Hitting Reset on the Internet and Mobile

Reset_Button

Every day there seems to be a new figure released that enforces the notion that mobile is also eating the world. The problem with most of the coverage of this type of data is that (1) the pace of mobile adoption shouldn’t come as a surprise and (2) the definition of what constitutes ‘mobile’ needs to be revised.

With smartphone penetration about to cross 60% and tablet ownership almost doubling from last year to a third of the U.S. population in 2013, it’s no coincidence that the amount of incremental traffic that mobile brings to the 50 most-visited internet properties now averages 28% (reaching a high of 223% in one instance) according to comScore. In response to this, media companies are reinventing their content consumption experiences to meet the growing demands of mobile users. Atlantic Media launched Quartz, a digital-first, mobile-oriented publication late last year while The New York Times is in the process of redesigning its online presence (slated for release this fall) to resemble the single-page stream layout popularized by social networks. Even native web media outlet ReadWrite is leveraging responsive design to adapt to their multidimensional mobile audience. This design trend will only accelerate the transition of internet activity from the desktop to mobile devices.

Remember, the personal computer, which reached the mass market more than 15 years before the web browser, was never intended to be a web-centric device. The evolution of wireless technologies and networks combined with the invention of smartphones and tablets are allowing digital companies to finally hit the reset button and create internet experiences that are designed to be more useful, from both a content and advertising perspective, than the current incarnation of the commercial web which borrowed heavily (to everyone’s eventual detriment) from print.

What this means for evaluating the mobile phenomenon is that instead of accepting all these stats at face value, we need to look at mobile’s ability to drive incremental adoption and create new monetization opportunities above and beyond the natural growth that comes from cannibalizing PC-based audiences and revenue streams.

This brings us to the issue of what exactly constitutes ‘mobile’. Typically we think of smartphones and tablets as providing mobility. But if you take into account that over 90% of tablets being purchased only use WiFi and, as a result, are primarily used inside the home, what differentiates these devices from laptops, which we consider PCs, aside from the form-factor? If you also include the divergent behavior of smartphone and tablet users the whole concept of what mobile is and represents needs to be redefined.

Instead of thinking of mobile as a device, we need to think of it as an activity. The two data points that matter most in defining mobile activity then are a user’s location and their data network. So if someone is at home or at work they shouldn’t be considered mobile. In this context the use of smartphones and tablets (instead of desktops and laptops) for accessing the web and certain apps (that also exist as websites) is done out of convenience rather than the need for a specific capability- and usually enabled over a WiFi network. The only experiences that should be classified as mobile are in locations where people usually don’t spend an extended amount of time at with their devices and are typically connecting to the internet by way of cellular or MiFi networks- so pretty much everywhere else. Building products and services that maximize utility in these scenarios is where mobile becomes useful. If we can agree on a better definition of mobile, then we can better quantify this opportunity, understand network constraints and figure out solutions that create new value.

This isn’t to say that devices that use WiFi networks or are used at home aren’t valuable- especially when you consider IP-based ad targeting and the second screen opportunity (something I’ll touch on in a future post). It’s just that the mobile activity on devices in these locations don’t generate incremental value unless they are using mobile-only applications (such as HotelTonight or Uber) and could, in fact, be destroying value for certain companies when taking into account that mobile users monetize at a lower rate than their desktop equivalent.

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The Valuation Disconnect in Mobile

Well before the media anointed mobile the Next Big Thing, venture capitalists saw its potential. Consumers have rewarded VCs for their foresight by how quickly they’ve adopted non-voice mobile services over these past couple of years. The result has been a number of high-profile liquidity events this year starting with mobile ad network Millennial Media’s IPO followed by Facebook’s acquisition of Instagram for an eventual price of $736 million and record levels of gaming sector acquisitions led by mobile. With all this positive momentum it’s not surprising that VCs continue to allocate an increasing share of deals and dollars to mobile startups as the overall number of investments has reached its highest levels since the dot-com days.

In contrast to this optimism in the venture community, Wall Street is down right negative towards mobile. Google’s third quarter earnings announcement was met with a 8% drop in share price in part due to the increasing number of search queries being performed on mobile devices which is causing a deceleration in the company’s revenue growth. And while Facebook’s most recent quarterly earnings report resulted in the stock rising 20%, the company’s market capitalization is still only at 60% of its peak value from its first day of trading. This is in largely due to concerns over Facebook’s ability to monetize their growing mobile audience, which now consists of 600 million users, including 126 million of which use Facebook mobile exclusively.

The Typical Relationship

So why the disconnect in how these investors value mobile? It can be partially explained by how each type of investor evaluates investment opportunities to begin with. Venture capitalists, especially early stage ones, typically look to buy private, and thus illiquid, stock in pre-revenue companies with nascent, but potentially market-disruptive, ideas. As such, these investments may take up to 10 years to realize a return for their VCs, if at all. Contrast this with public market investors, such as hedge and mutual funds, which focus on the predictability of earnings and revenue growth relative to a company’s market value and reevaluate their investments in real-time based on news and quarterly earnings reports since liquidity is readily available in these stocks.

So when VCs invest in start-ups, especially consumer-oriented ones that are ad-supported, they are betting not only on a company’s potential to execute on their business plan but also on the formation of a rapidly growing market. Due to this, the focus is usually on customer acquisition and market share growth- not revenues. As a market begins to mature in size and opportunity, monetization solutions are developed, usually by other start-ups, allowing the entire market to benefit from the creation of new revenue streams. Companies that don’t get acquired and can show they have a path to profitability have the opportunity to go public and in the process become industry bellwethers, using their new capital infusion and stock shares as currency to further enhance their market position.

Why Mobile Had Been Different

In the case of mobile, a couple of things happened that has affected the usual relationship between the private and public markets. First, the consumer adoption of mobile has outpaced any other technology in the history of the U.S.- including radio, TV and the internet. As such the native monetization solutions that were developed alongside these other technologies have been slow to scale in mobile because (1) the ad formats currently being used are largely re-purposed ad technologies from the desktop internet, such as banner and rich media ads, which were easy to launch with in an effort to capture mobile revenue early on and (2) advertisers have been slower to allocate advertising budgets to mobile than previous technologies due to this speed of growth- funds that would be used to help spur innovation in ad experiences on mobile devices.

The economic realities of increasing supply of mobile ad inventory coupled with relatively low demand for quality ad experiences thus far has resulted in effective CPMs that are 1/5th the price of desktop internet advertising. This disparity in monetization capabilities between mobile and desktop is forcing public investors to reevaluate consumer tech investments where mobile is becoming impactful enough from a usage perspective to potentially affecting earnings. With Millennial Media, a pure-play mobile ad network, and Pandora Media, whose ad-supported internet radio audience is now 75% mobile, still not profitable as publicly-traded companies, investors will continue to discount the mobile businesses of public consumer technology companies for the foreseeable future.

Without having proven their business models to Wall Street yet, Millennial and Pandora can’t be considered mobile bellwethers, which is needed to preserve the private-to-public valuation relationship. Companies such as AdMob and Instagram might have achieved bellwether status if they hadn’t been acquired before realizing their potential as stand-alone public companies. As such it might be left to existing ad-supported consumer internet tech leaders who are able to make the audience and business transition into mobile to perpetuate the ecosystem. Facebook, which has faced scrutiny over its performance as a public company in part due to mobile, has the momentum in user growth and sheer audience size to accomplish this transformation if they can prove their various mobile ad products can profitably scale. Because of this you could argue that Facebook actually went public too early, instead of too late, if you look at it as a mobile-first company. Probably the best positioned public company though is Google which acquired what is now the most popular mobile operating system in Android, largest mobile ad network in AdMob and is seeing mobile growth in its core search business as well as across YouTube.

Mobile is Really Two Different Experiences

The second part of the answer to the valuation disconnect is in the definition of mobile. When research companies forecast trends and investors talk about opportunities they always speak about mobile as if it were one cohesive distribution channel when in fact it is composed of two distinct experiences- smartphones and tablets. Being able to differentiate between the two is critical because of the activities each device is best suited for based on the physical limitations of each display as well as their monetization opportunities.

Smartphones

While Apple might be credited with ushering in the consumer mobile era with the launch of the iPhone in 2007, it was the launch of the App Store the following year that enabled smartphones to properly leverage their mobility as the physical limitations of mobile phone screens (3 to 5 inches in length) required task-specific applications be built instead of all-encompassing web experiences. Because of this, the most successful app experiences, as Benchmark Capital’s Matt Cohler eloquently describes it, mimic a remote control in that they are easy to use and provide a specific utility to consumers. In turn, advertising on mobile phones need to abide by these same principles in order to be valuable.

Rare Crowd’s Eric Picard described the current mobile ad format problem in a recent article while also presenting a possible solution for smartphones that is interruptive without being intrusive- and can be delivered at scale. For app developers that have large enough user-bases though, creating native experiences, especially ones that can leverage location, will always result in better value for both the advertiser and consumer. Expanding on sponsored ad units that Facebook (via Sponsored Stories) and Twitter (via Promoted Tweets) have popularized in the social activity stream and more recently on mobile, location-based social exploration platform Foursquare launched Promoted Updates for local merchants this past summer and crowd-sourced traffic app Waze launched its own self-service advertising platform earlier this month that focuses on solving users’ location-based needs.

Tablets

Like smartphones, Apple can also be credited with jump-starting the tablet market a mere 3 years ago. The company was prescient in introducing the iPad as a tool for consuming media as users have made watching TV shows, playing games and reading the primary uses for the device. This makes sense when you consider the screen size of tablets (ranging from 7 to 10 inches) allows consumers to replicate the offline experience of reading a magazine or watching television in a more convenient and personal format than traditional computers allow for. Because of this, advertising on mobile tablets can be interruptive like traditional media and less concerned with other vectors such as location since most people are using their tablets at home and as a second screen complement to watching television. That means online video and rich media interstitials, which are higher-valued ad units than traditional banner ads, will work with minimal refactoring compared to smartphone ad experiences. That doesn’t mean there isn’t an opportunity for companies to innovate around the ad experience as start-ups like Kiip are proving by rewarding user engagement and retention within mobile apps with real world rewards.

When It’s All Said and Done

With tablets expected to outsell PCs by next year, focusing efforts on this part of the mobile market might be the most prudent move for consumer tech companies with mobile audiences since the advertising experience most closely resembles the desktop internet from both a format and value perspective. The smartphone advertising market will take longer to scale simply because of the utility-oriented nature of the user experience.

As these advertising solutions sort themselves out though, so should the discrepancy between public and private market investor valuations around ad-supported business models. As start-ups fill these gaps in the consumer mobile space with monetization solutions that prove to be effective, so to will public investors get comfortable with the long-term value mobile users have to offer, which, at the end of the day, will benefit everyone involved in growing the value of the mobile industry.