worth noting. The key question for these firms is how to drive restaurant visits and sales from these pages when food is, by definition, offline activity.
7. Fanning specific niche passion products (Olive Garden bread sticks, Sharpie markers, Swedish Fish, Cookie Dough) and seasonal items (Cadbury Eggs) may plateau when the initial novelty and/or the natural “audience” for those products is achieved.
8. Inter-category brand differences are evident and warrant further investigation. For example, why are Hollister, Abercrombie, and Forever 21 growing so much faster than Wet Seal (27%) and Pac Sun (42%)? And why do these same three brands have 3X-4X more fans than their competition?
9. An interesting brand story is happening right now in Dove soap. While Dove did not qualify for my initial analysis because it only had 271,000 fans in December, it’s 340% growth made it the No. 1 fastest 1-million fan brand page in my analysis.
10. As brands achieve critical mass and become more comfortable investing in their Facebook presence, they will become far more concerned with fan engagement, fan differentiation, loyalty and efficacy. The key question is: once they have an audience, what will they do with it?

I believe there is a lack of clarity by both technical and non-technical entrepreneurs of the role of a business leader in the lean startup environment.  I hope this post serves two purposes.  One, as a checklist of skills non-technical entrepreneurs need to develop to become valuable startup team members and to be an attractive business partner for top-tier engineers.  And, two, for Y Combinator and engineering-led startup CEO’s, I hope this can be used as a practical guide to help you evaluate a non-technical co-founder or business leader for your rapidly scaling product.

I recently spent the afternoon at Harvard Business School with Professor Tom Eisenmann and 90 students taking his new class “Launching Technical Ventures”.  Most of the students are interested in either launching their own companies or working in product, business development, and marketing roles at fast-growing Internet startups.  They wanted to know what were the best things they could do to be successful in the startup environment.  Similarly, I have spent time with many talented technical co-founders who wanted guidance on bringing a business leader onboard.  Below you will find the 6 main ways I see that MBA’s and other non-technical entrepreneurs can best add value to technical CEO’s and co-founders.

1.     Product and Business Acumen in Startup Environment

2.     Strong and Verifiable Business Network

3.     Strong Venture Capital Connections

4.     Passionate Technology User With Innovative Ideas

5.     Culture Fit and Proven Staying Power

6.     Understand How To Market Yourself- The Google Test

The HBS course is a different approach for the school-  practical startup concepts and agile product management tactics for future business entrepreneurs- that seeks to chronicle and inculcate otherwise hard-won entrepreneurial battle scars.  What is most exciting is that Tom (along with Eric Ries and Jeff Bussgang) is institutionalizing a base level of understanding and common language for non-technical leaders to have with technical founders and CEO’s.  It is a simple fact: if an MBA or business entrepreneur can’t code then she, by definition, needs to work with engineers.

So is the inverse true?  Are strong technical founders ultimately more successful when paired with a strong business leader?

With the advent of the lean-startup framework, minimal viable products, open web architecture, and engineering-focused accelerators like YC, it has never been a better time to be an entrepreneur with technical skills.  A typically-constituted team of three, with a talented back-end and front-end engineer with a product/visual designer can certainly conceive, build, launch, and iterate on a product and acquire 1MM+ users.  So, it’s not that surprising that in my interactions with top engineers over the past few years, I have noted a strong anti-MBA/anti-business leader bias.

Many younger technologists think of MBA’s as risk-adverse, impractical techno-fools that capitalize on their ideas, cause product delays with feature creep and micromanagement, expect a disproportionate share of equity for less value, and possess high salary requirements without the constitution for the lean lifestyle.  But it is also a simple fact: a product with 1MM+ users does not by definition equate to a good business.

I believe the anecdotal evidence suggests that, except for rare circumstances, most consumer web companies eventually need strong technical and business collaboration to realize its potential.

Many of today’s fastest growing consumer Internet startups all have amazing technical CEO’s and founders as well as strong business leadership in place.  Groupon has Andrew Mason and Rob Solomon; Zynga has Marc Pincus; LinkedIn has Reid Hoffman and Jeff Weiner; Facebook has Sheryl Sandberg; Chegg has Dan Rosensweig.  If you look at smaller web companies, Square has Keith Rabois, Path has Dave Morin, AirBNB has Brian Chesky.  If you go back to 1999, Google hired Omid Kordestani to turn search results into one of the all-time greatest business models.

So here are the 6 competencies you, as a non-technical MBA/business leader, need to develop to demonstrate your value to a top-tier technical CEO or co-founder.

1.     Product and Business Acumen in Startup Environment

Simply point, receiving an MBA from Harvard, Stanford, or other top-tier MBA program is a great foundation but not sufficient- just as is a CS degree from a top university for engineers.  Both are tremendous academic accomplishments but there is not necessarily a correlation between education and startup success.  Not all graduates are cut out for entrepreneurship.  I believe a lot of the resentment by engineers toward top MBA programs is justified based on the poor behavior by many of these graduates over the past decade who acted like they were provided a secret decoder ring at graduation to miraculously unlock the web riches contained in the code created by tired engineers.  As entrepreneurship has become professionalized, this attitude has been scaled back to the personality types that would act like this regardless of their chosen field.

In a fast-growing startup environment you need to demonstrate that you have the skills to do any non-technical duty in the company with no limited resources- primarily product collaboration, financial modeling, business development, marketing, hiring, raising capital. You need to show that you understand how to think about products, get customers to pay for something when they never have before, what the different levers are to pull, what the proper metrics are for your business, analogs of what has worked and what hasn’t.  You should expect a technical CEO to ask you in detail what you would do, to show your work with a functional model, talk about connections at key potential partnerships.

2.     Strong and Verifiable Business Network

Just as the best engineers have trusted colleagues they can tap to help them solve difficult technical problems, you need to be connected to business people that can help the company succeed.  This serves two main purposes: 1) engineers can verify that you are an “A” player and 2) you will need your network to do business development and market the company.  It is commonly understood that “A” engineers will only work with other “A” engineers.  The same is true for business types.  “A” engineers also want to work with “A” business people and other “A” business types are similarly attracted to “A” players.  It also follows, then, that a technical CEO will want to easily tap into his own network of MBA contacts to verify that you are indeed an “A” player.

The best way to develop this capability is to: work at fast-growing, private technology companies with a strong engineering culture; network with classmates and engineers at CS programs while getting your MBA; attend parties and meetups of the startups you are tracking.

3.     Strong Venture Capital Connections

It used to be that the VC community was 100% comprised of MBA’s from top programs.  And it used to hold, then, that the MBA would be mostly responsible for securing financing to keep the company going.  While this tends to still hold true, the industry is evolving as more accomplished entrepreneurs and operators with varied backgrounds become partners and technical co-founders have become more confident with the business aspects of entrepreneurship.

That said, you should leverage your alumni network and make sure Associates, Principals and Partners at the top firms know who you are and develop a relationship with them.  Venture capital is a relationship-based business- people risks are one of the top risks that VC’s have to mitigate against- so the longer someone knows you and can verify your work product, the more likely they are to back the company with which you are affiliated.

This takes years, so connect with alumni VC’s, introduce yourself to Board members of startups you are following, follow their blogs and Twitter feeds, and be a trusted referral of quality projects that fit with their investment thesis.

4.     Passionate Technology User With Innovative Ideas

While you can’t write CSS or a MySQL query, you need to be a passionate technology user and deeply understand web-based products.  All of the best engineers I know are creative and are motivated by big ideas- they want to make a positive impact on society with their code.  You need to be a thought partner for them and work on a shared vision of the world where your product or service can be used by millions of people.

The best way to develop this is to develop hypotheses and a point of view where certain industries are headed.  You only want to work on ideas that you think have a better than average chance of success with top engineers that can make it happen.  You can only do this if you know where to focus your energy.   The best way to develop this is to take classes like Tom’s; read industry publications like TechCrunch; keep a list of and track the progress of startups that you think are interesting; understand why startups have failed or succeeded; think about what areas interest you and why; and, best, begin experimenting with some ideas of your own.

5.     Culture Fit and Proven Staying Power

Having a strong cultural fit and shared view of how the company is run may be the most important trait to develop and to demonstrate to top engineers.  Engineers are happy to work hard together on hard problems that they believe in.  But once you have agreed on certain core features and timeline, trust them and get out of their way.  Remember, engineers are as good or better than you are at your job and they possess the same interest in the company’s success as you do.  Product development is a collaborative and iterative process, so you need to show that you can productively work with demanding engineers in an empowering, creative environment.  If you develop a reputation for constantly micromanaging and making engineers miserable with no tangible business gains, you will have a short career.

Second, I believe you need to prove that you are someone that will, except for those unavoidable circumstances, see a project thru and not jump at every new opportunity that comes your way.  If you are develop a strong track record and are working with talented engineers, you will become an attractive business leader for other companies that will offer you more salary and potential equity.  Top engineers will only commit to you if you are someone they trust will be with them and will not cause the company harm by your premature departure.

6.     Understand How To Market Yourself- The Google Test

When I mention this to MBA’s they are initially surprised but then see the reasoning behind it.  Just as MBA’s look for engineers that are considered leaders in their field with, say, contributions to open-source or side projects on their “down” time, there is a similarly easy test to see if an MBA is a good marketer- Google their name.  I would suggest that if a business leader’s name doesn’t appear near the top of the search results then they either have a very common name (I’m talking to you John Smith) or it means they haven’t taken the time to learn the tools of the trade.  There are so many free tools out there to get involved in the startup community- Twitter, blogs, Quora, Lean Startup communities.  Top engineers need to be confident that you can represent the company well and can move it into relationships that can help it succeed.

What do you think?

One of the biggest business opportunities in the consumer Internet space is to create products and services that attract a share of the billions of dollars in held-up brand marketing that has yet to find its way onto the web. With the explosion of various kinds of content and the innovative ways advertisers can segment and track users, why are marketers so reluctant to open up the floodgates? Quite simply, because the current online solutions—search, lead generation, display, video—do not provide a high enough return for these kinds of categories and are not consistent with the image these brands have invested so heavily to achieve.

Commensurate with the potential riches, there is an enormous amount of startup energy and experimentation going on in this area. In this installment of the TechCrunch Teardown, I will look at the four leaders—Facebook, Twitter, Foursquare, and Groupon—and how their new interactions—“like”, “follow”, “friend/check-in”, “group coupon”—are fairing with brand advertisers.

The $20 Billion Opportunity

According to Ad Age, the Top 100 Global Advertisers spent over $100 billion in 2009 across the various print, television, radio, outdoor, and Internet channels; based on data from the previous year, 39 of the 100 had budgets of $1 billion or more (see table 1, click to enlarge). Procter & Gamble, manufacturer of 50 leading brands (such as Tide, Dawn, Pampers, Gillette, and Crest), of which 23 generate $1 billion or more in sales, is the world’s largest advertiser, spending close to $9 billion annually. It should follow, then, that the Internet economy as a whole is effected by how the brand managers at these companies decide to allocate their funds online.

As you can see from the last column in the table at right, the leading marketers are only spending $1.8 billion, or 2.6% of their total budgets, online, despite the fact that consumers are spending close to 30% of their time on the Internet. Of the top marketers, only General Motors, Disney, Bank of America, and News Corp. allocated more than $100 million to the web.

So who has found the best marketing value online? Companies that market and sell financial services, insurance, automotive, communications and media, and consumer technology. It makes sense: these are companies with products that can be found easily using search, and whose customers are most likely to be acquired online because they can transact online. To date, Google and vertical content sites such as Yahoo! Finance and Bankrate have been the largest benefactors of these re-allocated dollars.

New Kleiner Perkins partner, and former Morgan Stanley analyst, Mary Meeker, estimates that closing the gap between consumer attention and ad dollars spent on the Internet to be a $50 billion global opportunity. If the Top 100 marketers bring their marketing budgets in alignment with 30% of time spent, I estimate online brand marketing to be a $30 billion global opportunity and $20 billion in the U.S. As evidenced by Google’s recent pursuit of Groupon, its traditional CPC and display advertising may not be sufficient enough to meet these marketers’ needs.

The Four Horsemen

There are four Internet companies currently best positioned to work with brands to create innovative marketing solutions that will appeal to millions of consumers—Facebook, Twitter, Foursquare, and Groupon. I acknowledge it is not exactly a fair comparison for two main reasons: 1) Facebook has enjoyed a 3-4 year head start on the field and 2) each product has a different use case and thus attracts a different audience with distinct revenue opportunities. Each company, though, has found its way into the mainstream and now finds itself with an attractive platform for brand experimentation.

I see the four product experiences these companies offer on a continuum of online-to-offline interaction on one axis, and requiring passive-to-active behavior on the other. The Facebook experience, for example, is largely an online one where a user can say something about herself by associating with a particular brand by “liking” it. This is an incredibly passive expression that requires a split-second action with little to no long-term repercussions. She can choose to visit the brand page and see the news feed at her convenience.

Twitter, on the other hand, is a personal tool for gathering realtime information—no one knows which feeds the consumer decides to consume or to ignore. While Twitter is similar to Facebook in its largely online-focused consumption, it is a much more “active” medium. Users are constantly reminded when they are following a brands’ information stream. As soon as the information becomes unimportant, too frequent, or spammy, she will simply cut off the connection.

Groupon (which I wrote about in an earlier teardown) is the lightest application, ironically, even though it is the only one of the four that requires a user to make a purchasing decision. Transactions occur easily online and the offline experience of presenting a coupon is consistent with decades of proven user behavior.

As of now, Foursquare asks the most of its users in relation to branded campaigns, but it is also the closest of the four to placing customers in the physical proximity of brands and retailers.

How They Are Doing

You can see how the four different interactions 1) naturally lend themselves to different brands and 2) exhibit a large disparity in terms of the sheer number of participants. And this is not necessarily a bad thing: 44,000 passionate luxury fashionistas at NY Fashion Week may be more valuable to Yves Saint Laurent than 5 million fans on Facebook.

It should come as no surprise that the biggest brand in the entire social ecosystem is Coca-Cola with 20 million Facebook Fans. Whole Foods is the biggest brand on Twitter with 1.8 million followers and the Gap, having sold 440,000 half-off coupons using Groupon, is that startup’s largest brand experiment.

Of the top 50 pages on Facebook, 8 of them are leading advertisers and brands, compared to Twitter which doesn’t have a single brand in its top 50 users. Of Facebook’s top 50 brand pages, 31 of them are food and beverage companies, while 11 are consumer products such as Converse All-Stars and Victoria’s Secret. The most important takeaway is that brands have a far greater following on Facebook than they do on their own sites. Facebook’s best move has been to convince brands to market their Facebook pages rather than driving traffic to their own websites.

The most interesting finding is that what seems to be popular on Facebook is not so on Twitter. If you click on the table at right an dlook at the top 50 brands on Facebook, the “Follower/Fan Ratio” (the result of dividing the number of Twitter followers to Facebook fans) does not get higher than 8% (Disney). This indicates that Twitter might have a more difficult time than Facebook in attracting overall brand dollars with its current product feature set.

This is evident when you look in detail at one CPG company and its portfolio of brands. I did a comparison of the differing success of P&G’s top brands using the two platforms (click on table at right to enlarge). In every case except one (Dawn), the branded experience on Facebook is more popular in terms of numbers than on Twitter. In a few cases, there does not appear to be a reason for even having a Twitter presence. It is interesting to note that the most followed P&G Twitter account is the company’s own corporate PR team.

Facebook still has a lot of work to do and it is far from a foregone conclusion that it has won. While the lightness of its interaction makes getting to scale easier, maintaining enough valuable interactions on the branded pages and engaging long-term customer interest is a huge challenge. For example, according to eMarketer, nearly 1/3 of Facebook users who unsubscribed from a branded page simply were no longer interested in it. And, more to the point, simply because Coke has 20 million Fans does not necessarily mean Coke will pay for the privilege to advertise on Facebook if it cannot see a return.

So what brands seem to be working well on Twitter and far better than on Facebook? Daily deals, such as Dell Outlet, Amazon, and Woot, and companies that place customer service and community at the heart of the brand experience, like Zappos and Etsy, exhibit the most lopsided Follower/Friend ratio. It is important to note that two companies that had horrific customer service challenges over the past few years—JetBlue and Toyota—have fully embraced Twitter as a direct communications channel. The biggest driver of Twitter success as compared to Facebook is the timeliness of the information.

Twitter, then, is well positioned to capture marketing dollars from companies optimizing for deals, retailers that have frequent specials, ticketing and events, movie studios, television shows, last minute deals, airlines, and hotels.

It is still early days for both Foursquare and Groupon in terms of working with big brands. Foursquare has seen traction with high-end luxury and media brands, likely as a result of its headquarters being located in New York and early media partnerships. Of course, Foursquare’s long-term viability as a stand-alone “check-in” company is still an open question with Facebook Places breathing down its neck. This is a strategic move on Facebook’s part to get closer to offline actions, transactions, and local commerce.

While Groupon is the defining company of next-generation e-commerce, it has a tougher road in terms of working with brands and large retailers. These companies tend to be more sensitive to heavy discounting as they don’t want to train their customers to wait for 50%-off coupons. And, they don’t like to be so indiscriminate with their offers.

Overall Assessment

I evaluated the four companies along the six different types of offers and campaigns that I can see consumer brands wanting to engage in:

• Coupons: Simple discount off purchases
• Location: Physical check-in or product scan
• Loyalty: Frequency, “Mayorship
• Time-based
• Special Events: VIP’s
• Inventory Close-Outs

Based on my research, while Facebook, Twitter, Foursquare, and Groupon are the best positioned to capture the estimated $20 billion in pent-up consumer marketing dollars, none of the four are currently optimized to execute along all of the necessary dimensions. There are considerable opportunities for startups to innovate and capture share. I look for this to be one of the most attractive areas for entrepreneurs in the consumer internet for years to come.

This is the second part of an analysis of different consumer Internet business models the originally ran on TechCrunch.   It is suggested that you first read Part I.

Most consumer Internet startups fall into a baker’s dozen of possible business models. In the first part of this post, I tried to lay out the three main buckets those business models fall into (media, paid service, and physical commerce) and then began to sketch out the first four business models (search, gaming, social networks, and new media). In my analysis, I include a rough financial model showing the key drivers necessary for each different type of business model to generate $10 million in annual revenues.

In this post, I continue with the final nine business models (marketplace, video, commerce, retail, subscription, music, lead generation, hardware and payments). As I mentioned last time, this list is not meant to be exhaustive but it should cover most consumer Internet startups today. Please feel free to comment or email me at tcteardown at gmail to let me know what I may have overlooked or help me flesh out my analysis. You can also view, download, and use each of the below financial models here.

Type 5: Marketplace

As I wrote in detail in the Teardown on hand-made goods marketplace Etsy, online marketplace companies create efficiencies between buyers and sellers that are difficult to achieve in the real world. The leading online marketplace is eBay, which happens to run the default sale process as an auction, but fixed price sales have emerged as competitive due to their simplicity and ease of use. Marketplace companies make money by getting as many people as possible to put their goods up for sale and charging a nominal fee for those listings. The more products available for sale the more buyers are attracted to the platform, and the higher the likelihood that a sale will be consummated, generating a commission for the company. Due to the network effects of marketplaces and small fees, these businesses are notoriously difficult to achieve critical mass and take a long time to build. But once they do, these companies tend to have a long, profitable existence. Newer listing companies, like AirBnB, which focus on higher price points ($100+), may achieve scalability faster than traditional product marketplaces.  In my financial analysis below, I estimate that a typical marketplace would require 2 million listings a month generating gross sales of $12.5 million a month in order to achieve $10 million worth of annual fee and commission revenues for the marketplace itself.

Key Drivers:

• Listings
• Listing Fee
• Sales
• Commission

Type 6: Video

While the cost of video production has come way down, creating high-quality video content still requires a moderate investment and high level of skill. Innovation in the video space has seen the use of freelance video producers who charge $200-$300 to produce and edit a 5-minute, professional-looking video on a variety of subjects. Once you have a handle on production, video companies need exposure to as broad an audience as possible, so distribution is key. Video ad rates are typically amongst the highest in online media ($15-$20 CPM) but a viewer will only see one ad per viewing. Therefore, the number of ad impressions is critical because the broader your audience, the higher you will rise in importance with the online media buyers. Most media buyers will not even consider your videos as a buy until you can guarantee their clients exposure to tens of millions of viewers.  An Internet video company would need 120 million video views per month at an $8 CPM in order to reach $10 million in annual revenues.

Key Drivers:

• Unique Viewers
• Ad Impressions
• Sellthrough Rate
• CPM

Type 7: Commerce

Selling physical goods online is one of the more proven consumer business models. With Google’s ascension over the past decade, e-tailers are getting smarter and smarter about driving cost-effective traffic to their offerings via free search engine optimized pages as well as paid keywords. Social media via Facebook and Twitter has become another main activity to aggregate purchasing intent; Groupon, for example, drives more than 50% of its traffic from Facebook and Twitter. Creating unique community experiences, like Threadless and ModCloth, is another innovative way to increase customer loyalty and repeat purchases, while keeping the marketing spend low.

Once you drive potential consumers to your offering, you need to convert those people into paying customers. Because of these free and low-cost direct marketing channels, it has never been easier and more cost-effective to launch an ecommerce business. That said, fulfillment, customer service, and managing a warehouse is incredibly complicated, so attaining profitability for these companies can take years.

Key Drivers:

• Uniques
• Conversion Rate
• Average Spend
• Gross Margin
• Acquisition Cost

Type 8: Rental

Similar to commerce companies, rental startups like Chegg, Zipcar, and RentTheRunway, sell access to a digital or physical good. The biggest difference with these companies is that they are selling short-term access rather than ownership, so how frequently they turn over their inventory along with the average rental rate and frequency of rental are the main drivers of the business. Cost effective access to inventory and how many times an asset needs to be turned over to breakeven are keys here.

Key Drivers:

• Uniques
• Conversion Rate
• Average Rental Rate
• Repeat Purchases
• Customer Acquisition Cost

Type 9: Subscription

Subscription companies sell access to a premium service recurring on a monthly, quarterly, or annual basis. Subscription businesses are typically either content (music, video), information-based (financial, news), access-based (LinkedIn), or data services (Box.net). Regardless of what kind of premium service you are providing, the single most important metric is customer lifetime value (LTV). LTV incorporates your churn rate (what percentage of your customer base stops paying you each month) and dictates how much you can spend on customer acquisition. Once subscription-based businesses mature, they are incredibly predictable and profitable—see Netflix—because the company knows how to aggressively and cost-effectively acquire a customer based on expected margin. These kinds of businesses should never spend more than 40% of expected LTV on marketing to ensure profitability. Like marketplaces, subscription businesses often take several years to get to scale but if they hit 50,000 subscribers, they are typically around for the long haul.

• Uniques
• Conversion Rate
• Customer Acquisition
• Churn Rate
• Life Time Value

Type 10: Music

As I wrote in the Teardown on Pandora, consumer audio/radio startups are difficult to monetize because they are typically amongst the lowest-valued forms of advertising. It makes sense because audio ads are not actionable, and display ads often get ignored (music apps tend to stay open in a browser tab in the background). The other challenge to audio companies is access to cost-effective content—music rights are difficult to secure and typically cost-prohibitive. Pandora has shown that a sustainable business can be created, but it also takes huge scale (10 million+ users) to reach that critical point.  If you can attract 10 million unique listeners a month and show them 40 ads each at a $2 CPM, plus you can convert 1 percent of those into paying users of some kind and squeeze out an extra $2.50 from each of those, then you can get to $10 million in annual revenues.

Key Drivers:

• Uniques
• Ad Impressions
• CPM
• Conversion Rate
• Upsell Value

Type 11: Lead Generation

I have found that lead generation businesses are amongst the most widely followed, least understood of the 13 consumer models. The reason I say that is not that entrepreneurs don’t know what the model is, they do, but that the scale required to generate a sustainable lead gen business is not appreciated. Lead gen businesses need to do four very difficult things well:  1) drive a ton of traffic; 2) get people to click on offers; 3) convert a significant portion of those clicks to complete the offer; and 4) have enough high-value offers that the company generates enough revenue. Successful companies here either focus on a vertical, like financial services, that pays high bounties ($50+) or they have figured out how to encourage significant volumes of repeat purchases. The challenge with financial services lead gen companies is that customers don’t tend to turn over their credit card company or open a new brokerage account several times a year. A startup like Hunch, if it chooses to monetize via leads, has a shot at increasing repeat purchase volume due to its personalization engine and forecasting demand.

Key Drivers:

• Unique Visitors
• Offers Viewed
• Conversion Rate
• Affiliate Cost Per Action

Type 12: Hardware

Perhaps the most traditional business model of the group, hardware companies manufacture a physical good and then distribute the product through online and offline channels. Hardware companies make money based on retail price less cost of goods sold, minus marketing costs. Hardware startups, such as Kno, and Tivo and mobile phones before that, are bundling hardware with ongoing services. There are three factors that lead me to believe that we will see an explosion of innovative hardware companies over the next few years: 1) manufacturing costs in China continue to come way down as is their ability to cater to customized, small runs; 2) software is becoming easier to update remotely; and 3) the ability to bundle unique services on the devices. This is a space to watch.

Key Drivers:

• Units Sold
• Gross Margin
• Marketing

Type 13: Payments

Payments are a volume-based business. These companies are charging pennies for each transaction that flows through their systems, so the biggest drivers of these kinds of businesses are the number of customers that have access to your payment method and the size of the average transaction. The characteristics that make up a good payments or financial services company are the number of high-quality distribution deals you can enter with a customer base that has demonstrated it will pay for goods and services.  You need one million customers a month making payments of at least $25 to get to $10 million in annual fee revenue, assuming a 3.5 percent fee.

Key Drivers:

• Unique Users
• Average Payment
• Transaction Fee

After last month’s TechCrunch Disrupt, and to provide a business companion to the popular “Lean Startup” customer development methodology, this TC Teardown focuses not on how one specific company makes money but rather seeks to provide a breakdown of the main general ways consumer Internet startups try to make money. Consider it a guide to Internet business models. If you are currently thinking about or are in the process of developing your own consumer startup idea, these key business models will help give you a working knowledge of what it takes to get to $10 million in revenues (assuming you have a good product that the market wants).

(Before you post in the comments about how unique your startup is, this list is not meant to capture every consumer business permutation. There are always going to be exceptions. And the breakaway companies like Zynga, Groupon, Facebook, Twitter, and Foursquare, to name just a few, inevitably introduce nuances to pre-existing models.)

You can think about consumer Internet companies in three major categories. The following three categories of consumer Internet startups and the representative underlying thirteen business models should give you a more than basic understanding of the main drivers of 95 percent of the consumer Internet startups you hear and read about on TechCrunch. The best consumer investors are intimately familiar with these metrics, so make sure you know which business you are in and how you can get to $10 million before meeting with them.

The two main points I am trying to convey are 1) the activities needed to monetize each kind of consumer Internet startup are different and 2) the activities are not difficult to understand.

Currently there is not a good resource to demystify the various consumer Internet business models. In my effort to reduce these to basics elements, I know I have likely overlooked something obvious. Please feel free to comment or email me at tcteardown at gmail to let me know what I may have overlooked or to introduce your truly unique take on one of the models so that I can update this post and it can be useful to others. You can also view, download, and use each of the below financial models here.

The 3 Main Ways Consumer Internet Companies Make Money

As a consumer Internet company, you are trying to attract enough potential customers by providing one (or more) of three kinds of products: 1) media, 2) premium services, or 3) access to a physical good. These are not mutually exclusive—a startup can generate revenue from more than one of these sources. For example, many media companies make money off of both advertising and premium services, like LinkedIn.

1. Media:

If you are a media company, you are providing free content and collecting purchasing intent so that you can either sell ads, send leads to products or services your audience might be interested in, and/or upsell to a subscription or digital goods. This category is comprised of a large percentage of consumer Internet startups because startup costs are typically the lowest. As has been said many times before, these kinds of companies are cheap to start but expensive to achieve scale. Representative media startups are those creating applications in search, gaming, social networks, new media, video and audio, and lead generation companies.

2. Paid Service:

If you provide a paid service, you are trying to attract as many potential consumers to you as cost effectively as possible, get them to pay you for a service, and then work to keep them as paying subscribers for as long as possible. Most startups in this arena follow the “Freemium” strategy, where some content or basic service is provided for free in the hopes of converting a small portion of the free base to paying subscribers. “Freemium” is by no means the only way to acquire customers, but it can usually be the most cost effective means, especially if the service is built upon cheaply produced media or third-party infrastructure providers such as Amazon’s S3, and the variable costs to serve a new customer are minimal.

Payments and financial services companies are included here because they provide some services for free or for a fee and also charge businesses a small percentage of each transaction. Representative startups are companies that create premium subscription services, new banks or investment firms, and payment companies. These kinds of companies frequently require more capital than media startups to start, but may need not as much to scale, since they can leverage the cash paid in from consumers.

3. Physical Commerce:

If you sell a product that is fulfilled via a warehouse, can be sent via UPS, or is a coupon that can be used to purchase goods and services in the real world, you are running a commerce company. These startups generate revenue for each transaction and need to be disciplined around the efficiency of their warehousing operations, returns and customer service, and the amount spent on sales and marketing.

13 Consumer Internet Business Models

Below you can see a chart depicting the 13 consumer Internet business models (with examples), the 3 or 4 key monetization drivers for each, and the scale a company needs to achieve to get to an annual revenue run-rate of $10 million. Of course there are lots of activities companies in these categories need to do well, but these are the most important drivers to building a sustainable business.

The 13 kinds of consumer startups are (in no particular order):

1. Search
2. Gaming
3. Social Network
4. New Media
5. Marketplace
6. Video
7. Commerce
8. Retail
9. Subscription
10. Music
11. Lead Generation
12. Hardware
13. Payments

Below is a brief overview of the first four company types with corresponding mini business models so you can see how the key drivers work. The remaining business models will appear later in Part II.

Type 1: Search

As a search company, you are trying to get as broad an exposure as possible to consumers looking for products and services. The more queries you are able to generate, the more likely a user is to click on one of your paid links. The key metrics for this kind of company are:

• Monthly Uniques
• Queries Per Month
• Percentage of users that click a paid link
• Revenue Per Click

These metrics are inter-dependent so the number of uniques per month you need, for instance, will largely be dependent on the average revenue per click you can command. For a company where 5 percent of searchers click on paid links and command $0.35 per click on average, the company needs to have 2.5 million monetizable clicks per month to get to $10 million in revenue. Hunch is a good example of a startup that combines elements of traditional search with a new-kind of service, in this case a personalization engine, to provide more accurate product recommendations, and therefore, hopefully will achieve higher conversion rates and better revenue per click.

Type 2: Gaming

As I wrote in detail in the Teardown on Zynga, the casual social gaming startup, online gaming companies create entertainment via casual games, fantasy role-playing games, virtual worlds, and mobile games. The idea is to create core intellectual property around a concept, provide a portfolio of games for free, and then upsell a percentage of users to pay for virtual goods. The main drivers of the business are:

• Monthly/Daily Average Users
• Conversion Rate to paying user (typically 1% – 2%)
• Average Monthly Spend

As this is a volume business, gaming companies need to achieve at least 5 million monthly average users to have a chance to hit $10 million in revenues. In this last way, social gaming companies, like Zynga and Nexon, combine elements of traditional media with commerce by replacing fulfillment of a physical good with a digital one.

Type 3: Social Network

Startups that create media around shared experiences or common interests typically make money from ads and sponsorships, and less frequently, premium services. As a new media company, a social network like MyYearbook (junior high school students) or Dogster (pet lovers), cares about how many unique visitors a month they are attracting, how many ad impressions they are able to display, how much of their inventory they can sell, and the average rate an advertiser will pay. In general, the more focused the social network is on a particular vertical, the higher the CPM rates tend to be. A startup needs to get to several million users and high repeat usage to offset a typically low CPM media buy.

• Unique Visitors
• Ad Impressions
• Sellthrough Rate (ie, what % of your inventory is sold)
• CPM

Type 4: “New Media” Platform

The hardest to define of all the startup types, and also the hardest to predict their ultimate success, are new media platform companies which create content around new technology-enabled experiences. Many of these companies are commonly thought of as social networks. But Facebook, Twitter, and Foursquare are all examples of startups that require consumers to change current behavior and consume media in a new way. For Facebook it is providing a new way of keeping up-to-date with our social network; for Twitter it is providing a way to interact directly with newsmakers and current events; for Foursquare it is providing a way to stay up-to-date with our friends and family’s whereabouts.

• Unique Users
• Actions (eg, Tweets, Check-Ins)
• Perrcentage Monetizable
• CPM
• CPA

Key metrics here are the number of people you can attract to your service (both creating content and consuming it), the number you can convince to change their behavior to create new content (status update, tweet, check-in), and the percent you can monetize in this new format. The great thing about these companies is that if you can convince people to use these new tools and consume the content, you will likely have a fast-growing business that easily surpasses $10 million on very little capital. The challenge is that these companies are typically hit-driven, winner-take-all businesses that require significant capital to scale. And you will likely need to convince media planners and advertisers that creating a new ad format is worth their ad budget.

A few weeks ago, Etsy, the New York-based marketplace for handmade goods around the world, raised $20 million in new capital at a $300 million valuation—3 times the valuation of its last round in January, 2008. In contrast to the meteor-like rise of Groupon and Zynga, Etsy’s revenues have grown consistently since its launch in 2005, while establishing a trusted brand and international platform for makers of all kinds of wares to sell their products. Based on my analysis, Etsy will do $380 million in gross merchandise volume (GMV) and generate $30 million in revenues this year, up from $180 million in GMV and $15 million in revenue in 2009. This implies a 10X revenue multiple in the company’s latest valuation, compared to EBay’s 3.6 multiple.

The two key questions for Etsy are: How big is the market for handmade products? And can it continue to take share from eBay’s marketplace business?

Let’s take a look at how Etsy makes money and how it can reach $100 million in revenues.

What is Etsy?

Etsy provides an online marketplace where artisans can sell their wares to people looking for one-of-a-kind, handmade goods. Unlike sites such as eBay, Etsy does not run any auctions. All goods are for sale at a fixed-price.

Based on data from Compete, 5.6 million people visit the site each month, up from 4.4 million a year ago, and that is after rebounding from a rapid fall-off in traffic following the holiday shopping season. (Click on charts to enlarge). The good news appears to be that Etsy is able to retain new buyers and sellers who try it out, presumably due to a great shopping experience.

Etsy has over 6.7 million products listed for sale, half of which fall into just three categories: jewelry, art supplies, and vintage. Jewelry alone, with 1.5 million listings, accounts for nearly 25% of all of Etsy’s products.

While this is trivial compared to eBay’s 117 million listings, Etsy’s 6.7 million products are more than double eBay’s 3.2 million listings for similar handmade goods. Ebay’s largest crafts categories appear to center more on hobbies such as sewing and scrapbooking, suggesting Etsy is attracting new sellers into the market.

In a little over four years, Etsy has firmly established itself as the place to buy and sell items such as art, glass, jewelry and art supplies, among others. This suggests further that eBay continues to be vulnerable across other categories where 1) community is a core part of the selling-buying experience, and 2) the company has been unable to attract higher-end sellers.

For a company of its age, Etsy has gone international exceptionally fast. It has sellers in over 150 countries and supports 23 currencies. It is rare for a startup to have garnered international demand so quickly and it is operationally very difficult to support. This is a huge competitive advantage.

How is Etsy Doing?

Etsy makes money in two ways: it charges sellers $0.20 to list a product for 4 months, regardless of the price of the item, and then it receives a flat 3.5% commission for each completed transaction. This contrasts starkly with eBay’s complex listing and commission structure.

I compiled and analyzed the data Etsy releases in its monthly “Weather Report” since 2008. Based upon my projections for the upcoming quarter, Etsy will do close to $30 million in revenues this year, up 80% year-over-year. (This is on the low end of the $30 million to $50 million range CEO Rob Kalin himself projects)

When you look at my estimates of where Etsy derives its revenue from on a monthly basis, two interesting things emerge. One, similar to other retailers, Etsy generates a disproportionate percentage of its revenues during the fourth quarter, suggesting the company is largely seen as a site for gifts. And two, while the business is driven by commissions, Etsy is seeing incremental revenue by keeping listing fees low so that sellers keep products on the system longer (ie, “Legacy Listing Revenue”).

Let’s look a little deeper at each of Etsy’s revenue components. Gross merchandise value (GMV) is the total value of goods sold. Looking at this metric each month since January, 2008, this has been steadily growing, with December witnessing the largest sales volume. Last December, Etsy achieved its highest total of $25.6 million. After reaching a new plateau, the company sold $25.6 million worth of good. This holiday season should see 2X-2.5X last year’s sales.

Etsy is achieving these gains by increasing both the volume of transactions as well as seeing a higher average price point. The number of items sold each month has risen steadily from under 400,000 in January, 2008 to 1.4 million in August, 2010. Meanwhile, Etsy’s average sale price has increased from $12.25 to $18.16 in that same time period

Etsy is also seeing steady growth in attracting new listings. As evidenced in the data, new listings are growing at a much faster rate than new members joining the site. This suggests that legacy sellers are continuing to value Etsy as a sales platform, but that it has to do more to attract both newbie sellers and buyers. Once consumers interact with the site and find something to either buy or sell, they seem to become loyal customers.

In terms of the team and profitability, Etsy has not had to spend resources on advertising and marketing. Etsy is an engineering and support-driven company, 90% of the people are either building the platform or supporting buyers and sellers. To put a fine point on this, Etsy has more people dedicated to its community (12) than it does to marketing (8). This suggests the company should be able to scale the business profitably without an outsized investment in customer acquisition.

If you look at Etsy’s online marketing efforts, it spends next to nothing on customer acquisition.

Etsy’s Growth Opportunities

While eBay saw its marketplace growth stagnate at just over $1 billion a quarter, I see several areas Etsy must optimize just to pass $100 million in business:

1. Expand Internationally with localized platforms. Etsy experienced unusual organic international demand from the outset. While the majority of usage still occurs in the US, Etsy needs to take a page from Groupon and get into the local markets and establish a strong local presence quickly. Scaling and supporting an international platform is difficult so if it can figure it out over the next 12 months, it will provide a strong competitive advantage
2. Attract More Sellers and Listings. As I discussed above, new users are not keeping pace with new listings. The company is already running local meetups, which is a smart strategy to take from eBay’s playbook. I am not sure if Etsy yet has an annual awards ceremony or eBay Live equivalent but there are many incentives the company could employ to encourage current power sellers to bring in new sellers and perhaps get a cut of their sales.
3. Increase Merchandise Value. Etsy has done a good job of providing a trusted platform for sellers, which will naturally lead to higher-priced goods. It needs to continue in this direction and explore additional categories than are consistent with its brand position.
4. Better matching of local supply-demand to avoid shipping charges. One of the biggest challenges to additional sales is expensive shipping rates. Etsy has to match local supply and demand and act as a matchmaker for similar or related products by geographic area.
5. Improve Discovery On Site and Personalization. Etsy has a common problem for marketplaces in that it is very difficult to find certain products. I anticipate that the company will continue to improve in this area as well as in personalizing product and artisan recommendations. Last December, the company acquired a company called Adtuitive to presumably spearhead these efforts.
6. Leverage Community Self-Selling and Sellers Groups. Etsy’s competitive advantage is that it has now reached the inflection point of a community of artisans. The company needs to allow those artisans to form collective seller’s groups and merchandise and advertise their wares together. The more Etsy can distribute its marketing efforts to the sellers themselves, the more it reinforces the community ethos and its economics.
7. Address Seasonal Nature. With nearly 50% of gross sales come during Q4, Etsy needs to merchandise products around other gift-giving occasions, such as birthdays and holidays, and have its sellers market them.
8. Create Additional Value and Revenue Streams. In May, 2008, Etsy launched a compelling service called Alchemy, that allows customers to put out a bid for custom-made goods. I looked at two random days over the past 2 weeks and counted 193 and 192 respective bids for goods. Right now Etsy allows this to be done for free, but this is an area where I can see a lot of promise. Furthermore, at some point in the near future it might make sense, given its international footprint, to create its own payment method.

Don’t call it a comeback
I been here for years
Rockin my peers and puttin suckas in fear
Makin the tears rain down like a MON-soon
Listen to the bass go BOOM
Explosion, overpowerin
Over the competition, I’m towerin

LL Cool J, “Mama Said Knock You Out” (1990)

Founded in 2000, Internet radio startup, Pandora, has had more name changes than Diddy, more styles than Madonna, and more near-death experiences than Ozzy.  Through it all, the company has systematically listened to and catalogued every song by hand along 400 different attributes to provide one of the most personalized music experiences in the world.  Based on recent growth rates, the release of Apple’s new iPhone operating system as well as Android’s emergence as a solid platform, I project the company will have 100MM registered users by the end of the year and generate $125MM in revenues in 2010 (at an average of just $.146 per user per month).  However, just like the aging metal singer, Pandora’s long-term health is far from assured.  The key question: Is Pandora scooping up barrels full of pennies in front of an oncoming Apple steamroller?

Company History and Finally Getting User Traction

While Pandora has raised more than $56.3MM in capital, the company subsisted on $12.3MM for nearly a decade, including $1.5MM over a four year span when no investor was willing to put in any new money.  This is a company comprised of passionate musicologists and savvy management experienced at putting the needs of the company ahead of their own.  After two previous business models failed to get traction, Pandora Radio launched in August, 2005 and garnered 2.5MM users in the first 10 months.  By October, 2007, 8.5MM listeners had registered and were joining at a clip of 500K new users a month.

Then the company’s prospects were forever changed with the release of Pandora’s iPhone app in July, 2008.  It was the top downloaded app that year and its registered users went from 17MM in Q3 2008 to 50MM at the end of Q1 2010.  Mobile (and other connected devices) now account for 30% – 40% of Pandora’s usage and this will continue to rise.

As you can see from the chart from Compete, fewer people as a percent of the user base are going to the website, preferring to listen to Pandora on their mobile device.

Pandora’s 5 Key Assets

Pandora competes in a highly competitive industry where traditional and satellite radio broadcasters battle with streaming music services, such as Rhapsody, and highly anticipated new entrants such as Rdio, Spotify, Google, and Apple.

Pandora has five key assets that are difficult to replicate at scale:

1. The Music Genome: Pandora has created a proprietary database of attributes that personalize and recommend music in the most effortless user experience today.
2. Preferences Database:  Pandora has a treasure-trove of more than 1B thumbs up/thumbs down/skips interactions to augment the Genome.  The company has said that listeners interact 7-8 times per hour to give feedback or configure settings.  This gives the company three advantages over traditional radio: higher levels of personalization, more opportunities to monetize, and additional demographic data.
3. Large Customer Base:  Advertisers buy reach, not music.  With 50MM registered users and 25MM+ listeners a month, Pandora is now an attractive advertising platform.   The large base allows Pandora to segment and geo-target to achieve higher CPM’s.
4. Distribution:  As the de facto Internet radio product, the company has been aggressive to partner with as many home electronics manufacturers as possible.  One can access Pandora on Sonos, Blue-Ray players, Radio’s, Digital Media Players, Home Theater Systems, and Car Radios.  They key driver, of course, is the iPhone app.
5. Experience and Clout with SoundExchange/Label Relations:  The biggest barrier to entry and the most significant cost of operating a music service is dealing with the record label and SoundExchange over royalties.  Pandora has years of experience dealing with this complex system and has so many users now that the company can strike more favorable deals than smaller players.

Pandora Makes Money, Pennies At A Time

Pandora has three tiers of service, 40 hours/month of free ad-supported music, $.99/month for unlimited listening after 40 hours, and $36/year Pandora One, and it makes a little off of affiliate fees from track downloads- but nearly all of its revenue comes from advertising.

Based on revenue and average user numbers released by the company in 2008 and 2009, and using simple ratios, I estimate the company will average just over 70MM registered users for the year and generate close to $.15 per user per month, on average, or $1.75/year, up from $.138 and $1.66 respectively last year.  To be clear, this is not to say that Pandora will average 70MM listeners over the year.  This is clearly a scale business since royalties are variable with each hour listened and there is little margin for error.

Traditionally, CPM’s for Internet and radio have been the lowest compared to every other form of advertising, other than outdoor.  Online, audio, and mobile (another low CPM medium) are the three advertising channels available to Pandora.  While a home page takeover can garner a $20 CPM, an audio ad can be as low as $4, and a little banner on the iPhone $.50 CPM.

In an interview with Bambi Francisco last year, the company stated that they are getting average CPM’s of between $8 and $10.  But not all ads are created equal and early mobile advertising has been in the $1 to $2 range.  Depending on where a user listens, ad type and frequency, sell-thru rates, and frequency caps, Pandora is generating different CPM’s by the hour.  I assume the company will run two ads per hour with some being of “high quality” CPM’s of $10, some of “medium quality” of $7, and some of “low quality” of $4 across its inventory to get the following chart:

Based on those assumptions, I project the average Pandora listener who listens to 11.6 hours a month generates $.228 in revenue and $.0767 in gross margin.  Depending on the customer lifetime value (how many months the average customer listens), this does not leave a lot of money left over to spend on marketing to acquire new users.

There are passionate Pandora customers that easily surpass the free 40 hour per month limit.  Because of the chart above, you can see that if the company does not monetize its heaviest users smartly, it could literally go bankrupt from the variable royalty fees.  I assume that when a listener pays the incremental $.99 she is likely go to way over.  Based on my analysis, Pandora breaks-even on its royalty fees at 120 hours a month (4 hours every day).

For its premium customers that pay $3/month or $36/year, they would have to listen to 8 hours every single day for the entire year to breakeven on royalties.

This is the math that Pandora must do on a daily basis.  The company needs to be smart at predicting and monitoring its listener behavior.

Strategy: Pandora Platform

Pandora’s goal is four-fold: 1) to provide the most personalized music recommendation service, 2) to gradually add in as many high CPM advertising opportunities without degrading the user experience, 3) to carefully monitor and project listening hours by its heavy listeners, and 4) to be available wherever and whenever people consume music.  Because of the high variable cost of music royalties imposed on the business, Pandora is paying between 60%-70% of revenues to SoundExchange.  This leaves very little margin to spend on customer acquisition, so ubiquity is the only way it will grow its user base.

Pandora Is Still At Risk

Despite reaching nearly 100MM by the end of 2010, the company still faces many challenges:

1. Size Matters: Compared to all the other music streaming services, Pandora’s catalog is quite small.  Comprised of 700K tracks, the company has made a conscious decision to filter out many albums.  While this may not be a big deal to many listeners, it does mean that Pandora tends to repeat songs more than the others.
2. Limited Reach: Because of the restrictions placed upon the company by the royalty holders, Pandora is only available in the United States.  This situation will need to change over the next few years or Pandora’s upside will be severely impacted.
3. New Entrants: Rdio, Spotify, Google (http://www.dmwmedia.com/news/2010/06/15/cnet-google-music-service-could-debut-fall)
4. AT&T Data Plan Changes:  AT&T’s decision to limit data plans could be potentially disastrous for Pandora.  This situation will have to be watched closely.
5. Limited Listening Options:  While the simplicity of the product makes Pandora such a compelling, frictionless experience, customers may miss no rewind or repeat, limited skipping, and the inability to pick whatever they want to listen to.

If you go back and consider the 5 core strengths of Pandora, there is one other company that has them too- Apple.  Once Apple gets serious about streaming music (and it will), Pandora will face the biggest challenge in its history.  Therefore, I expect Pandora to generate alot of strategic interest from Google, Clear Channel, Sirius/XM, and traditional radio broadcaster CBS.  I expect Pandora to be acquired in the next 24-36 months.

This post originally ran on TechCrunch.  You can check out my previous analyses of Groupon and Zynga.

Chegg may very well be the fastest-growing, most successful, second-generation e-commerce startup that you hardly ever hear about,except maybe for the fact that it’s raised more than $140 million. Chegg is the “Netflix for textbooks.” It lets students across 6,400 college campuses rent from a virtual bookstore containing 4.2 million books. Based on my analysis (which I get into more detail below), the company is on track to generate $130 million in revenues in 2010, up from $25 million in 2009, and $10 million in 2008. During the January, 2010 semester, I estimate the company made close to $1 million in revenue a day, up fivefold from $200,000/day the previous January, and it should double that this coming September. My analysis suggests Chegg will do close to $50 million in revenue this September alone. It is underappreciated, to say the least.

Chegg is disintermediating the $5B+ college textbook market by providing a low-cost, short-term, nationwide rental alternative to the high-priced university bookstore. This disruptive model will likely shrink industry revenues by half in the coming years, with Chegg in a leadership position to command 80%+ market share. The key questions, of course, are: 1) Is this a winner-take-all market, 2) What can Chegg do to fend off the likes of the major bookstore owners, Barnes & Noble and Follet, as well as Amazon and Apple, and 3) Is Chegg a harbinger of a new age of startup rental services?

Old School
The Chegg story is different from those of other breakout startups, such as Groupon and Zynga, in five key ways. First, rather than creating an entirely new industry, Chegg introduced a proven service concept and relied on established customer behavior (mail-order rentals) in an old, highly dysfunctional category, whose customers felt captive and where costs were spiraling out of control. Second, founded in 2003, the company took four years to find its business, so it was not a rocketship from inception. Third, rather than targeting a broad audience, Chegg focused on solving the pain point of a specific customer set desperate for an alternative. Fourth, Chegg, like traditional e-tailers Amazon and Zappos, requires a complex infrastructure to handle warehousing, shipping, and returns for millions of physical items, as well as a customer service desk that is highly seasonal. And fifth, because Chegg is innovating in an existing industry, the company faces rampant competitive threats from both the old guard and new entrants alike.

Not Just Extra Beer Money
According to the Department of Education, the annual cost of tuition, room and board for a four-year public institution is now $13,500, while a private university will set you back $30,400.

While college tuition costs have far outstripped inflation, having grown at an average rate of 7.74% per year since 1978, guess what constitutes the second highest educational expense for college students? Textbooks.

And those costs have grown at an average annual rate of 6.9% over the same time period, more than the growth of medical care expenses, causing real hardship to students who can already barely afford to put themselves through school. The issue of textbook affordability is so acute that in 2005 Congress asked the Department of Education to conduct a study on the matter and then released a plan in May, 2007 to make textbooks more affordable.

BMOC: Big Monopolist on Campus

According to the National Association of College Stores, students have historically been paying nearly identical prices for both new and used textbooks. Last year, the average list price for a “new textbook” was $64 compared to $57 for a “used textbook.”

When you consider that bookstores are making significantly higher margins on used vs. new books (35.7% to 22.3%) as a result of taking advantage of students by buying back (for very little money) the very books they just sold them last semester, its is clear that bookstores have little incentive to change. Students, on the other hand, are more than ready for a more economical solution that treats them like customers.

“Hi, I’m Chegg”

Chegg launched its rental service in 2007 and it quickly gained traction with students. Highly dependent on the fall and spring semesters when the majority of textbook-buying occurs, Chegg saw a nearly 2X increase in traffic to its website  from Fall, 2009 to Winter, 2010.  In January, it drew 1.3 million unique visitors, according to Compete. This was 10 times more than its closest startup competitor, Bookrenter. Based on its current growth pattern, I expect to see another 2X – 2.5X increase in traffic to the website this fall.

How Fast is Chegg Growing?

Sometime in 2008, Chegg began publishing on its homepage a real-time tally of the total dollars the company was saving its customers. Thanks to screenshot captures and Google image search, I was able to put together the following chart, which shows the explosive growth the company has experienced since the beginning of 2010. The company passed the $100 million savings mark on January 11, 2010 after two years of operation and needed just an additional three months to cross $200 million in May.

Financial Report Card

Jim Safka, the former Chegg CEO, said in an interview that the company generated $10 million in revenues in 2008.  According to a company press release, Chegg saved students just over $16 million in 2008. That means the company is saving students 63% off the list price of books and making 37% in revenue. Using this ratio, I estimate the company did close to $1 million in revenue per day during the winter semester 2009-2010, an increase of four to five times its daily average of $200,000 a day during “off peak” business days.

Based on this ratio, I estimate Chegg generated $25 million in 2009 and will do $130 million in revenues in 2010, accounting for increased traffic and awareness, almost half of which ($50 million) will come in September alone.

Based on my analysis, Chegg is likely operating at breakeven or at a slight loss each month, making the bulk of its profits in September and January. The reason for this is the complex and expensive warehouse and customer service operations required for this business.

Chegg hires three different tiers of employees: full-time engineering and marketing, warehouse, and customer service. Chegg needs to preserve as much flexibility as possible with its customer service and warehouse teams, so that they can be ramped up or down depending on the time of the year. When things are slow, the company still needs to carry the costs of its warehouse.

With a strong affiliate program that costs the company 8% of revenues, and its textbook buyback program, Chegg’s profitability comes down to how effectively they manage three aspects of the business: 1) textbook wholesale cost, 2) warehouse efficiency, and 3) customer service operations. These are three competencies that are very difficult to learn and mimic, creating strong barriers to entry.

Chegg is clearly planning for continued future growth. In February, the company announced plans for a brand-new warehouse facility in Shepherdsville, Kentucky, which will cost the company $27 million and employ another 100 full-time and 1,200 seasonal employees.  Based on my analysis, Chegg will likely have to double its monthly revenue run rate to $10 million in order to cover these additional expenses. Chegg had previously raised $55 million in debt in November, 2009 to invest in this area.

Is This A Winner-Take-All Market?

The nascent textbook rental market is looking a lot like the early days of the online DVD rental business. Online-only startup, Netflix, managed to out-innovate, out-operationalize, and outlast its deeper pocketed rivals—mainly Blockbuster—that had the added advantages of a local physical storefront and customers who already rented movies!

The potential challenges for Chegg look a lot like those facing Netflix a few years ago (and a key one that does not):

• Lack of a physical footprint on campus
• Industry long dominated by a few, deep-pocketed players; in this case, Barnes & Noble and Follett, which operate more than 1,500 campus bookstores between them
• Impending threat of digital replacement of physical goods
• A seasonal product need that does not fully utilize operational capacity

But here is what Chegg does better than anybody else, which makes it difficult to compete against and win:

1. Test Quickly and Fast Rollout: The company can test concepts in discernable communities with limited risk and capital outlay. At the formation stage, the company could limit the number of books it needed. As it grows, it can roll out new services quickly after proving out the concept at say, Florida State.
2. Marketing: There is nothing as viral as a college campus. FTW!
3. Operational Excellence: Like Netflix, Chegg is excellent at pick, pack, ship, and return. This is incredibly difficult to do. And will become more so when the company begins experimenting with extending the model to other books. See #1.
4. Scalable: Chegg will always have better inventory than local bookstores and better pricing. There is nothing stopping Chegg from offering other kinds of books for rent.
5. Customer Service: 30-Day refunds, free return shipping, customer support, tree planting. As I mentioned above, managing for peak and off-peak times is difficult.

Based on my financial analysis above, operating a physical bookstore and running an online rental service require different core competencies. I believe this is a winner-take-all business and that Chegg should control 80%+ market share over time.

Strategic Plan

In order to further ensure its position as market leader, I believe Chegg should position itself as the “Amazon for College Students” and cater to their unique university needs. The company should also go deep into expanding its classroom offerings, such as class notes and digital goods.  Here are some other things it could do

1. Partner with bookstores for physical presence and kiosks a la Red Box
2. Expand its assortment of books to leverage its operational expertise and capacity
3. Expand classroom offerings and potentially acquire companies in this space, such as lecture capture company, Echo 360
4. Embrace digital a la Netflix and partner with publishers
5. Work with Apple and e-reader company Kno (started by Chegg founder Osman Rashid)

The big question for Chegg down the line is how do they counter the cyclicality of the textbook business with more steady streams of revenue.  I’d rent a novel for $5 if there was an easy way to return it.  Wouldn’t you?

Like YouTube, Twitter, and Groupon, social gaming pioneer, Zynga is a member of the “fastest from founding to $1B valuation” club, having earned its membership in just 19 months.

There are two significant traits that distinguish Zynga from its comparables, however. One, Zynga has generated the highest revenue and profitability numbers of any startup ever in such a scant amount of time (more so than even Facebook itself to date). Based on my estimates, Zynga is likely making a 30% net margin on $50 million in revenue a month, or close to $15 million in profit a month. Two, Zynga’s complicated relationship with Facebook means the company has less control of its own destiny. Zynga is under significant pressure to make a series of strategic moves to ensure its continued success. If it cannot do so, its attractive revenue and profitability metrics are certain to be impacted.

In this teardown, I will detail how Zynga achieved its rapid success and dive into the key challenges facing the company.

What is Zynga?

Zynga is the leading producer of online casual social games that can be played with friends and family across the leading social networks, on mobile phones, and now on the web. Indeed, playing games is one of the most popular activities on Facebook, up there with looking at profiles, sharing photos, and “liking.” As you can see from information I pulled from AppData, Zynga’s 246 million unique users per month means that over half of Facebook users are playing Zynga’s games. Zynga has almost 5 times more players than Electronic Arts, its closest competitor.

While Zynga got its start with social versions of already-proven gaming titles such as Risk, Battleship, Boggle, Blackjack, and Texas HoldEm Poker, it quickly applied what it learned about these new gaming experiences to create its own franchises. In a short amount of time, Zynga has developed worldwide hits such as Farmville, Café World, Mafia Wars, Petville, and Fishville. Farmville alone now attracts over 100 million unique users per month, just 10 months after it launched.  While the company has been accused of borrowing heavily from predecessor games, there is no denying the fact that Zynga is an expert at applying social gaming mechanics at a scale unlike any other company.

How Profitable Is Zynga?

There already has been a fair amount of work done to try and estimate Zynga’s revenues. Rather than focus on the top line, I took a stab at coming up with an estimate of the company’s profitability. Assuming an annualized revenue rate of $600 million, or $50 million a month, I arrive at a snapshot of what the financials might look like for April, 2010. (Note that $600 million estimate is on the high end, it could be half that amount).

According to BusinessWeek, Zynga now has 775 employees, which at a $10,000 fully-loaded cost per month (including health care and taxes), would put its monthly obligations at $7.75 million. It also is estimated that the company spends between $5 million and $8 million a month on Facebook advertising. I believe this will be higher—$10 million per month—as a result of the rule changes to Facebook’s feed and increasing awareness for new platforms such as ZLive and the Zynga toolbar. I assume a significant infrastructure is required to serve 250 million players so that is likely running about $10 million per month. Transaction processing is difficult to estimate since PayPal usually charges a flat rate (say $0.30) in addition to a small percentage of the transaction, typically totaling 2% – 3%. PayPal said last week that Zynga is now its 2nd largest customer by volume, however, Zynga deals in micro-transactions so a typical fee structure does not make sense. In the BusinessWeek article the company stated that they are paying “under 10%” for each transaction, so let’s use 10% to be conservative.

Based on these assumptions, I estimate that Zynga is earning at least $15 million per month, or 30% net margin.

This is a significant number because of Facebook’s plan to force its application developers to use its proprietary currency, Facebook Credits, so it can take rent from all of the transactions happening on the site. A 30% transaction fee, which is what Facebook will demand, along with shrinking revenues and increased marketing to raise awareness of Zynga games on the web, could wipe out Zynga’s profit.

How Fast Did Zynga Grow?

According to the company, Zynga had 269 million active players in April, 2010. With that many people, it would be more accurate to talk about “Zynga Nation” considering that number of players would make the company the 4th largest country in the world—ahead of Indonesia and right behind the U.S. Last April the Company reported 30 million monthly players, thus Zynga has grown its monthly users by eightfold in just 12 months! Facebook, in contrast, grew almost 2.5X from 200 million to 484 million over the same time frame. I put together the following chart from user numbers released by the company over the past 18 months and you get a sense for the scale of its rapid adoption.

How Did Zynga Grow So Quickly?

There are six main drivers of Zynga’s growth.

1.  It Was The Beneficiary of Facebook’s Growth:

There is no denying the fact that Zynga benefitted greatly from the astronomical growth of Facebook itself. To test this, I looked at both companies’ announced monthly usage milestones since November, 2008. As you can see in the chart, the trend line suggests that as Facebook added new accounts, those new users in turn discovered Zynga games.

So, on the one hand you could say that Zynga happened to be the right company at the right time and is the beneficiary of a once-in-a-decade tectonic shift in the Internet landscape.

2.  It Pioneered And Perfected Social Game Mechanics In Games People Love:

If only reason No. 1 was true then other early Facebook applications, such as Slide and iLike, would have taken off in the same way; and they did not. And, as I mentioned earlier, Zynga has grown faster than Facebook over the past year. Zynga created addicting games with core functionality that incorporated social elements and public interaction. Rather than trying to “win” games in the traditional sense, game play is an ongoing “experience” that does not end, where people play with one another, and others outside of the game play can follow along. As you can see, Zynga accounts for 31% of all active applications on Facebook, more than 2 times Facebook’s own apps. Clearly, Zynga has given people something to do on social networks. You even could make the argument that Facebook grew because of the value Zynga brought to the experience.

3.  It Took Advantage of The Facebook Feed

Zynga was aggressive in promoting game updates in user news feeds. This allowed Zynga to get in front of millions of potential players without having to pay for customer acquisition. With Facebook removing this functionality, you can see how it could directly impact the company’s profitability by requiring it to increase marketing for the same level of promotion .

4. It Used Its Installed Base to Cross Promote Other Properties

In addition to expertly using the Facebook feed, Zynga was smart at using its in-game inventory to raise awareness of its other games. I looked at the company’s top 13 games, which account for 98% of all Zynga monthly players on Facebook. You can see in the “Months Live” column how Zynga leverages the traffic from its big franchises, such as Farmville, Texas Holdem, and Mafia Wars to introduce its new games. Notice that its newest title, Treasure Isle, which launched just last month is already the 4th largest game, having attracted its user numbers without the benefit of the Facebook feed. Preserving engagement of those long-standing hits is a critical component of its getting players to become aware of new games.

5. It Used It’s Capital Resources Wisely

Because of Nos. 1 and 4 above, Zynga generated higher revenues and returns on its games, giving it access to advertising dollars that its competitors could not match. In addition, Zynga was able to acquire fast growing properties, such as Yoville and Friends For Sale, with its valuable stock and then leverage its distribution system to acquire new users. The company also continues to sit on a warchest of its largely unspent $219 million in venture capital that it was able to raise because of its rapid success.

6. It Figured Out How To Get People To Pay For Virtual Goods

Despite years of hype and numerous failed attempts at building a business based on virtual goods, Zynga was the first U.S. company to make it a reality. Who would have thought that millions of people would spend real money on a special octopus for their aquarium or a prized pig for their farm? Zynga deserves a lot of credit for effectively converting 1%-2% of its significant audience into paying customers.

What Are Its Competitive Advantages?

Zynga creates, launches, and manages games better than any other company. Games are a hit-driven business and have become more like Hollywood blockbusters in their heavy development costs and large marketing budgets. It is not inconceivable for EA to spend many years and $100 million to create and market a new game.

Zynga does this at a fraction of the time and cost. For example, the company took just 5 months and 25 people to launch Café World, which now boasts close to 30 million players. The company did this for likely under $10 million in development and $20 million – $30 million in marketing. So it has both a development and marketing cost advantage over EA and other traditional gaming companies.

Zynga has also perfected “in-game evolution”—meaning the company is continually making enhancements to game play after it has shipped the product. By methodically monitoring how players are using the games, it can make continuous improvements to increase engagement, and therefore, revenue opportunities.

Zynga is expert at building social mechanics into gameplay to boost its user base. Innovative tasks such as getting friends to clean your aquarium or needing “neighbors” to assist you reinforces the proposition, but also helps Zynga scale much more quickly and efficiently. Zynga seems to do this much better than others

Lastly, Zynga has raised more money than any other company in the space. The company was smart to build capital resources when it could because it allows them to outspend smaller competitors and to compete with larger companies such as Facebook and Apple.

Zynga’s Moment

At this time, Zynga faces three significant challenges to its business. And it is playing itself out in realtime.

1. Maintain Revenues/Profitability Amid “Mortal” User Growth: Zynga’s incredible hockey stick growth of the past 2 years appears to have come to an end. Comparing its growth from July – September, 2009 where it doubled its monthly players, last month was completely flat. Zynga needs to launch new hit franchises to continue high levels of engagement and convert a higher percentage of its players to pay for premium services and virtual goods.

Strong Growth July, 2009-September, 2009


Growth Flattening April, 2010-May, 2010


2. Become Less Reliant On Facebook: As TC reported last week, Zynga is moving quickly to launch ZLive, as well as individual destination sites for all of its games. This is critical to prevent the company from being held hostage to Facebook revenue share demands. A 30% revenue share could virtually eliminate Zynga’s bottom line. As you can see below, it has done a great job of getting a portion of its players to the first of these sites for Farmville. But, after a rapid ramp up, usage has been stable for the last quarter. It will similarly launch standalone websites for its other properties. Will its users embrace them?
3. Prepare for Battle With Apple in Mobile: With over 60 million iPhones, iTouches, and iPads sold to date, Games are the No. 1 application in the Apple App Store. Collectively mobile games are a $3B+ a year business, according to Electronic Arts. Steve Jobs has stated that the company is going to be aggressive in social gaming across the iPhone and iPad with its next OS 4.0. Additionally, if Apple also controls advertising across apps, Zynga will lose another of its competitive advantages in cross promotion. It is unclear how Zynga will fare in this increasingly competitive mobile ecosystem. I suspect the company will combine the social mechanics that have worked so effectively online to a world where location is key, along with a continuous string of compelling premium Apps.

Much has been written about the rapid growth and success of Chicago-based local daily deal company, Groupon. And it is for good reason. No other startup has gone more quickly from launch to $1 billion+ in valuation except YouTube (12 months), which Groupon achieved in 16 months with its latest $135 million infusion two weeks ago. Just as unprecedented, the popularizer of the “group coupon” increased its valuation 4X in the span of just 3 months. What is going on here? Is Groupon yet another example of frothy venture capital valuations or is the company one of the next, enduring consumer Internet brands?

The Teardown

To find out, I did a teardown of Groupon’s business with data available on its website over the most recent quarter, compared my findings to what I calculated for the final three months of 2009, and then looked at how all of this compares to the top competitors. I conducted two analyses: 1) I looked at every deal across the Groupon network for a single day last November and a day this past April to see how revenue is scaling and how the company is benefiting from rapidly opening support for new cities. I then analyzed every deal listed on the Groupon website across 5 cities (San Francisco, Boston, St. Louis, San Diego, and Denver ) for all of Q4 2009 and Q1 2010 to determine how the company is growing once it enters a market and to see how the product mix is changing. The key finding is that Groupon is achieving considerable revenue growth across all measures: more customers, higher deal prices, and rapidly expanding markets.

How Groupon Makes Money

Groupon takes the old Entertainment Coupon Books that your mom used to buy and brings it to the social web. Groupon sells a “Deal of the Day” in each of it’s now 52 supported cities offering significant savings for local restaurants, service providers, activities and memberships, and takes a commission. The trick is that the deal is only “triggered” once enough people buy in. This creates the incentive to share the deal with friends and family, until “the deal is on.” It’s great for local businesses because they can set the parameters for the offer and they know a minimum for how many offers they will have sold in advance. By combining the social web and virality with hard-to-replicate deals, Groupon has created a network-effects business for commerce that makes its model highly attractive (hence, every week seems to bring new copycats).

Traffic

Groupon had nearly 3 million unique visitors in March, up from 900,000 in September. It is now bigger than Woot, in terms of traffic, and quickly approaching Zappos (5 million). According to Compete, Groupon gets more of its traffic from Facebook than any other site, including Google, and when people are searching they are typing “groupon”- meaning it is already enjoying the benefits of its brand equity as the company becomes synonymous with the category. As a result, Groupon is spending very little money on search engine marketing (as opposed to say Netflix or Amazon), which is a significant cost advantage. Leading direct competitor, LivingSocial, by contrast, flattened out at 900,000 but now appears to be ramping up again.

What Are People Buying?

Coupons for restaurants, massages, discounted memberships to fitness clubs and museums, local activities, tourist attractions, and merchandise continue to make up the bulk of what is being sold. You can tell a lot about a city by what is being bought on Groupon. To wit:

• Boston residents love laser hair removal (655 purchases), gliding around town on Segways (4,311), and learning how to fly a helicopter (2,575). Hopefully not all on the same day.
• St. Louis residents love their plants and garden supplies (6,106) and, of course, Llwelyn’s Pub (5,832)
• San Diegans are into Pole Dancing and unlimited carnival rides (3,875)
• Denver loves them some Cold Stone Creamery (7,110) and Speed Raceway (1,938)
• Atlanta is into NASCAR (1,063)
• Chicagoans enjoy the Tall Ships (7,119)

If you look at the top 10 deals by number of purchases, local merchants appear to be getting more comfortable with the Groupon marketing channel. Restaurant coupons will also be popular but offers like discounted clothing, flowers, house cleaning, and local events like boat shows are increasingly appearing on the site. As you can see below, between the fourth quarter of 2009 to first quarter of 2010, “Activities” replaced “Dining” as the #1 category and “Merchandise” took a big jump. My guess is that this will become more prevalent as Groupon increases its salesforce and these more local merchants begin to experiment with unique offers.  Consumers will benefit as they have the opportunity to grab more of their favorite things at deep discounts.

How Big Is Groupon’s Business and How Fast Is It Growing?

On April 16, 2010, Groupon had 31 deals, 45,910 paying customers and sold nearly $1.3 million worth of coupons. This was a significant increase from the 17 deals, 10,018 customers and $240,000 in gross sales it had on November 6, 2009. Along every measurement I looked at—the number of deals /day, average customers/deal, average deal price, average gross revenue/deal—Groupon is seeing tremendous growth. Of particular importance is that its average deal price is increasing (from $24.65 to $44.94) and it is rapidly opening up new markets.

All of this is what is causing Groupon’s revenues to scale quickly. Assuming a 30% revenue share, Groupon netted $72,000, last November for a monthly run rate of close to $1.5 million, assuming 20 deal days each month. In April this had jumped 5X to $380,000, implying a monthly run rate of $7.6 million. As you can see from the chart below, not only is the number of deals increasing, but the number of customers per deal more than doubled and Groupon was able to elevate the price per deal. That formula of (more deals + more customers) X (higher ticket items) seems to be working.

Based on these numbers and the company’s growth rate, Groupon should easily surpass $150 million in revenues in 2010. And as revenue ramps, most of this will be pure profit since the company does not hold any physical inventory and its customer acquisition costs are so low.

How Is Groupon Doing Once It Gets Into A Market?

(Note: For some reason, there are not deals listed for every day but this seemed to be the case for both time periods, so we are looking at an apples-to-apples comparison. )

While there were nearly the identical number of deals during the two time periods (106 vs. 107), Groupon more than doubled its average gross revenues per sale from $23,000 to $47,000. The company doubled the average number of customers per deal from 874 to over 1,800 and increased the deal price from an overage of $27.20 in Q4 to $38.36 in Q1. I also thought it was interesting that the most purchased deal in Q1 was 7,119 (for a $16 ticket to ride the Tall Ships in Chicago), more than double the most popular sale in Q4 (2,918 for a $15 Vegetarian Dinner in Denver).

How Is The Rampant Competition Affecting Groupon?

Obviously I am not the only one running these numbers. Because of this dramatic growth and the wild profit potential of the emerging daily deals category, a number of companies are trying to become fast followers. You can see a comparison below of Groupon with its two most well-funded followers, LivingSocial and BuyWithMe (which recently brought on an experienced CEO in Cheryl Rosner, formerly CEO of TicketsNow and Hotels.com). Groupon has raised a total of $171 million to-date, employs more than 200 people, and serves 52 markets. Its next biggest competitor, LivingSocial, has raised $49 million, employs about 50 people, and serves 14 markets.

Of the companies the press likes to mention as competitors, the reality is that only LivingSocial has established enough traction to provide sufficient data to draw a comparison. LivingSocial is now in 14 markets compared to Groupon’s 52. I compared the daily deals for Groupon and LivingSocial for the same day as above, April 16.

As you can see below, LivingSocial looks a lot like Groupon did 6 months ago. LivingSocial had 10 deals compared to Groupon’s 31. On every measurement, total customers (45,910 vs. 5,976), average customers/deal (1,481 vs. 598), average deal price ($44.94 vs. $29.00), and average gross revenue per deal ($40,753 vs. $18,276), Groupon is far ahead. The data suggests that Groupon is not yet feeling the impact of all the new entrants.

The $1 Billion Question: Is This a Winner-Take All Market?

I think the potential for these kinds of offers on the web is a $5B+ opportunity. There is no reason to believe that this concept couldn’t be extended to virtually any category or service provider.

But I do not think this is a winner-take-all market like auctions were when eBay took that market.

There are no real technology advantages, there is nothing preventing a local vendor from using multiple platforms, and buyers don’t care where they buy so long as the deals are good.

That said, my take is that this is a winner-take-most market and looks more like search, where the bulk of the revenues will fall to the leader. There are definitely network effects in play and they appear to be stronger than I initially assumed. When Groupon enters a new market it is starting from scratch but it can leverage its significant investment in its platform. This is the reason it has raised so much capital and it is racing to get into new cities before the competition. The question remains whether fast followers like LivingSocial and BuyWithMe will be able to grow into mini-Groupons with Groupon already firmly entrenched in a city.