I think it’s probably worth digging a little bit at how numbers in these marketplaces break down. I’ve worked at a bunch of advertising related startups in the past, and there are some basics of market sizing that I don’t run across as often as I would expect to. Basic market sizing is important for anyone starting up a new venture. Especially if you’re looking to raise some money. Even if you don’t run these numbers the people who you’re talking to definitely will.

The first important point to recognize is that your income as an advertiser is someone else’s cost of doing business. With the relationship abstracted through advertising networks it’s often easy to forget the simple relationship that exists. Take the App Store for example. Just to use round numbers lets say that the App Store is generating a billion dollars in raw revenue. That’s the total market size, and you need to work backward from there to figure out how much value you can capture running advertising. First you need to take out Apples share, so you end up with $700M going to third party publishers.

This is where most folks stop, but that $700M number has nothing to do with how much money you can get out of running advertising on mobile. If $700M is the amount of raw revenue that app developers are making with both direct sales and in-app purchases, it’s some percentage of that which they should be willing to spend on advertising. Cause in a rational market people will spend less on advertising than they make in revenue. Otherwise the marketplace as a whole isn’t working.

Because of that I’m not surprised at all that virtual goods would outpace advertising as the major source of revenue. Currently most folks are making money off direct sales or in-app purchases, so they’re spending less to get users than they’re making off those users. That’s good news actually, pretty healthy. During the initial land grab for a new marketplace you might see more ad revenue coming out of a system than sales revenue, but that’s not a long term sustainable position. The way the ad marketplaces crashed in 2000 is a good example there.

The way to really open up the advertising marketplace in mobile is to get folks who aren’t selling mobile goods and services to advertise on mobile. It would be great if we could size the advertising market for mobile not based off the revenue numbers from the App Store, but based on other offline revenue streams. The numbers get a lot bigger a lot faster if the advertisers and the inventory providers aren’t the same people. If the only people spending money in mobile advertising are people making money directly off mobile you end up with an unsustainable marketplace. Literally the equations don’t balance. I make X off my mobile service, so I’m willing to spend 10% of X to market my service. If the only way I make money is advertising then the amount of money being put into the system needs to equal the amount of money coming out of the system (at a macro level). So X = X * 1/10. That equation only works out when X = 0, which is what folks mean when they say “the market is unsustainable”.

Right now we’re getting a decent amount of lift in the system as a whole because there are large numbers of new users coming online and a lot of speculative investment going into attempting to capture large user bases. At some point that won’t be the case however. And the smart money is looking to spread out the model some, looking for folks who have significant chunks of their revenue streams from something other than advertising. That way if the market in mobile crashes out the way the online advertising market did in 2000 you don’t have to fold up your business and go home.

I agree with the Flurry folks though that the streams on all ends should keep growing. I think the shift from direct sales to virtual goods is a good intermediate step to help mobile advertising through the real step it needs to take – which is getting offline commerce transacted through mobile devices. When you take a look at chunks of revenue like like the $1.5B that eBay is making through their mobile service you get to numbers that look like game changers pretty quickly. I think the long term potential of this shift is why there’s so much activity going on in mobile payments (even if just being a mobile payment system for online desktop offers, that still opens up a large pool of money relatively speaking) and local advertising (which is the one area of advertising where a large healthy mix of the spend comes from physical merchants looking to drive foot traffic). I’m happy to see things shifting pretty smoothly too. If the progress keeps up hopefully we won’t have to struggle through yet another painful “correction” in mobile as a whole.

I’m a developer, so the answer to that question has always been no. Although us developers are pretty much “pure” online interaction – we don’t have a lot of the need for offline interaction that lots of other professions do – everyone just assumes that if you’re going to be a developer you’re going to have a computer system of some kind. What if that wasn’t the case however? What if the knowledge of local conditions or business models trumped the other concerns? What are the tools you could use to get the job done if you had a business opportunity and a mobile phone, and that’s it? These are the kinds of questions that have been dragging me out of bed lately.

I was going to hold off on this topic for a while, but then I ran across this gem of a report from our beloved US government explaining why mobile payments could destroy the world. The whole topic area right here just strikes me as backward, small minded, and at it’s base just really stupid. Here we have the potential for a fantastic system, uncoupling the concept of money from bits of paper and metal. Making it easy for people to do what they want with their money when they want. Being able to reach out and help friends and relatives in far away places instantly.

But instead of seeing the potential upside (not, potential upside, most of us don’t have the ability to do the things discussed in that report under the current set of services), instead what’s called out is the potential for abuse by a very small percentage of the population. I just don’t get that mentality at all. It’s like not allowing cars because people could get drunk and drive around in them. Or declaring that everyone has to walk around naked cause someone could hide weapons under their clothes. It’s just absurd. Why cripple everyone because you’re concerned about the behavior of a few? Apparently all you have to do is include the word “terrorism” and you can propose just about anything you want.

I personally don’t buy it at all. If you want to cut off the potential use of a system by terrorism, sure, by all means! I’m not going to stand in your way. But if you want to cripple a system that dictates what I can do with my money, how I can do it, and when I can do it, well then we have a bit of an issue. If you want to cut off terrorism do things that affect terrorists and money launderers. Inconveniencing everyone in order to do so is just lazy thinking. Unfortunately people have strong and irrational feelings about things like this cause they feel their safety is threatened (Surprise! You never really had safety, you’ve just become more aware of not having it), and any bit of absolutist thinking they can hold on to in order to make them feel better. Well darnit, that’s just going to have to do. Cutting off terrorism by cutting off their funding is one of those areas (Surprise! That’s not going to work either, probably won’t even slow it down).

Unfortunately what we’re working at here, at heart, is a fundamental change in the way people think about money. And like any major change, that really makes people nervous. Especially people who have a vested interest in the particular limitations, controls, and structures brought about by the incidental effects of the current system. People like governments and banks, who unfortunately are holding most of the cards in this game. In order to figure out a workable system we either need to work around the folks who would normally stand in our way, or convert them to our side. Most of the efforts that have come before are based around a third option of giving incentive to the existing folks and caving in to their restrictions. I don’t consider that option to be on the table, limiting a new system to make the players in the old system happy isn’t a path to progress in my opinion.

Converting the existing folks to our side seems like it could be pretty difficult. Hard to say though with the setup the way it is in mobile payments. With the carrier sitting in the middle of every significant transaction we might be able to play the banks against the carriers to come up with a system that works at scale to break open that market for the banks. But the banks have their own sets of issues. Working completely around the existing system might be the real option we have. Direct user to user payments with something only vaguely resembling a bank in the middle. Using alternative “payment” methods like trading prepaid minutes or prepaid messages. That gives us a bit of a foothold, but how does the regulation and legal arena look for schemes like that? For instance can I take $25 from someone in CA and at their request provide it to someone in NY for withdrawl? What needs to be reported and recorded in that case, and what base restrictions are there? If someone has good pointers please share them.

The first thing I want to say is that existing mobile payments do not work. I’ve heard it said a number of times that mobile “comes with a built in payment system”, but that’s really a load of shit. Allow me to elaborate.

First of all theres the structure and revenue share of the existing payment infrastructure. In the cases where it’s possible to bill back to the customer bill the functionality is backdoored in frequently through premium SMS messaging. The carrier generally takes a large share of the transaction (I hear numbers like 50 percent here in the US, and I’ve been told it’s even worse in India). And of course the transaction isn’t directly from merchant to carrier to customer. Oh no, of course not. Theres the premium SMS provider in the middle as well also wanting their cut. It’s a hostile environment for merchants with way too much lockin for existing players. The base costs to use these systems are so high, and the overhead so steep, that it really discourages lots of potentially interesting usages.

Second is the off-deck payment systems. Stuff like Google Checkout for mobile, PayPal Mobile, and Obopay. First is of course that there are some user interface or user perception issues around the services. They also assume a credit based economy. No problem in the US and Europe, but a horrible problem in Africa, India, and China. “Who cares about people in China” you say? (particularly if you live in the Bay Area, people around here just love to dismiss the rest of the world) Well, ask anyone who watches construction and commodity markets where they think interesting stuff is happening. I bet those folks are interested in China at the very least. For all the nastiness of carrier billing, at least it handles the cash based economy and prepaid cell plans relatively well.

And finally, say we had a magic system that everyone could use with minimal setup and a great experience, every user had access to it, and every online merchant accepted it. Now you start having to worry about some pretty heavy regulation. There are banking and financial regulations meant to insure the basic level of trust. But recently there are also more regulations meant to curb money laundering and nefarious activities. How many people are familiar with those regulations on a global level? Even if we crack the technical problems and solve the user interface issues and gain user trust there’s still some potential issues with the G-men, whoever those shadowy puppetmasters might be.

So thats what we’re looking at. Tough, but things worth tackling normally are. Next post on this topic is a bit of background on whats been tried in the past and what technologies exist. The hat will be tipped to David Chaum I’m sure, but I need to read up a bit before I’m ready for that.