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A FIVE FORCES ANALYSIS OF NICHE AND GENERIC NETWORKS IN THE ONLINE SOCIAL NETWORKING INDUSTRY

A THESIS Presented to The Faculty of the Department of Economics The Colorado College

In Partial Fulfillment of the Requirements for the Degree Bachelor of Arts

By James R. Fry December 2008

A FIVE FORCES ANALYSIS OF NICHE AND GENERIC NETWORKS IN THE ONLINE SOCIAL NETWORKING INDUSTRY

James R. Fry

December, 2008

Economics

Abstract

An online social network is a venue on the internet designed for interactions among members of a community. Hundreds of millions of people across the world engage in social networking to connect with each other making this relatively new practice a significant part of our lives. This year online social network membership is expected to include 50% of internet using adults and 84% of internet using teenagers.

This study compares several factors relating to the two sectors of the online social networking industry, which are niche and generic websites. The analysis of these factors is used to conduct a five forces analysis on the industry. The analysis attempts to determine the competitive environment, the current state of the industry and where it might be heading.

It was found that users of niche networks showed much higher levels of loyalty meaning switching costs for niche users were higher than for generic users. Niche users also showed much higher levels of engagement than generic users, which potentially will generate higher levels of profits as social networking grows. The five forces analysis concluded that the industry is an attractive one to enter if the entrant pursues a niche strategy, can cope with strong supplier forces, and can effectively build a large as well as highly engaged member base, thus generating very high traffic and profits.

Keywords: (five forces analysis, online communities, social networking)

ON MY HONOR, I HAVE NEITHER GIVEN NOR RECEIVED UNAUTHORIZED AID ON THIS THESIS

Signature

TABLE OF CONTENTS

ABSTRACT HONOR CODE 1 INTRODUCTION

11

111

  • 1.1 History

of Web 2.0

..

  • 1.2 Current Industry Growth

................................................................................

5

  • 1.3 Niche vs. Generic Sites

............

..................................................................

8

  • 2 LITERATURE

.....................

6

  • 2.1 Social Network Analysis

......

.......................................................................

7

  • 2.2 How Strangers Connect Online

.....................................................

8

  • 2.3 Reasons for Engaging

................................................................

10

  • 2.4 Application of Five Forces ModeL

.................................................

13

  • 3 THEORETICAL FRAMEWORK

......................................................

15

3.1. The Five Forces Explained

.............................................................................

17

  • 3.2 Applying the ModeL

......................................................................................

19

  • 3.3 Hypotheses

.................

...........................................................

20

  • 4 METHODOLOGY

21

  • 4.1 Populations and Samples

21

  • 4.2 Interview and Survey Design

23

  • 4.3 Procedure

24

  • 5 RESULTS

24

  • 5.1 Sample One Data

28

  • 5.2 Sample Two Data

29

  • 6 DISCUSSION

37

  • 6.1 Internet Advertising and User Engagement

37

  • 6.2 CPM and CTR

38

  • 6.3 User Engagement is Key

39

  • 6.4 Implications for Hypotheses

24

6.5.1 Barriers to Entry

46

  • 6.6 Intensity of Rivalry Among Existing Competitors

49

  • 6.7 Threat of Substitutes

50

  • 6.8 Bargaining Power of Buyers

51

  • 6.9 Bargaining Power of Suppliers

52

  • 6.9 Overall Analysis

55

7

CONCLUSION

57

APPENDIX A

58

APPENDIXB

59

APPENDIX C

62

APPENDIX D

63

SOURCES CONSULTED

64

LIST OF TABLES

  • 5.1 Executives Responses to Interview Questions

..............................

...

29

  • 6.1 Internet Advertising Basic Revenue Calculation

................................

39

LIST OF FIGURES

  • 1.1 US ONLINE SOCIAL NETWORKING AD SPENDING .........................

3

  • 3.1 THE FIVE FORCES

..

...

16

  • 3.2 ONLINE SOCIAL NETWORKING INDUSTRY VALUE CHAIN

........

....

17

  • 5.1 NICHE AND GENERIC USER SATISFACTION ................................

30

  • 5.2 PERCEIVED MEMBER CONCERN ................................................

31

  • 5.3 NICHE AND GENERIC USER HOURS P/WEEK

 

....

31

  • 5.4 NICHE AND GENERIC USE OF OTHER NETWORKS

.....

...................

32

  • 5.5 USER LOyALTy

.......................................................................

33

  • 5.6 USERS WHO WOULD JOIN A NEW NICHE NETWORK (%)

...........

.....

33

  • 5.7 PREFERED TIME ALLOCATION AFTER JOINING NEW NICHE

34

  • 5.8 CHANGE IN TOTAL TIME SPENT ON SOCIAL NETWORKING

...........

35

  • 5.9 CHANGE IN TIME SPENT ON NETWORKS AFTER JOINING A NEW 36

NICHE NETWORK (HOURS/WEEK)

..................................................

.

6.1

US

ONLINE ADVERTISING SPENDING .........

............................

....

54

6.2

THE FIVE FORCES: ONLINE SOCIAL NETWORKING INDUSTRy

......

55

CHAPTER 1

INTRODUCTION

The internet is used by about 248 million people in North America and online

social networking plays a roll in the life of over 115 of Americans l .An online social

network is an electronic venue on the Internet for a community of people to interact with

each other. Common functions of a social networking site include "friending", "bloging",

private and public message sending, instant messaging, and sometimes more advanced

options such as music and video posting or even video conferencing 2 .The purpose of this

research is to analyze the competitive environment for profits within the online social

networking industry.

This research discovered that niche networks showed higher levels of user

engagement and loyalty, which makes sense due to the fact that niche networks target a

user's specific interests which have context in their everyday lives, driving them to use

the site with more frequency. The research also uncovered interesting insights from the

managers of online social networking companies that helped greatly in the industry

analysis chapter.

I "Online Social Networks, Virtual Communities, Enterprises, and Information Professionals- Part 1. Past and Present." Information Today, Inc .. http://www.infotoday.com/searcher/juI07/Reid Grey.shtml

2 "Kohut, Andrew. "Internet's Broader Role in Campaign 2008." People-Press. 11 Jan. 2008. Pew Research Center. 23 Sept. 2008 <http://people-press.org/report!?pageid=I233>.

2

Online social networks fall into a category of web applications commonly referred to as Web 2.0, or "the 2 nd version of the internet" in which users not only consume content, but produce and consume content produced by other users. These types of websites like Wikipedia, MySpace, and Blogspot are described as being a form of "online participatory culture,,3. However a similar yet more applicable term for this form of web interaction that is used in this thesis is "user engagement". Massively popular social networking sites like MySpace.com and Facebook.com have realized extraordinary revenue gains (mostly from advertising revenue) in less than five years. Facebook boasts 100 million active members and MySpace currently has 180 million members in total. Total US advertising spending allocated for online social networks is estimated to reach $1.5 billion this year see figure x below. It was estimated in June 2008 that MySpace gains about 230,000 users per day from all over the world 4 MySpace revenue is projected to top $500 million by the end of this year

5

.

3 Beer, David, and Roger Burrows. "Sociology and, of and in Web 2.0: Some Initial Considerations." Socialogical Research Online 12, no. 5 (2007): 1-16.

www.socresonline.org.ukl12/5117.html

4 Sellers, Patricia (2006-09-04). "MySpace cowboys", Money, CNN.com.

5 Dignan, Larry.

"Fox interactive turns annual

profit." ZDnet.

<http://blogs.zdnet.com/btll?p=5 899>.

8

Aug.

2007. 23

Sept.

2008

3

FIGURE 1.1 - US ONLINE SOCIAL NE T WORKING AD SPENDING

us Online Social Network Adv~rtl$~ng SpendIng. 2006·2011 (mUUons and % change) S2.020(~) 2010 S2AOO (19 %)
us Online Social Network Adv~rtl$~ng SpendIng.
2006·2011 (mUUons and % change)
S2.020(~)
2010
S2AOO (19 %)
2011
52.700 (13 %)

Note: tndudes general SOcial neh'lOlt sites Where SOCial netWOfkmg is the primary aCtiVity; sacial lIetWOlk offMngs from portals such a-s Google. 'mhoo! and MSN: niche socJ31 networks devoted to tI specIfic nobby or Interest afIIJ mSf/(eter-spomored SOCial netwo rks,' in till caseS. figures Include Ortfifl(! advertising spendmg as well as Slte or ptofiJe-page aevefopmem COStS, figlJres exdiJde tJser-generat(!d content Sites With

social nerworkmg features, eg YOUTube

Source : eMarkerfN, December 2007

3 FIGURE 1.1 - US ONLINE SOCIAL NE T WORKING AD SPENDING us Online Social Network

Source: e Market er . "Social Ne tworking. /I 1- 7. www. e Marketer . co m

Aside from the aggregate generic networks with member bases that rank in the hundreds of millions, there exist smaller niche online social networks. As consumers have become more comfortable with the idea of social networking and alienated or annoyed by the larger networks, these smaller networks have risen in popularity6. User specific networks for all types of people including musicians , students on the college search, soldiers , and even carpenters ha v e been created 7 Despite the global popularity of this industry there is very little scholarly research on the topic. There exist bodies o f literature on sociological theories defining social networks and literature on how these net w orks exist on the Internet. Michael Porter , who

.

6

TechWatch. "Renegade Marketing 's CEO Dr e w Neiss e r's Predictions for 2008." www.techwatch.com / socialnetworking (accessed December 2, 2008).

7 "List of social networking websites." Wikipedia. 23 Sept. 2008 . 23 Sept. 2008 < http:// en .wikipedia.orglwikillist_o C social_ networkinL websites > .

4

specializes in business strategy, has written extensively on the competitive landscape of

various industries. There exists extensive literature on Porter's Five Competitive

Industry Forces and on how the Internet can affect an established industry. A handful of

case studies on small experimental online networks have been conducted. The following

research analyzes the competition for profits within the online social networking industry

using the theoretical framework of Michael Porter's Industry 5-Forces Competitive

Model.

The three most used and successful online social networks in the United States today

are MySpace, Facebook, and Bebo. The strategy of these networks has essentially been to

allow site membership to anyone with access to the internet and the desire to

communicate with others. There also exist smaller networks that cater to special interest

groups, these sites are called niche social networks and are a primary aspect of study in

this thesis. Members are offered the use of these sites for free, however are subjected to

viewing advertisements while the website charges companies a fee for this "ad space"

real estate on each webpage.

The industry of online social networking services is relatively new and there still

exists much potential for expansion. Currently, 37% of adult internet users engage in

social networking on a monthly basis and that percentage is expected to grow to 50% by

2011. Teens are even more engaged with 70% of the teen internet using population on

social networks 8. The industry is currently beginning to experience changes that will

8 eMarketer. "Social Networking." 1-7. www.eMarketer.com

5

affect the choices of many users as well as online social networking company managers.

Although these online networks are popular with millions of people around the world,

much information remains to be discovered on the topic. Will the rise in popUlarity of

social networking services and the demands of social networking users result in a shift in

industry profits from large generic networks to smaller more user specific niche networks

in the future? This important question remains to be answered and can be determined

through an analysis of the industry's competitive landscape.

The following Chapter reviews all relevant studies that have been conducted to

answer the question of why people spend so much time engaging in online social

networking activities and will look at the analytical model that this study will use which

is again discussed in Chapter 3. The methodology on how the study was conducted is

found in Chapter 4 and the data collected for the thesis is compiled in Chapter 5. The

bulk of the industry analysis as well as data interpretation is shown in Chapter 6 and

Chapter 7 offers a short conclusion. Chapter 2 starts by taking a step back from economic

theory and uses a sociological perspective as a way to develop a basic understanding of

online social networking.

CHAPTER 2

LITERA TURE REVIEW

It is important to first understand sociological and market factors as background

knowledge before analyzing the industry of online social networking websites. For this

thesis, a competitive analysis model known as the Five Forces Model was used to

establish a framework for analysis of this industry. The following will explain the topic in

detail.

People all around the world love online social networking, as seen by the

explosive growth and sheer numbers of site membership. It allows them to interact with

friends, family, and acquaintances, who live near and far. However, in order to

understand the competitive environment of online social networks as an industry it is

important to first understand the history behind them and why they have become so

popular among millions of consumers. In addition we must learn what are the main

drivers that compel users to engage on these sites, which can help us to interpret the

changes in their preferences between generic and niche sites. Besides learning about the

history of social networks and its consumers we must also examine Porter's Five Forces

Model and its use in analyzing the influence that the internet has on industry structures.

We then can identify the utility that this Five Forces Model has in analyzing the online

social networking industry.

6

7

The concept of social network analysis began developing in the mid- 1960's by

scholars Harrison White and Charles Tilly at the Harvard graduate Department of Social

Relations. The idea of social network analysis is to approach the study of community

with a mindset that acknowledges communities as relationships between people rather

than considering them as geographic entities.

The well-known sociologist Barry Wellman says "Communities are about social

relationships, whereas neighborhoods are about boundaries,,9. It is of crucial importance

that we understand this paradigm especially when analyzing communities in the modem

age when people can use long distance transportation, telephones, or the internet to

connect with people on the other side of the globe. This factor plays a role in the reason

why online social networks have become so ubiquitous. In defining community Wellman

concludes that people belong to a community depending on what things they provide

each other (whether it be emotional support, services, or goods) rather than on where they

liveIO. Interestingly, as social networking theorist Albert Baraba.si says, "The world is

shrinking because social links that would have died out a hundred years ago are kept

alive and can be easily activated". All this is because of technology and its ability to

connect us no matter where we are located geographically". This fact supports

Wellman's claims on the dwindling importance of local community interactions.

9 Wellman, Barry. Networks in the Global Village. Boulder: Westview Press, 1999. p347 10 Wellman, Barry. Networks in the Global Village. Boulder: Westview Press, 1999. p14

II Rosen, Christine. "Virtual Friendship and the New Narcissism." The New Atlantis: Journal of Technology and Society 1, no. Summer 2007 (2007): 15-31.

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In addition, Christine Rosen describes that within online communities we find that

community (or in this context group) membership is not through a neighborhood or

geographical reference point, but through personal interests and hobbies. Rosen states,

"Here [online], the old

arbiters of community -geographic location, family,

role

...

have

little effect on relationships". This observation is supported by the presence of niche

online social networks like Ravalry.com (for knitters) and W A YN.com (for travelers) in

which a shared hobby or interest becomes the main requirement to join the si te 12. The

members of these interest based communities exchange valuable information, which

fosters a form of friendship among strangers.

In attempts to answer why it is that our society spends so much time engaging in

online social networking, sociologists have conducted studies that examine the nature of

the "friendships" created on online social networks as well as the other reasons that

individuals use these online services. In the article appropriately titled Virtual Friendship

and The New Narcissism, Rosen describes the desire of MySpace users to request another

member's friendship as an impulse to collect and display other users as trophies. This

impulse becomes "not an expression of the human need for companionship, but a

different need no less profound and pressing: the need for status,,13. This mildly pathetic

form of building status is related to the equally sad practice of "pimping" or embellishing

ones profile to make it more attractive and flashy. This is arguably a main reason for why

12 Rosen, Christine. "Virtual Friendship and the New Narcissism." The New Atlantis: Journal of Technology and Society I, no. Summer 2007 (2007): 21.

13 Rosen, Christine. "Virtual Friendship and the New Narcissism." The New Atlantis: Journal of Technology and Society I, no. Summer 2007 (2007): 20.

9

MySpace users interact on the website. As Rosen says, ultimately these sites provide us

with an outlet for "the timeless human desire for attention,,14.

On the other hand however, users of an equally well-known network called

Facebook use the site to "organize and manage" their network of offline friends and

connections. The functions and applications make this process of communication fun and

more importantly, easy. One student from Harvard (the campus from which Facebook

originated) said in an interview with The New Yorker, "it [Facebook] is a way of

maintaining a friendship without having to make any effort whatsoever". In some ways

these social networking tools become very useful for expanding and maintaining our

network of friends 15. It's just one more service technology like email or cell phones that

we can use to organize the social or professional parts of our lives. The bottom line

however, says Michael Birch (founder ofBebo.com the 3 rd largest online social network)

is that social networking is downright "addictive". He says that "looking at other people's

pages becomes a slightly voyeuristic thrill" 16.

Generic sites like MySpace and Facebook have their own useful features that

consumers obviously enjoy. However a new type of niche social network has been

gaining recent popularity, which is a primary aspect of study in this thesis. Today there

  • 14 Rosen, Christine. "Virtual Friendship and the New Narcissism." The New Atlantis: Journal of Technology and Society 1, no. Summer 2007 (2007): 15.

  • 15 Rosen, Christine. "Virtual Friendship and the New Narcissism." The New Atlantis: Journal of Technology and Society 1, no. Summer 2007 (2007): 29

10

are many of these niche sites that cater to diverse specific interest groups. There exist

groups for musicians, sports fans, business professionals, travelers, moms and even

vampires (gothic industrial culture). Several of these sites like Vampirefreaks.com and

Cafemom.com have large member bases, with 2 million and 1.2 million users

respectively17. There exist networks for all age groups including Club Penguin, a site that

allows children to interact with their chubby cute penguin avatars. There are also sites for

older individuals such as Eons.com, which is for baby boomers and has nearly a quarter

of a million members 18. As more niche sites have started to flourish marketers have

begun to realize the value not only of advertising on generic sites, but also the value of

advertising on niche networks. As more consumers spend more time surfing online social

networks rather than watching television, marketers have realized the need to act and,

interestingly, interact. Online social networks offer marketers an opportunity to actually

. h

mteract WIt

.

consumers

19

.

The other key aspect to studying this industry is to look at the suppliers to the

industry. Advertising and marketing firms are the key customer group for online social

networks and the main form of revenue for online social networks comes from selling

advertising space and selling archived information about their user's preferences. Most

sites do not charge membership fees to their members. Corporations are excited about

17 "List of social networking websites." Wikipedia. 23 Sept. 2008. 23 Sept. 2008 <http://en.wikipedia.orglwikillist_of_social_networking_ websites>.

18 E, Respondent. Interview by author. Colorado Springs, December 10,2008

19 DataMonitor. "Online Social Networking: A Potential Marketing Tool." 6. www.datamonitor.com (accessed November 3, 2008).

11

social networking. A Procter & Gamble representative was quoted as saying that online

social networks are "going to be one giant living dynamic learning experience about

consumers,,20. The fact that OSN users are not concerned with privacy and obsessed with

telling everything about themselves it makes the websites great places for "data mining"

on consumer likes and dislikes which are in turn used to target advertising to users.

Facebook's specialized software automatically scans the users profile and discussions and

presents them with ads that might pertain to their interests 21 .

As mentioned OSN can are places where marketers can also interact with

consumers. In a 2007 study on building online communities based on certain products

gives insight into the possibilities of interaction among marketers and consumers. The

study concluded that individuals who engaged in sports and body building showed high

levels of online engagement when given the opportunity to interact on a social network

based on health supplements. The website was sponsored by a nutritional supplement

marketer and the users greatly enjoyed interacting with company representatives and

other consumers of the

products 22 .

  • 20 Rosen, Christine. "Virtual Friendship and the New Narcissism." The New Atlantis: Journal of Technology and Society 1, no. Summer 2007 (2007): 18

  • 21 Beer, David, and Roger Burrows. "Sociology and, of and in Web 2.0: Some Initial Considerations." Socialogical Research Online 12, no. 5 (2007): 1-16.

www.socresonline.org.ukJI2/5117.html

  • 22 Macaulay, Linda A., Kathy Keeling, Peter Mcgoldrick, George Dafoulas, Emmanouil Kalaitzakis, and Debbie Keeling. "Co-evolving E-tail and On-line Communites:

Conceptual Framework." International Journal of Electronic Commerce 11, no. 4 (2007):

12

The Five Forces Model as designed by Michael Porter is used to analyze the

online social networking industry in this thesis. In simple terms, this model expands the

paradigm in which we view an industry by considering five influential forces. The first

four forces are external forces that act inwards towards the industry and the fifth force

considers rivalry within the industry itself. As Porter states "the extended rivalry that

results from all five forces defines an industry's structure and shapes the nature of

competitive interaction within an industry". To avoid redundancy I will call to the

reader's attention that this model and how it is used in this particular study is explained in

more detail below in the Theoretical Framework and Methodology chapters.

Porter's model is very well known among academics and business professionals

alike. It has been used to great length and can be applied to the analysis of many

industries. Despite its age it is still proven relevant time after time in our ever changing

modem times. In a competitive strategy article written this year, Porter reasserts the

power of this model and gives detailed examples that discuss how each force affects the

industry. Some of the most useful information presented in this publication however are

the hints given on industry analysis. For example Porter describes that point of

conducting an industry analysis is to understand the dynamics of industry competition

and the main reasons for profitability. It can also be used to determine if the industry is

attractive to enter or not. In addition, he describes that a good analysis sees the industry

as a system, predicting the changes in one of the competitive forces and how such

13

changes will in tum affect each individual force. This advice is useful and has been

applied in this thesis 23 .

The literature base on the use of the Five Forces Model in the internet industry is

sparse. This may be due to the inherent differences in the structure of the business. Most

published work related to Five Forces Models and the internet have been to observe the

effects that the internet as a technology has had on certain industries rather than to

analyze an online industry. In 2001 Porter revived the Five Forces in "Strategy and the

Internet" as a way to verify the importance of internet technology, but also to insist that

the internet was not something that would change industry to a point that strategy would

no longer playa role. On the contrary, he states that attention to strategy is more

important than ever in the age of the internet. Porter concludes that the internet can have

an overall negative effect on industries. First, the internet reduces the size of the

geographic market by bringing any buyer or supplier from any part of the world

cyberspace. This increased proximity makes things better and worse, Porter states "The

great paradox of the internet is that its very benefits -making information widely

available; reducing the difficulty of purchasing, marketing, and distribution; allowing

buyers and sellers to find and transact business with one another more easily - also make

it more difficult for companies to capture those benefits as profits,,24.

  • 23 Porter, Michael E. 2008. The Five Competitive Forces that Shape Strategy. Harvard business

review 86, no.

I (01) : 80-84.

  • 24 Porter, Michael E. 2008. The Five Competitive Forces that Shape Strategy. Harvard

review 86, no.

I (01) : 80-84.

business

14

Another study by Siaw and Yu (2004) valuated the effects the internet has on the

competitive environment in the banking industry using Porter's model. The study found

that the internet greatly shifts the competitive landscape of the industry, offering both

opportunities and threats to managers. With the advent of internet banking, there is no

longer a need for a physical location or as many employees. As a result it has become

much easier for smaller companies to enter the market and/or have access to clients that

are geographically more dispersed. This lowers the barriers to entry, which is one of the

Five Forces under analysis. Because internet features level the playing field, the branding

strategy that banks have followed is less effective today. Since all banks essentially offer

the same service, consumers can do business on the internet

for half the cost 25 . The

internet in this situation has created a substitute for physical banking. The dynamic of

product and substitutes are another force in this model.

Although the research on strategy implementation in the world of traditional

bricks and mortar and even e-business is well documented and the body of literature on

the success of websites is developed, it is clear to see that there are gaps in the research in

regards to online social networking websites, particularly in the realm of strategic and

competitive analysis. It is necessary to research the five forces within the social

networking industry to see where the industry might be heading and decide if it is an

attractive industry to enter.

25 Siaw, Irene, and Alec Yu. "An Analysis of the Impact of the Internet on Competition in the Bank Industry, using Porter's Five Forces Model." International Journal of Management 21, no. 4 (2004): 515 and 517.

CHAPTER 3

THEORETICAL FRAMEWORK

The purpose of this research is to determine the competitive environment for

profits within the online social networking industry. A "Five Forces" industry analysis

was conducted as an attempt to determine the factors that influence the level of

competition for profits in this particular market. The five forces model was designed by

Michael E. Porter in 1979. When first introduced in the Harvard Business Review that

year, the reception was tremendous and started a revolution on the topic of strategy

within the business community. The model is used to determine the competition for

profits within an industry. The following describes each of the five forces, then in the

Chapter (discussion), each force is analyzed by interpreting a collection of industry data.

The Five Forces of Competition

Each of the five competitive forces influence the dynamics of an industry.

Depending on the relative strength and weakness of each force we can determine the ease

with which various industry players can obtain profits. Four of the five forces that

influence the industry come from outside entities that "surround" the industry including

the buyers and suppliers. The fifth force comes from within the industry itself and has to

do with the rivalry between the industry players. This is represented in figure 3.1 as seen

below. Since some of the five forces come from within the industry value chain, thus it is

15

16

also useful to have a look at figure 3.2. The following presents and describes each of the

five forces individually.

FIGURE 3.1 - THE FIVE FORCES

The Five Forces That Shape Industry Competition

Bargaining PoWer of Suppll....
Bargaining
PoWer of
Suppll....
Thnlllt of New Entrants Bargaining ~I'of Buy .... Threat of Substitute Products or Service.
Thnlllt
of New
Entrants
Bargaining
~I'of
Buy ....
Threat of
Substitute
Products or
Service.

Source: Porter, Michael

E. .

Competitive Strategy: Techniques for Analyzing

Industries and Competitors. New York: The Free Press, 1980.

17

FIGURE 3.2 -ONLINE SOCIAL NETWORKING INDUSTRY VALUE CHAIN

d'.~<'M*",~'_' z_. Q Corporations c. -- n ~ j :r Pushing C) (I) Online ~ Advertising
d'.~<'M*",~'_'
z_.
Q
Corporations
c.
--
n
~
j
:r
Pushing
C)
(I)
Online
~
Advertising
Online
I
Social
I
Networking
I
Industry
r

Online

Advertising

Marketplace

Force 1: Threat of New Entrants

 
Social Networking Members
Social Networking Members

Social

Networking

Members

Threat of new entrants to the industry is a crucial part of the model that studies the

safety of industry profits in the hands of the existing players. Usually, a highly profitable

industry attracts much attention, thus the number of already established and start-up

companies trying to enter increases. The factors that deter this entrance are of course the

barriers to entry. Porter describes six main barriers (listed in Appendix A) that can deter

smaller firms from entry or can be of minor importance to a larger company with more

resources. Porter insists that "it is the threat of the entry not whether entry actually

occurs, that holds down profitability,,26.

  • 26 Porter, Michael E

Competitive Strategy: Techniques for Analyzing Industries and

.. Competitors. New York: The Free Press, 1980.

18

Force 2: Intensity of Rivalry Among Existing Competitors

While the other four forces listed above are often overlooked, the rivalry among

competitors usually gets the most attention by strategists. Innovation, marketing, and

price are just examples of arenas in which firms can compete for industry profits. The

profits are diminished depending on the ferocity and basis of the competition between the

firms. The more rivalry, the lower the profits. Lack of product differentiation and price

sensitivity of buyers for example can result in price-based competition, which usually

results in diminishing revenues and thus profits to the benefit of the buyer.

Force 3: Threat of Substitutes

A substitute product from another industry can be a factor that threatens the

profitability or even existence of the industry. The market for express mail services were

affected by the popular use of email because of its ease of use and thus massively

diminished the profits of the now dubbed "snail mail" services industry.

Force 4: Bargaining Power of Buyers

Buyers of the industry's product are on the opposite side of suppliers in relation to

the industry. Buyers are in a position of power if there are a few strong buyer groups that

can demand higher quality (increasing costs of the industry) or that show price sensitivity

and thus influence drops in price (diminishing industry profits). Buyers also become

powerful when switching costs for a product or service are low and the options for

switching are numerous. Buyers however, are weak when the product is one of a kind or

hard to replicate. An example would be the players in the personal computer industry

who must buy operating systems from Microsoft due to its general Ubiquity. Buyers and

19

suppliers can also "integrate" backward or forward along the value chain to enter new

industries. This encroaches on the profits of the industry and relates in the "threat of new

entrants" force depending on how far forward or backward they intend to integrate.

Force 5: Bargaining Power of Suppliers

The bargaining power of suppliers is studied to determine how much leverage a

supplier has over the industry players in transactions. If the industry has a single

monopoly supplying a crucial input and the supplier has the ability to raise prices or shift

its costs to the participants then the power of suppliers is determined as strong. On the

other hand, if there exists a diverse array of suppliers and the industry players have a

choice between where they source their input materials. The cheese making industry is an

example because the basic input (milk) is widely available. Thus, in this situation,

industry players have more power to negotiate and we can determine the power of

suppliers to be a weak force.

Applying the Five Forces Model

As stated, an industry analysis using the five forces model on the online social

networking industry or a purely internet based industry has not been conducted to date.

Thus clarification is required to define which parties contribute to each of the five forces.

Due to the commonly used strategy of using advertising revenue to support the site

financially, online social networking services are usually free of charge to the consumer.

Meanwhile advertisers buy space on the web pages that display advertisements. By

viewing the online social network as a venue for these two groups to connect rather than

their individual contributions to the site, we can determine that the users are the "buyers"

20

(although the usage is free) and the advertisers are the suppliers in this digital

environment. The price the user pays to visit the site is the cost of being shown

advertisements.

From this model, four hypotheses for the analysis can be inferred. This thesis

attempts to find support in favor of the following hypotheses.

HI: Niche site users are more engaged and have a higher degree of loyalty to their niche

networks.

H2: Generic site users are likely to switch to a niche network if they were to find one that

interests them.

H3: The creation of niche networks will expand the industry and increase overall industry

revenue.

H4: Generic sites could lose market share as the industry expands.

H5: Advertisers prefer placing advertising on niche networks rather than generic

networks.

CHAPTER 4

METHODOLOGY

This study used the five forces model as a basis for an industry analysis that was

both qualitative and quantitative. Interviews with executives of five online social

networking companies were performed in order to gather data used to determine factors

that may influence or contribute to the strength or weakness of each of the five forces.

Surveys were distributed to users of the sample networks to obtain additional information

on buyer preferences. Aside from the interviews and surveys, quantitative data was

collected from industry publications to help statistically support the determination of each

force's strength or weakness.

Populations and Samples

This study used samples of two separate populations to collect data. According to

Porter (1980), determining the population and adequately defining as well as sizing the

industry, is a crucial part the model's analysis. The first population is online social

networking companies (the industry players), and the second population is the users of

the online social networks. In the populations of social networking companies and

members there are two sub-populations that are defined in this study as generic networks

and niche networks.

21

22

Essentially, there are two types of online social networks; generic and niche. The

generic sites are usually sites that connect people based on little pre-requisite interests

and usually by geographic area. On the other hand, niche networks have a more

homogenous user base that have a certain pre-determined interest or affiliation that serves

as the basis for the communication and networking relationshi ps 27.

Sample One

The population for the online social networking companies for this study was

defined as websites with member bases of at least 10 million members for generic sites

and at least 750,000 members for niche sites. Dozens of such sites exist. The population

was also defined as online social networks that had similar features that aid in unique

user interactions based on the standard features like messaging, friending, picture

uploading and blogging. This targeted the bulk of the major industry players. A random

sample of 14 generic and 14 niche sites was drawn from this population and used as

sample one, a full list of these websites is available in Appendix C.

Sample Two

The second sample was selected by randomly selecting users of four generic

networks and four niche networks from Sample One. A total of eight networks were

selected due to time constraints on data collection. The following are market leading

generic networks that were selected for this sample; Myspace.com, Facebook.com,

27 AdWeek. "Niche Social Networks Offer Target Practice." 3. www.adweek.com/social

23

Bebo.com, and MyYearbook.com. The niche networks selected were WA YN.com (for

travelers), Cafemom.com (for mothers), LinkedIn.com (for business professionals), and

Care2.com (for environmental activists). Hundreds of survey requests were sent to users

from each site and about 10 responses from each site were received resulting in 86

completed surveys. The responses were used for quantitative data analysis.

Interview and Survey Design

The format of interviews, survey questions, and sample groups were designed

based on Porter's techniques for analyzing industries. Below in Appendix A lists each of

the determinant factors used to define the strength of each of the five forces. Each survey

question aimed to help determine the individual strengths of the forces. For several

aspects of these factors the strength was easily inferred with basic data from published

articles. Most factors however, required clarification of ambiguities and thus were

incorporated into the interviews and surveys. For example, factors such as technological

barriers to entry were obvious due to common knowledge concerning the internet,

whereas switching costs for buyers was more ambiguous. It appears at first glance that

switching costs are zero, however it is possible that loyalty to the website and the number

of friends a user possesses increase switching costs. This question was one addressed

with the surveys.

Procedure

Contact information for the 28 online social networking companies was gathered

and a request for interview was issued to each one via email and! or phone to collect data

24

for Sample One. At the time of contact every company was solicited with the following elevator pitch.

My name is James I am a senior economics major at The Colorado College in Colorado Springs. I am conducting research for my senior thesis. I will be doing a Five Forces Industry Analysis of the Online Social Networking Services Industry. I would like to conduct a short interview with a member of the executive team. The interview can be conducted via skype or telephone. The questions are attached to make the interview easier. Thank you for your time.

Only two companies responded to the request, however useful interviews were conducted with a knowledgeable executive representative from each company. After explaining the purpose of the research and Porter's model, interviewees were asked a series of questions designed to aid in determining the strength or weakness of each of the five forces. The method for designing these questions is described below and in Appendix A. As stated, Porter's model approaches industry analysis from multiple perspectives from within the industry value chain. Appendix D illustrates the sources from which analytical data can be gathered.

To collect data for sample two a personal profile with the name "James Fry" was created on each of the selected generic and niche networks. Members were selected at random from the list of "online now" users or by searching for common male and female names like John or Mary. Users were sent either a message or a friend request containing a short introduction message as seen in the example below.

I'm James Fry, I am an economics major at Colorado College. I am doing researchfor my thesis, interested in knowing what you think about Care2.com. Be part of an important analysis, by taking my quick survey. Thanks! www.survevmonkey.com

25

Interviews

The questions asked during interviews were designed to ask the company

executive about the various aspects of the market. The initial questions asked were about

the "threat of new entrants", which determined the difficulty that new companies faced in

obtaining finances, technology, and members. The second series of questions was to

collect data on loyalty and member input (identical questions are seen in the survey), a

question about economies of scale was also asked. The third series related to the

relationship that networks have with advertisers and asked about the number of ads and

ad companies served, but most importantly questions about negotiations with advertisers

were also asked. Finally, the interviewee was asked about the relations with their

competitors (other online social networks). These questions are significant because they

are used to gauge the perceptions that the industry players have regarding the forces that

affect their industry, which is part of building a five forces analysis.

Survey

The surveys for all networks (including generic and niche) were identical. After

the respondent clicked the link and was transferred to the survey he was presented with

the first page of the survey, which displayed the explanatory paragraph shown below.

Hi there, thanks for deciding to take my survey.

As you know, WA YN.com is an Online Social Network. A place where you can connect with

your community online.

My name is James Fry, / am a senior at The Colorado College. The results of this survey will be used to collect data for my senior thesis on internet based communities. / don't ask for your name thus, you don't have to worry. Your information is kept private.

Thanks again for your help.

26

The second page of the survey (see Appendix B) presented a series of general

uncomplicated questions. Question 1, 3, and 8 were designed to help gauge the potential

for the existence of switching costs among members. Question 1 asks the respondent to

explain their level of satisfaction with the selected network. Question 3 gauges to what

degree the member feels integrated in the community by asking how much they think the

management is concerned with the personal opinion of the members. The 8 th question

asks the respondent to gauge their level of loyalty to the network. These three questions

all used a five point "likert scale".

Questions 2 and 5 were extra questions that were not used in the data

interpretation section. Question 4 which asks the number of hours per week the user

spends on the network was highly useful in the analysis of user engagement, the

importance of which is described below. Question 6 was a probing question that

attempted to discover flaws with generic network by asking to describe something they

disliked about the network. Question 7 required the user to list which networks they used

in order to determine if niche network users still engage on generic networks. Finally

question 9 simply asks if the respondent has any hobbies. If the answer to 9 was yes then

page three was presented and more questions were asked. If the respondent indicated that

they would join a niche network that shared their common interest (on page three) they

were directed to page four. Here the questions became more complex. Question 4.1 asked

if they would spend more time on their original old network, the new network (that they

agreed to join in 3.2), or both equally. Then in question 4.2 the subject was asked if their

total time using social networking would increase or remain unchanged from what they

27

answered in question 2.4. If the respondent answered "increase" for 4.2 then the last

question was presented.

These questions from pages 3 and 4 were very important in determining the

possible user engagement that would result from the proliferation of new niche networks.

These questions attempted to discover if the total industry revenue would be divided

among the players or if the market would be expanded.

CHAPTERS

RESULTS

The interviews conducted with sample one provided excellent information on the

perceptions of industry executives, but yielded little quantitative data thus, sample one

information will be briefly mentioned in this section with a full examination appearing in

the discussion (Chapter 6). However, an initial analysis of the data collected from sample

two provides insight into this experimental sample and the population of online social

networking users. Out of 86 surveys from eight different networks a myriad of data was

collected and used to help prove the hypotheses listed in Chapter 3. One data entry was

removed from the study because the respondent mentioned that he was an employee of

the network of study thus making him a strongly biased respondent. The following shows

the data tables and graphs generated from the responses to each question.

Sample One Data

From the sample of 28 online social networking companies only five different

representatives were available for an interview. One respondent gave several answers but

then decided not to continue the interview, yet gave some useful data. Other respondents

did not have ample time to complete the question set thus some questions were left out.

Due to these interview mishaps and the fact that the number of interviews was low, there

was not enough data to create a compelling quantitative analysis, thus most information

gathered via interviews will be interpreted in a qualitative manner. The results of these

28

29

questions are organized in table 5.1 below, the response to each question is shown.

However, the true value of information gathered can only be analyzed qualitatively and

will appear in the discussion section.

TABLE 5.1- OSN EXECUTIVES RESPONSES TO INTERVIEW QUESTIONS

Respondent

A

B

C

0

E

Question la. New Entrant: Ease of entry

easy

very difficult

easy

easy

very easy

2.

Ease of obtaining

 

2a. financing

difficult

very difficult

difficult

neutral

very difficult

2b. tech

easy

easy

neutral

easy

very easy

2c. members

difficult

difficult

neutral

easy

difficult

3.

Perceived member loyalty

very

N/A

healthy

N/A

die hard

 

loyal

loyalty

4a. Use multiple networks

yes

N/A

yes

yes

yes

4b. Concern with 4a

low

N/A

low

low

low

5.

Member influence on

medium

N/A

high

N/A

high

management

 

6.

Negotiations: leverage with

medium

N/A

low

medium

medium

advertisers

 

7.

Level of industry

healthy

N/A

healthy

N/A

relatively

competition

 

tame

8.

Ability: prevent stealing of

N/A

N/A

average

average

N/A

market share

 

9.

Substitutes

yes

N/A

yes

N/A

yes

Sample Two Data

As stated, question 1 measured the perceived satisfaction that members had with

their respective networks. The graph below depicts difference in the responses between

30

the niche (dark color) and generic (light color) networks . Members of niche networks

said they w ere more satisfied in general than users of generic networks . Of all niche

users surve yed , 46% said they w e re "v ery satisfied" whereas only 26% of all generic

members gave the same response . For niche networks , 19% of users were "extremely

satisfi e d" while only 11 % of generic us ers showed this level of maximum satisfaction

and no niche indicated that they were " not satisfied".

FIGURE 5.1 - NICHE AND GENERIC USER

SA TISF ACTION

 

extreme

extreme
 

s; lti s fi

e d

   

v ery

 

sa tisfi e d

sa tisfi e d • Niche

• Niche

.lliuo s t

. lliuo s t Gelleric

Gelleric

not s.ltistled

 
 
extreme s; lti s fi e d v er y sa tisfi e d • Niche

Results for question 3, which asked users their perceptions on how concerned

their network was with the input of members (found in figure 5.2). On average , many

more niche users felt that their network ' s level of concern was higher than that of generic

users. In fact , the level to which generic users thought their network expressed "no

concern" or " slight concern " was higher than that of niche network users.

31

FIGUR E 5.2 - PERCEIVED MEMBER CONCERN

31 FIGUR E 5.2 - PERCEIVED MEMBER CONCERN Gt'Ilt'ric t o p pri or it y
31 FIGUR E 5.2 - PERCEIVED MEMBER CONCERN Gt'Ilt'ric t o p pri or it y
Gt'Ilt'ric

Gt'Ilt'ric

t o p pri or ity

v el)'

COllc e l'llE'd

cOllc t' rtlE'd

s light COli Ct' rtl

31 FIGUR E 5.2 - PERCEIVED MEMBER CONCERN Gt'Ilt'ric t o p pri or it y
~,'.
~,'.

not COli ce I'll NI

31 FIGUR E 5.2 - PERCEIVED MEMBER CONCERN Gt'Ilt'ric t o p pri or it y
  • 0 .00% 1 O.OO % 20 .00I)ii~30.00(J.M·O.Ooo/b50 .00'¥o

Data from question 4, repres e nted in figure 5.3, asked how many hours per week the network was used showed that niche users are engaged on the websites for two hours more per week on average than the users of generic sites. We can assume that the engagement on LinkedIn.com is low because it is a network for business professionals and that particular community values efficient use of time and brevity within interpersonal interactions.

FIGURE 5.3 - NICHE vs GENERIC USER HOURS P/WEEK

em :' 2

Lillk t>dlll C lfE' 1\1 () III ." -V' - ·--_¢ ·· f---~_ Vv'AYN Nidw TOTAL
Lillk t>dlll
C
lfE' 1\1 () III
." -V'
- ·--_¢
·· f---~_
Vv'AYN
Nidw TOTAL
f\l y Yearb o k
Fact>b o ok
J\'
·r

MySpacE' GE'IIE'ri c TOTAL

o 5
o
5

10

• Avt'I'agE's .Ii Hours p / wt'E'k

15

32

Although it was not a primary metric analyzed in this study, results from question

7 were used as supportive data. Users were asked which networks they use other than the

network with which they had received the survey solicitation. The responses showed that

niche network users participated on more "other networks" than generic users . (see

Figure 5.4).

FIGURE 5.4 - NICHE AND GENERIC USE OF OTHER NETWORKS

32 Although it was not a primary metric analyzed in this study, results from question 7

Niche Users

Gellerk USE'l'S

0% 20% 40 % 60%)
0%
20%
40 %
60%)

• Other Nkhe Sites "" Other Generic Sites

80%

100%

Responses from question 8 again showed a strong correlation between niche users

and level of loyalty. Within niche networks users who stated they there "very loyal" and

"die hard fans" of their network were 11 % and 7.7% higher respectively than their

generic counter parts. Meanwhile the degrees to which generic users stated they were

"somewhat loyal" or "not loyal" were 8.5% and 7.1 % higher respectively than niche

users. There exists a higher degree of loyalty to niche networks among niche users.

33

FIGURE 5.5 - USER LOYALTY

Very Loyal '"' Generic Not 10Y;11 0.0% llHI% 20JI% 30.0% 40.0%
Very Loyal
'"' Generic
Not 10Y;11
0.0%
llHI%
20JI%
30.0%
40.0%

Question 3.2 asked if the user would join a new " niche" network that had their listed main interest as the network theme. The following data represented in Figure 5.6 shows the percentages of respondents who answered yes to this question and thus continued on to answer questions on pages 4 and 5.

FIGURE 5.6 - USERS WHO WOULD JOIN A NEW NICHE NETWORK (%)

Care 2 Linkedln Catel\lolll WAYN Niche TOTAL
Care 2
Linkedln
Catel\lolll
WAYN
Niche TOTAL
M,vYearbok Farebook MySp ;lce '"' _. __ ·.... "' _"'"""' - _" _ '!"'I... . ....
M,vYearbok
Farebook
MySp ;lce
'"'
_.
__
·....
"' _"'"""' - _" _
'!"'I...
.
....
Generic TOTAL
o
0.2
0.4
0 .6
0.8

• AveJ,;\ge%

",Ok

34

This figure shows that on average 65.6% of nich e users agreed to join the new network

whereas only 53.7% o f generic users agreed to do the same.

Responses form question 4.1 which site the y would use

more often once they

joined the new niche network that was tailored to their interest. The users could choose to

spend more time on their original network (old), the new niche network (new), or on both

equally. As shown in figure 5.7, most users admitted that they would spend time on both

networks and that mor e users wou ld spend more time on their original network than on

the new niche network. We also see however that 15% of generic users would spend

more time on the niche whereas only 2.5% of user who already have a niche would

continue to use their original niche site .

FIGURE 5.7 - PREF E RED TIM E ALLOCATION AFT E R JOINING NEW NICHE

BOTH I New OLD O.OO(Yo 20 .00 1}~) 40.00 %
BOTH
I
New
OLD
O.OO(Yo
20 .00 1}~)
40.00 %

Niche

...

Generic

80.00 %

Question 4.2 asked users if their total time spent on social networking changed if

they joined the new niche network. The majority of users responded that there would be

35

However, 41 % of gen e ric users and 36% of niche users said that their total time would

increase. Respondents who selected "increase" for this question were directed to page 5

while users ind i cating " no change " were finished with the survey.

FIGURE 5.8 - CHANGE IN TOTAL TIME SPENT ON SOCIAL NETWORKING

-Niche

...

Generic

, / ; .., ; No Challge Illcrease 0.00% 20.00% 40.0 0 (YCI ()o.o 0 0/(,
,
/
;
..,
;
No Challge
Illcrease
0.00%
20.00%
40.0 0 (YCI
()o.o 0 0/(,
80.clO %

Question 5.1, the final question of the survey, asked the remaining respondents to

specify further the division of time between the two online social networks (the original

network and the new niche network) they spent in terms of hours per week. There were

only 17 respondents who reached this question. Below in figure 5.9 we notice that,

despite the fact that the total social networking time of generic users increased overall,

data showed that they would use their old network 30 minutes less on average after

joining a new niche network. Those same users showed on average that they would use

the new niche network for about three hours per week. Meanwhile niche users actually

showed an increase in the use of their original niche network of 1.25 hours per week on

average

and an equal increase in the use of the new niche .

36

FIGURE 5.9 - CHANGE IN TIME SPENT ON NETWORKS AFTER JOINING A

NEW NICH E

36 FIGURE 5.9 - CHANGE IN TIME SPENT ON NETWORKS AFTER JOINING A NEW NICH E

N.,\v Nirh~

36 FIGURE 5.9 - CHANGE IN TIME SPENT ON NETWORKS AFTER JOINING A NEW NICH E

-1

OLD o
OLD
o

• Niche

iii G.,n"l"ic

As seen in the above data, a great deal of exciting data was collected via the

surveys and interviews. The following chapter discusses the significance of this data and

uses it to complete the five forces analysis of the online social networking industry.

CHAPTER 6

DISCUSSION

This section holds a discussion of the results and the full Five Forces analysis of

the online social networking industry. First, here are some things to keep in mind about

this study. This research study is not comprehensive in terms of total online social

networking user information, unfortunately time constraints only allowed for a small

sample of the online social networking users population to be surveyed. On the other

hand, the interviews from the social networking company executives although few were

highly valuable to this study and can be trusted as valid perspectives on this industry.

Before a detailed analysis of the data, however, I must clarify the importance of user

engagement and describe the primary revue model used in this industry.

Internet Advertising and User Engagement

In essence an online social network follows the same business model as a

newspaper, it provides content (often times for free) and its readers are exposed to

advertising which is paid for by companies promoting products. The larger the user base,

the larger the potential revenue can be. Online social networks offer users a free venue to

interact with content and just like a newspaper, slots for advertisements are sold to

generate revenue. When growing an online social network, attracting as many new

members is very important, but the more important key to making the most revenue is

37

38

getting members to come back to the site and use it as much as possible 28 . The simple reason for this relates to the structure of the revenue model. When an internet user sees an advertisement one time, it is called an impression. In the internet advertising industry a key term is CPM, which stands for cost per mile and means the cost of 1000 unique impressions. This is one common way that advertising revenue is counted. For example, one respondent indicated that his CPM averages about $6.85, which is quite good. The going rate for 1000 impressions is often determined (among other metrics) with another commonly used measurement called CTR or "click through rate" which means the ratio of how many times the ad is viewed divided by how many times viewers clicked on the ad and followed through with a certain action (such as a purchase). The higher click through rate a website has on its ads, the higher price they can command for CPM 29 . So, this revenue structure makes the online social networking manager very concerned with how many times the users are viewing the pages. As a result, creating a product that is attractive, functional, and engaging becomes as important as attracting new members 3o Table 6.1 below compares two example revenue calculations with differences in user engagement, which is represented by "page-views".

.

  • 28 0, Respondent. Interview by author. Colorado Springs, November 25, 2008

  • 29 A, Respondent. Interview by author. Colorado Springs, October 27,2008.

41

social networking in general than generic users. Unfortunately there is not enough data

from sample one to help reach a conclusion on this hypothesis. However, sample two

offers sufficient data to support this hypothesis. The second hypothesis assumes that

generic users would like niche networks if they knew about them.

H2

The survey data in Figure 5.6 shows that if more than 50% of generic users found

a niche network that catered to their primary interest or hobby they would become a

network member. Data from Facebook (generic network) users showed the lowest

tendency to join a new network out of all the networks surveyed. Most likely this is due

to the fact that Facebook management is focused on delivering a high quality well

functioning product which is expressed in their generally more aesthetically pleasing web

design when compared to other generic

networks 32 . Respondent E offered an interesting

perspective on this topic. Respondent E gave an example in which he compared a

newspaper and a magazine and named all the categories a newspaper holds such as

sports, classifieds, weather, and business. He said that "a newspaper is a mile long and an

inch deep while a magazine is the opposite, it's an inch wide and a mile deep". In this

analogy, the length is the category and the depth is the detail of the content. The

respondent continued to compare the generic social networks to newspapers because they

serve many categories of people and the niche sites are like magazines because it caters

to a specific interest. The importance of this analogy as Respondent E said that people

whatever is a mile long and inches deep as a directory to find the media that is inches

32 A, Respondent. Interview by author. Colorado Springs, October 27, 2008.

42

wide and miles deep. Essentially, the generic sites can be used for a while to find interesting categories but once the niche sites are found (and if they are compelling) they

can become

the center focus 33 . This perspective is supported

by the comments by

Respondent A who said that MySpace is actually looking at becoming a type of web portal for other online social networks. He says that this is because not all MySpace members interact with each other, "they oftentimes interact on the basis of interest groups, which can be up to half a million strong,,34. For the purpose of this study this data

gives us enough reason to support H2.

H3

The third assumption about this industry predicts that the presence of niche networks in the industry will expand the total "industry pie" or the total available profits. To test for this, the questions 4.1,4.2, and 5.1 were asked. Figure 5.7 on the bars labeled "New"shows that generic users who stated they would join a new niche network would spend more time on that new niche than the niche users presented with the same opportunity. 30% of generic users and 2.5% of niche users said they would dedicate more time to the new niche network. This could relate to the fact that niche users already belong to a niche that they are loyal to. The data from this question only tells us that the market has the potential to be divided among the niche and generic sectors. Question 4.2 however addresses the allocation of the division of time spent on the two networks.

33 E, Respondent. Interview by author. Colorado Springs, December 10, 2008 34 A, Respondent. Interview by author. Colorado Springs, October 27, 2008.

44

H4

The fourth supporting hypothesis simply assumes the possibility of generic sites

losing market share as the industry expands. As discussed in the above paragraph, Figure

5.7 shows that some generic users will have a tendency to spend a portion of their time on

a new niche network ifit interests and engages them. The data in Figure 5.9 also shows

that a portion (however small) of generic users would spend less time on their old generic

site when they found a niche that they liked. These observations were confirmed by

Respondent D who said "there will be a share oftime lost to niche sites". He continued to

say that "niches will take away from the total advertising revenue pie, however, in terms

of users, generic sites will still continue to gain new users as the industry user base

grows,,36. Because of this we can support H4.

H5

This hypothesis assumes that advertisers prefer advertising on niche networks.

This is a short and simple hypothesis that is easily proven but was a key part of the main

question of this thesis. Essentially, the advantage of a niche network is that it attracts a

specific group of people, whether it is by family role, occupation, or interest. Due to the

homogeneity ofthe community, advertisers know ahead of time which demographic

group they will be targeting without the risk of showing their targeted ad to potentially

uninterested users. During an interview, Respondent D confirmed that advertisers

obviously like niche networks when they want to effectively run a targeted ad campaign.

However he did add as a caveat that -'in order to attract the advertisers you need to have

36 0 , Respondent. Interview by author. Colorado Springs, November 25, 2008

45

very high traffic" on your site. Respondent C (a niche network executive), when asked

about his bargaining power with advertisers noted that his company's strength was the

demographic of the site. The given evidence allows us to support H5.

The above hypotheses were chosen before I embarked on the data collection

portion of the project. Thus, new information gathered during the interviews with sample

one rendered the above questions insufficient for conducting the full industry analysis. As

a result, several additional aspects of the industry environment will be discussed in

conjunction with the following five forces analysis. The following examines each of the

five competitive forces individually and then finally draws an overall conclusion.

Five Forces Analysis: Force 1 - Threat of New Entrants

When companies enter an industry they obviously want to gain market share and

make a profit. In doing so these new entrants can often bid down prices and reduce the

profitability of the overall industry37. There are several major barriers to entry covered

below and the "height" of these barriers determines the strength or weakness of the threat

this force possesses.

Barriers to Entry - Economies

of Scale

During correspondence with Respondent B I soon learned an industry term used

in online social networking called .economies of users, which is the industry specific

37 Porter, Michael E

Competitive Strategy: Techniques for Analyzing Industries and

.. Competitors. New York: The Free Press, 1980.

46

version of economies of scale. When a network achieves economies of users it costs

marginally less and less to attract each new user in terms of marketing efforts. This is

usually achieved when a viral marketing strategy is implemented meaning the users begin

to fuel the growth of membership by spreading the news among friends. Respondent E

noted that an important aspect of viral marketing is encouraging users to excite their

friends about the social network. He said that "virality is a friendship engine; it

encourages users to find others like themselves,,38. Economies of users are difficult to

achieve because it requires a "critical mass" point where enough users are excited about

the website brand that the website grows organically and growth becomes user driven 39 .

Product Differentiation

The differentiation of products is a significant barrier to entry within this industry.

In essence, the generic network sector of the industry is almost as large as possible by the

large existing players who have started expanding (some very successfully) into

international markets 4o . While the niche network sector still offers opportunities for entry

the entrant would need to find an unfilled niche that has a high potential user base.

Competing with another site that already has a significant stake in the niche can be

difficult for several reasons. Respondent A simply says that "there is room in the space

for one or two players, but not three". When using the newspaper analogy, Respondent E

explained that the niche has to have a large potential user base (a few million at least) to

  • 38 E, Respondent. Interview by author. Colorado Springs, December 10, 2008

  • 39 A, Respondent. Interview by author. Colorado Springs, October 27,2008.

47

be successful as a business. This is because if there is not a large enough base it will not

be possible to generate enough advertising dollars to make a significant profit 41 . This

same respondent, who operates a niche network with 755,000 users, commented that he

had seen many smaller sites trying to "poach" his members, but expressed little to no

concern over this issue.

Capital Requirements

Four of five respondents of sample one ranked the ability for entrants to obtain

financing as difficult (see Table 5.1). The only reason Respondent D ranked it as neutral

was because he (like the other respondents) had a dual answer. Respondents noted that at

the beginning it is easy to get seed financing because the costs of start up are low.

Designing a website and hiring people with the desired skill set are not costly. Even

gaining a member base of a few thousand people might not be difficult, however

Respondents C, D, and E said that raising substantial capital to run the website as a

successful company is more difficult. This is because, as Respondent C noted "it is hard

to generate enough revenues to get investors excited,,42. Not to mention, as respondent C

said, "Weare in tough economic times these days, financing is harder to corne by,,43.

Switching Costs

Anther barrier to entry to consider is the switching costs of buyers. In this

industry, there are almost always no costs to the buyers (social networking users). Since

there are no fees associated with the use of all social networks the cost of switching is not

  • 41 E, Respondent. Interview by author. Colorado Springs, December 10,2008

  • 42 C, Respondent. Interview by author. Colorado Springs, November 20, 2008

48

monetary. However, the cost of leaving a network could be great depending on how many friends a user has on their frequented network. The switching cost to a user is the necessity to leave their friend group behind and either build a new network or bring their network with them to the new site, which is unlikely to happen. This barrier is relatively high.

Access to Distribution Channels

This barrier to entry has two aspects. The first being the distribution channels in the traditional sense, which in this case is the internet. It goes without saying that these distribution channels are wide open for the company as well as its users. The second aspect however applies, however, is industry specific. As discussed above, since advertising revenue is the main source of income, access is need to the "Revenue Distribution Channel". As discussed above, it is very difficult for new networks to get into the budgets of advertisers. This presents a very high barrier to entry.

These four barriers to entry are ranked as significant. There are several other barriers to entry that were not covered because they are either small or do not exist. Buyer's switching costs for example practically do not exist in this market. Users can switch to any network whenever they want because most of them pay nothing to use the services. Access to technology is easy because it is widely available and there are essentially government restrictions or patents that apply in the market. Due to the above analysis I determined that new entrants do not massively reduce or divide industry profits and I classify the threat of entrants as a weak force.

49

Force 2 -Intensity of Rivalry Among Existing Competitors

Industry Growth

Slow industry growth will create a market share competition, which can increase

rivalry greatly. In a fast growing industry, however, the firms can make market share

gains and profits just by keeping up with the growth of the overall industry44. As already

seen in Figure 1.1 above, the online social networking industry is projected to continue

growing steadily in the next few years.

Lack of Differentiation or Switching Costs

If a product is perceived by its buyers as a commodity, the choice in using it is

dictated mainly by price and service 45 . In this industry however, price does not exists for

users, thus service becomes number one. Personal network, however, is also another

important factor. If the potential social networking user has a network of friends who use

a certain network, the new user will surely join that network.

Other than possessing as many members as possible to ensure that networks of friends

use the site, the networks can only compete on service. As discussed, web surfers will use

a network as long as it provides them with valuable content. So virtually there are no

switching costs. The goal then becomes constant modification and improvement to the

Porter, Michael

  • 44 E..

Competitive Strategy: Techniques for Analyzing Industries and

Competitors. New York: The Free Press, 1980. P 13

  • 45 .. Competitors. New York: The Free Press, 1980. P14

Porter, Michael E

Competitive Strategy: Techniques for Analyzing Industries and

50

website 46 . Respondent E said "you can sleep in this industry, just do a great job".

However, Porter says that "product differentiation can create layers of insulation against

competitive warfare because buyers have preferences and loyalties to particular sellers",

which has been already been discussed above and is shown in Figure 5.5. Niche sites

command a higher level of loyalty than generic sites. It is likely that generic sites, which

are less differentiated, face a higher degree of competition among each other than niche

sites do. This however could not be proven with this study due to lack of data.

Essentially, the executives from niche sites expressed little concern on the topic of

industry rivalry, but still acknowledged the importance of competing by constantly

improving their products. This is most likely because the industry is expanding quickly

and there is still enough revenue in the total pie for the players to take a piece and expand

their market share even though there exist few switching costs for buyers. As a result, we

can rank the rivalry between competitors to be a moderately weak force.

Force 3 - Threat of Substitutes

The threat of substitutes is a force that describes the ability of another seemingly

unrelated industry to take the market share of the industry under analysis. In our situation,

we identify substitutes by asking ourselves which products or services serve the same

function as online social networking websites. At the core, social networking is about

communication with others. So, any product that offers communication at the same or a

46 Delaney, Ian. "Be-boom or Bust - The Ingredients of a Social Network." eMarketer,

July 12,2006. www.eMarketer.comlbebo

51

lower cost could be a substitute. In the case of Respondent E, 99% of his potential

member base which is composed of older individuals still use email as their primary form

of communication. His current members are the "early adopters,,47. Another possible

substitute is another free communication tool that is now used internationally called

Skype, which uses the internet as a telephone connection instead of traditional phone

lines (cite skype.com). However, these substitutes are not as unique and interesting to use

as online social networking. Social networking is new, popular and multifaceted

communication with an element of entertainment and is unlikely to be eclipsed by any of

the mentioned substitutes. Thus, this force is ranked as weak.

Force 4 -Bargaining Power of Buyers

Buyer Concentration

Buyers with strong bargaining power have the ability to beat prices down and

demand higher quality services, diminishing the profits of an industry. If buyers are

concentrated or The social networking industry has a highly fragmented buyer group.

Buyers are counted on an individual basis and if the members have formed groups, their

relative power is still quite low. Also, the buyer uses the product for free and thus does

not have much say in the quality of services provided. Buyers are numerous in this

industry, there are millions of them. Not dealing with one buyer/member by blocking

them from using their site will not affect the network in anyway. Buyers have no way to

play industry firms against one another, so bargaining power already seems very low.

Switching Costs

47 E, Respondent. Interview by author. Colorado Springs, December 10, 2008

52

Buyers in this industry have some power, they have the power to choose. The

switching costs are low enough that buyers can switch between networks at ease if they

are not attached to a specific friend group as discussed above. However, as said, there are

so many buyers in the market that losing one or two will not affect the firm immensely.

This force can be ranked as moderately weak.

Force 5 - Bargaining Power of Suppliers

If suppliers to an industry are strong, they can threaten to raise prices or reduce

the quality of the goods or services offered, which can squeeze profitability out ofthe

52 Buyers in this industry have some power, they have the power to choose. The switching

Concentrated Sellers

In this industry, social networking companies negotiate directly with companies

who want to provide advertisements on the sites. These large accounts fill the majority of

the ad space inventory, but often times the excess inventory is often sold on websites like

Triffiq.com which is an internet marketplace where buyers and sellers can offer, bid, and

buy advertising space. Currently there are 8 million dollars in RFP (request for proposals)

listed on traffiq.com 49 .

Respondent B said that there are hundreds of American and

foreign companies that provide advertising to social networking sites. There are enough

non-concentrated suppliers that they do not achieve an edge. This does not make

suppliers strong.

Porter, Michael E

  • 48 ..

Competitive Strategy: Techniques for Analyzing Industries and

Competitors. New York: The Free Press, 1980. PIS

  • 49 The Premium Ad Marketplace." TRAFFIQ -

"TRAFFIQ -

The Premium Ad Marketplace.

53

Suppliers Competing with Substitute Products

As stated above, the online social networking industry uses advertising as a

primary source of income, thus advertisers are virtually the only suppliers to the industry.

Porter says that the power of large suppliers can be diminished if they have to contend

with substitute products for sale to the industrySo. There do not exist any obvious

substitutes that provide revenue to this industry and this makes the suppliers strong.

Importance of Industry as Customer to

Suppliers

If the suppliers of an industry have a wide variety and the industry provides only a

small portion of revenue to the suppliers then chances are the supplier will exert its

powerS I . Figure 6.1 below illustrates, the total online advertising spending in the United

States. Overall spending this year is expected to reach $27.5 billion, which is very large

compared to the portion of this spending that goes towards online social networks (a mere

$1.5 billion this year). Although, as Respondent E noted, the social networking industry

is staring to become an important group for online advertisers, the data indicates that the

suppliers sit in a strong position.

50

Porter, Michael E

Competitive Strategy: Techniques

for Analyzing Industries and

51

Porter, Michael E

Competitive Strategy: Techniques for Analyzing Industries and

54

FIGURE 6.1 - US ONLINE ADVERTISING SPENDING

us Online Advertising Spending. 2001-2011 (billions)

54 FIGURE 6.1 - US ONLINE ADVERTISING SPENDING us Online Advertising Spending. 2001-2011 (billions) .1 ~$6

.1

~$6 .0

532.S 2010 Sll.5 2011 $:120
532.S
2010
Sll.5
2011
$:120

Note : eMarketfJf benChmlJfts its us OI1hne tldll'efti$l1l8 spending

projections 8gaillSf [he Interactive AC1Vertising Bureau

(1AB)lPr1cew8CerhouseCoopers fPWCj d8ta. for which the last full)'edf mfasured was 2006: online 8d data incJud61i CBfE!gories as defined by IA8IPWC bfflChmMt-displlIY ads (such as banners), paid search Bds (including context1J8l text finks), rich media {including video}. dltSSified ads, spof7SOfShips. refemJls ~8d gtmer<ttionj .'tfld IHTlsillembedded 8ds onIyJ;

excludes mobile ad spendi~

Source: eMarketer. OCtober 2007

54 FIGURE 6.1 - US ONLINE ADVERTISING SPENDING us Online Advertising Spending. 2001-2011 (billions) .1 ~$6

Source: eMarket e r. "Social Networking." /-7. www.eMarketer .com

Importance of Supplier's Product to the Industry

As stated above, the advertisers product is crucial to the business of online social networks. It is essentially the only form of revenue for the industry! This gives the suppliers a great deal of potential power.

Suppliers have a great deal of bargaining power against online social networking companies. Respondent E noted that suppliers are already trying to use this power by

55

always arguing the "value ofthe impressions"s2. Respondent A noted a similar level of

power being exerted by suppliers, using the single example of Facebook's dismal CTRs

to argue the value of impression based advertising. This respondent said that Facebook's

poor performance could be driving prices down for everyone and single handedly

"running the industry into the ground"s3. Overall I have concluded that the bargaining

power of suppliers is a strong force in this industry.

FIGURE 6.2 - THE FIVE FORCES: ONLINE SOCIAL NETWORKING INDUSTRY

Moderately WNk Internal Competition
Moderately WNk
Internal Competition

/f'----"'\

.'

\

'\

".....

/

_-,-//

Woak

Threat of Substitutes

  • 52 E, Respondent. Interview by author. Colorado Springs, December 10,2008

56

Figure 6.2 shown below synthesizes the conclusions and discussion regarding the five forces presented above and represents the relative strength and weakness of each force in terms of size. The larger the force, the stronger it is.

CHAPTER 7 CONCLUSION The above data and discussion was used to conduct an analysis on the relatively new and rapidly expanding online social networking industry. It appears that the industry is an attractive one for potential companies looking to enter. It seems that an entry strategy should focus first on selecting a proper niche that is not currently filled and has a significant potential member base. Since the industry is expanding there is not much internal competition for a new entrant to deal with. Also, the basis on which firms may compete with each other is not as direct as in other industries so there are not many barriers to entry that can be erected by current industry players. The most difficult aspect of entering this industry would be "breaking into the budgets of advertisers". This can only be done sustainably when the network generates very high traffic, which takes time and constant effort until the site achieves viral growth. This presents a significant risk to a start-up in this industry. Since this study surveyed a small portion of the total social networking user population and only a handful of social network executives, which included a partial interview from one generic site representative. Representative, there still remains much research to be done on this new fast growth industry.

57

58

Appendices: Appendix A

Factors in Determining the Strength of Each Forces

Threat of Entry Determined by the Six Barriers to Entry Economies of scale Capital! Investment requirements Customer switching costs Access to industry distribution channels Access to technology Brand loyalty The likelihood of retaliation from existing industry players Government regulations Threat of Substitutes Determined by:

o

o

o

o

o

o

o

o

o

Does a substitute offer better quality?

o

Buyers' willingness to substitute

o

The relative price performance of substitutes

o

The buyers' costs of switching to substitutes

Bargaining Power of Suppliers Determined by:

o

Concentration of suppliers. Many or few

o

Is the brand of the supplier strong?

o

Profitability of suppliers

o

Suppliers threaten to integrate forward into the industry

o

Buyers do not threaten to integrate backwards into supply

o

Role of quality and service

o

The industry is not a key customer group to the suppliers

o

Supplier switching costs

Bargaining Power of Buyers Determined by:

o

Concentration of buyers

o

Are products standardized or differentiated

o

Profitability of buyers

o

Role of quality and service

o

Threat of backward and forward integration of buyers into industry

o

Buyer switching costs

Intensity of Rivalry Determined by:

o

The structure of competition

o

The structure of industry costs

o

Degree of product differentiation

o

Customer switching costs

o

Exit barriers

60

Page 1

continued

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61

Page

3 ' 3. 1. Please list your favorite hobby or Interest . 2. It a new
3
' 3.
1.
Please list your favorite hobby
or Interest .
2.
It a new online social netwoJ1( designed especlallv to connect people who shared (your answer to the above question) as an Interest. would you join
that new site?
y~s
No
Pr ey
~
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Page
4
4.
1.
Assuming that you Joined that now stte. would you spend more time on
1
WA YN . (om
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63

Appendix D

FIGURE 8·2.

Sources of Field Data for Industry Analysis

Industry Observers

Standard setting organizations (e . g., underwriters laboratory) State government Federal government Unions Press, particularly editors
Standard setting organizations
(e . g., underwriters laboratory)
State government
Federal government
Unions
Press, particularly editors of
trade press and local press
where competitors' facilities
or headquarters are located
International organiz.ations
(e . g., OECD, United Nations)
Wat c hdog groups
(e.g ., Consumer's Union,
Ralph Nader)
Local organizations (i.e . ,
Chamber of Commerce) where
facilities or headquarters
are located
Financial community
(securities analysts)
Agencies involved in regulation,
industry promotion , financing ,
and
s o on
Customers
Interview Sources about Competitors
Service Organizations
Inside the Company
Market research staff
Trade associations
Sales force
In vestment banks
Service organizations
Consultants
Former employees of competitors,
observers. or service organization s
Auditors
Commerci a l bank s
Engineering staff
Advertising agencies

64

SOURCES CONSULTED

Books

Porter, Michael E

Competitive Strategy: Techniques for Analyzing Industries and

.. Competitors. New York: The Free Press, 1980. Scott, John. Social Network Analysis: A Handbook. London: Sage, 1991. Wellman, Barry. Networks in the Global Village. Boulder: Westview Press, 1999.

Journal Articles

Beer, David, and Roger Burrows. "Sociology and, of and in Web 2.0: Some Initial Considerations." Socialogical Research Online 12, no. 5 (2007): 1-16.

www.socresonline.org.uk/12/5/17.html

Garton, Laura, Caroline Haythornthwaite, and Barry Wellman. "Studying Online Social Networks." Journal of Computer Mediated Communication 3, no. 1 (2006).

www3.interscience.wiley.comlcgi-binlfulltext.html

Kim, Eonsoo, Dae-il Nam, and 1. L. Stimpert. 2004. Testing the Applicability of Porter's Generic Strategies in the Digital Age: a Study of Korean Cyber Malls. Journal of Business Strategies 21, no. 1: 19-45.

Kohut, Andrew. "Internet's Broader Role in Campaign 2008." PeQple-Press. 11 Jan. 2008. Pew Research Center. 23 Sept. 2008 <http://people- press.org/reportl?pageid= 123 3>.

Liu, Chang, and Kirk P. Arnett. "Exploring the Factors Associated with Crap Website success in the Context of Electronic Commerce." Information and Management 38 (2000): 23-33.

MacAulay, Linda A., Kathy Keeling, Peter McGoldrick, George Dafoulas, Emmanouil Kalaitzakis, and Debbie Keeling. 2007. Co-evolving E-tail and On-Line Communities: Conceptual Framework. International Journal of Electronic Commerce 11, no. 4: 53-77.

Pauwels, Koen, and Allen Weiss. "Moving from Free to Fee: How Online Firms Market to Change Their Business Model Successfully." Journal of Marketing 72, no. May (2008): 14-31.

66

Interviews:

A, Respondent. Interview by author. Colorado Springs, October 27,2008. B, Respondent. Interview by author. Colorado Springs, November 11, 2008 C, Respondent. Interview by author. Colorado Springs, November 20, 2008 D, Respondent. Interview by author. Colorado Springs, November 25, 2008 E, Respondent. Interview by author. Colorado Springs, December 10, 2008

Miscellaneous Internet:

Dignan, Larry. "Fox interactive turns annual profit." ZDnet. 8 Aug. 2007. 23 Sept. 2008

<http://blogs.zdnet.com/btll?p=5899>.

Sellers, Patricia (2006-09-04). "MySpace cowboys", Money, CNN.com.

"List of social networking websites." Wikipedia. 23 Sept. 2008. 23 Sept. 2008 <http://en.wikipedia.org/wiki/list_oC social_networking_ websites>.

Online Social Networks, Virtual Communities, Enterprises, and Information Professionals - Part 1. Past and Present." Information Today, Inc .. http://www.infotoday.com/searcher/juI07/Reid Grey.shtml

"TRAFFIQ -

The Premium Ad Marketplace." TRAFFIQ -

The Premium Ad

Marketplace. http://www.traffiq.com (accessed December 19,20