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How The Internet Killed Profit

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Editor’s note: Tom Goodwin is the founder of Tomorrow Group, a marketing and advertising consultancy for the post-digital age.

New eras in technology have always brought a fear of job losses and the devastation of legacy industries, but the Internet has taken us beyond “creative destruction.” It’s destroying the very foundations of business.

Software is indeed eating the world, in Marc Andreessen’s words, and we’re presented with an abundance of value being generated for consumers, but what if it’s killing the profit margin? It was Heraclitus who thought that nothing new ever came into our lives without a hidden curse, and from the steam age to the electrical age to the early Internet, we’ve long heard the cries of Luddites or neo-Luddites angry at the change.

They’ve had a point: Whether it was the industrialization of agriculture or the long decline of the postal industry, we’ve seen job losses on a massive scale. It’s always been the case that new technology improved the goods and services for consumers while boosting business profitability, and it’s been hard to ignore the benefits for everyone, except for the laid-off workers.

The pace of this change is accelerating. Technology is developing at a faster rate, with ever more devices becoming more connected, and at ever greater speeds. This exponential progress along a multitude of axes combines to create explosive growth. It’s an incredible foundation for a new era of companies, all set to exploit the most powerful change in technology in history — a new interconnected, always on, global population that can do more, buy more and experience more than we could ever imagine.

This limitless optimism and unparalleled excitement fuels the hysteria in Silicon Valley. We see huge salaries and skyrocketing real estate prices, all driven by some of the most spectacular valuations the market has seen. Whether it’s Snapchat being touted as a $10 billion company, Facebook trading over 100 times its profit per year, or the ultra simple Yo app being worth $10 million less than a week after launch, it’s impossible to ignore the confidence in the business world ahead — a world where user growth can come at all costs, because first-mover advantage can ride this wave of progress.

As consumers, we’ve never had it better: We can do more things than ever and do them more quickly, safely and easily than ever. Whether it’s a spontaneous hotel stay, a global flight, or every movie ever made, as users we have it all at our fingertips, at a fair price, a few clicks away. Never before has so much been so easy, but most notably so cheap.

But has this abundance of supply, combined with the rush to recruit new users and new ownership and behavioral patters completely stripped our ability to make money? What if the Internet was so powerfully efficient, margin became excessive.

Digitization

One of the most well-documented areas killed by the Internet has been music, as part of a growing number of products or services that once have become digitized, are unable to charge much at all for their consumption. While a box set of music has inherent tangible value, the move from physical form to digital destroyed the ability to charge a premium; but it was the next move, from ownership to streaming, that really killed an industry.

We’ve never listened to more music, in more ways, in more places, and yet after reaching a peak in 2000, the music industry now earns half the money, having lost over $7 billion of revenue and more than half its value since the dawn of the Internet. There seemed to be promising companies in this space: Take Pandora, the legacy player in music, with 250 million users, but which in its 14-year history has made a loss for all but one year, where it made a profit of 2 cents per user. Then we have Spotify, with its monthly subscription model attracting over 10 million paying users per month, which has never come close to making money. Many experts claim no real profit will ever be generated from streaming music because the music industry can’t charge less money and customers aren’t willing to pay more.

The same problem looks set to hit TV content companies, where despite the confidence in the future, neither Amazon Prime Video nor Vudu have ever come close to making a profit, while Netflix is valued at 250 times annual profits, but treads the same worrisome path of forking out ever more money per user while extracting less revenue per customer.

Other physical products now turned into digital face the same exact problem: spoiled users who won’t pay more but expect to get more each and every year due to competition for their business. Whether it’s Dropbox or Box in storage or Microsoft in software, it seems “X as a service” wasn’t the license to print money we all expected. Photos, news, encyclopedias and now software, storage, music and video are all businesses whose revenue streams were decimated by digitization.

Ad Funding

In a world where we don’t pay with our money, it’s assumed we can pay with our attention, and thus 80 percent of apps and most of the news and music industry is now focused on advertising as their primary funding principle. But the unspoken killer problems of ad funding are that digital ads don’t seem to work — their performance is declining, and the value of each ad is getting lower. While Facebook, the poster child of success, is worth over $190 billion, its revenue would place it well out of the top 1,000 companies. In a year, for all the value it provides, it extracts less than $10 per user per year. By contrast, the much-maligned AOL manages to make double this amount per month from their remaining dial-up subscribers.

The simple fact remains that few companies — in fact just one company ever, Google — has made an amount of money remotely exciting to those with a grasp of real-world economics. Newspapers may be creating more content for more people than ever, but the loss of advertising and subscription revenue is three times greater than what they make online as a replacement. As contrary as it seems given the optimism, the advertiser-funded Internet isn’t working and that won’t change soon.

Price Transparency

To the delight of users, we have a more competitive global marketplace than ever, whether it’s one of the many flight, hotel or car rental aggregation tools, or even the entire world of e-commerce, it appears we can comparison-shop and spot a deal in seconds.

Yet, while brick-and-mortar retailers like Walmart and other global giants have leveraged their buying power to dominate and make 4 percent margins, online players fact a more frictionless environment where price trumps all.

Amazon, the most successful retailer in online history and one we all assume to be the very sign of health in online business, has made losses most years and since it’s launch 20 years ago is still unprofitable over it’s history. While it reinvests more profit than most, even in it’s best years it’s made less than 0.5 percent profit. When the blogger Matthew Yglesias famously called Amazon “a charitable institution being run by elements of the investment community for the benefit of consumers,” he could well be describing the entire Internet.

Despite this, we still encounter the same endless optimism from companies that understand technology but have no idea about retail, and startups that think simply cutting out the middle man and bribing new customers with opening offers will lead to sustainable margins. History suggests it won’t work. But you can ask made.com or Zulily or fab.com.

Retail is an art. M-commerce won’t likely make you miraculously sell more things but reduce your chance to up-sell or cross-sell. Think you can sell groceries online and make a profit? Just know for over 10 years no company in the world has ever come close to making money, and not for a lack of trying.

In a world where the retail experience is removed, you compete only on price. Uber, Lyft, Hailo, Sidecar, BlaBlaCar, Djump and one of a hundred other companies competing for the future of personal transportation may think they can differentiate, but I see a future where all ride-share companies are forced down on price. Which, when you are spending money to recruit drivers and users and have product parity, just ends in nobody making money.

New Products

The Internet is removing friction but that is often where the margin was made. LinkedIn seems to connect people and jobs to the detriment of recruitment agencies. And look at Groupon — a company that’s not only managed to make a huge loss over its lifetime, but also led to a culture where few people are willing to pay full price for a massage or haircut again.

The Internet has taken services we’d historically needed, loved, and been willing to pay a price for, and given us Skype, WhatsApp, Viber and Line to ensure telecommunications companies or mobile operators could never again charge for international calls or text messages.

Above all else we’ve spoiled people; I’d say we are becoming the most demanding customers ever. But we are not customers, we are users, we don’t pay. In fact we don’t pay any money, we have no contract, no loyalty, we flock to the latest shiniest thing and it’s easier to do than ever, we are the people you wished would be a parasite on your competitors servers, but when new economic metrics value users above all else, we all become prized.

In our desperation to count users, we forgot to make money, the assumed byproduct that never materialized. Perhaps the Internet killed the profit margin and also common sense.