5 top trends in consumer-based Internet businesses for 2011

Jeremy Liew is managing director of Lightspeed Venture Partners in the U.S. He invests primarily in the Internet and mobile sectors.

Every year, Lightspeed Venture Partners goes on record with some prognostications for what the future holds. You can check out our 2010 predictions here (we figure we scored about a B on those). Here’s what we’re predicting for 2011:

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1. Putting fun into e-commerce
In 1995, when Amazon.com was founded, e-commerce was like the proverbial talking dog. It wasn’t about how well the dog could talk, it was amazing that the dog could talk at all. The first generation of e-commerce sites were focused on functionality, getting the dog to talk better. We got everything from price comparison engines to aggregated user reviews to one-click checkout. These early innovations were focused on optimizing the “workflow” of shopping to get users into the checkout as quickly as possible.

This worked great for most internet users at that time because, back then, most internet users were men, and in general, men do not like to shop. They treat it like a chore, a necessary evil that would ideally be minimized and optimized to take the least amount of time possible.

But a few years ago, that changed. There are now (a few) more women online than men. And in general, women tend to enjoy shopping more than men. If you enjoy shopping, you don’t want your “workflow optimized”. You don’t want to be rushed to the checkout as quickly as possible. Instead, you want to linger, to be delighted, to discover new things, to find great deals. You want shopping to be fun.

Flash Sales sites and Local Deals sites both make shopping fun by offering deep discounts. This is the mechanism they use to entice shoppers to buy something, even when they are not specifically looking for anything specific. But discounts are not the only way to make shopping fun. Sites like Modcloth make shopping fun through discovery. Modcloth highlights women’s clothes from modern, indie and retro designers. Because each item has limited supply, and selections are constantly changing, Modcloth builds in an urgency that has users coming back frequently to see what’s new and to make sure they don’t miss out.

Shoedazzle (a company Lightspeed has invested in) makes shopping fun by democratizing the personal stylist experience. After users take a style quiz to assess their profile, they are shown a selection of shoes, bags and accessories that have been specifically chosen to match their taste. Each month they get a new selection of on-trend pieces that fit their profile. JustFab and JewelMint have subsequently launched with similar models.

More models keep popping up. Recently launched Birchbox focuses on sending cosmetic samples to its users to help them discover the perfect eyeliner or blush. Pennydrop is a Facebook app that lets users peek at discounted and constantly dropping prices on items and jump in to buy when the price is low enough. I expect to see more applications of these formats, as well as more new formats, all under this overarching theme. Truly social shopping anyone?

2. Self-service ad platforms find their ceiling, and brand advertisers seek other avenues
About half of display advertising inventory is now moving through exchanges, DSPs and realtime bidding platforms. Yet these platforms are only two to three years old. While perhaps only 10% of online ad revenue is currently flowing through these channels, the trend here is clear. Today, two thirds of online ad spending comes from direct response advertisers, and soon the bulk of these budgets will likely flow through bidded platforms, including Facebook ads. Direct response advertisers move their budgets quickly to follow results, so this could happen within the next year or two.

Brand advertisers are also experimenting with bidded platforms. Each of the big ad agency holding companies has its own trading desk. However, adoption on the brand side will likely be slower and far from complete. Many of the exchanges, DSPs and RTB platforms allow for bidding strategies that are easily optimized for click-through rates, but optimizing for brand metrics is much harder. Brands also care more about content adjacency and brand-safe content, and these are harder to guarantee on an exchange type platform, where in some cases ad impressions are traded several times before finding their final buyer.

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In addition, exchanges, by definition, can only support standard ad units. Many brand campaigns incorporate custom elements, ranging from social media and other earned media components to custom microsites, site takeovers, roadblocks and other high-impact units. These are often tied to specific publishers and bundled into a broader media buy including standard ad units. Premium publishers depend on this sort of creative advertising to maintain the ad rates required to support the creation of high-quality content, and I think it is likely that this symbiosis between brands and premium publishers will continue to capture a large chunk of the brand ad budget. In fact, I expect to see a proliferation in custom ad units from the biggest and most premium publishers as they work to capture a greater share of brand budgets. Non premium publishers that have reached the scale to become “must buys” are doing exactly the same thing. Twitter’s Promoted Tweets, Promoted Trends and Promoted Accounts, and Facebook’s Social Ads and Likes are all great examples of this trend.

3. The field of competition shifts from user acquisition to user retention
Today, many e-commerce and subscription companies are growing very quickly through smart marketing. They are taking advantage of cheap media to cost-effectively acquire new customers. And, as I’ve mentioned above, the exchanges will continue to make it easier for direct marketers to reach their customers. Facebook’s self-service platform is still a relatively inefficient market, allowing savvy, analytical marketers to quickly and cheaply gain market share. However, in some categories (such as Local Deals) Facebook has quickly become efficient, and there is already a “market price” for a new Local Deals subscriber. As more marketers take the plunge into Facebook’s platform, more categories will become efficient, just as Google became an efficient market over time for almost all keywords. Once this happens, there will be a market clearing price for new customer acquisition across almost all categories, and smart marketing will no longer be as much of a differentiator.

On what basis then will winners pull away from the rest? Companies who are able to derive the highest lifetime value (LTV) from their users will squeeze out their competitors with a lower lifetime value. How can you improve LTV? There are three key factors: average revenue per user, gross margin and average lifetime. The e-commerce and subscription based companies that pull away from their competitors in 2011 will find a way to differentiate themselves from their competitors in one or more of these dimensions.

4. Social games chase hardcore gamers
Notwithstanding Disney buying Playdom (another Lightspeed investment) this year and EA buying Playfish last year, Zynga is still the market leader in social gaming. Its enormous installed user base gives it a real advantage in customer acquisition cost over its competitors; its ability to cross-sell installs to its new games at zero cost allows it to get a new game to scale with much lower marketing spend then smaller competitors.

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One strategy that the other social game publishers have developed to combat Zynga’s might is to focus on games with a very high LTV. High enough that the publisher can afford to rely on paid customer acquisition alone to build a user base, and still make money. Kabam (once know as Watercooler) pioneered this approach with Kingdoms of Camelot, a relatively hardcore social game that is reputed to be doing low- to mid-single digit millions in monthly revenue from about 750,000 Daily Active Users (DAUs)- a monetization rate that is dramatically higher than the norm for social games. Other publishers have taken note, and I would expect more games aimed at the hardcore gamer market to emerge over 2011.

5. Year of the Tablet
Smartphones transformed the mobile internet. Apps will drive $5 billion in revenue in 2010. Tech analyst Mary Meeker presents some great insight into the future growth potential of mobile in her Web 2.0 Summit presentation, Ten Questions Internet Execs Should Ask and Answer.

The same thing will happen with Tablets. While the iPad has the tablet market largely to itself this year, that will change dramatically in 2011 and beyond, just as Apple’s iPhone had the truly web-capable smartphone market to itself in 2008 but is now a minority after competition emerged from Android, Windows Phone 7 and modern Blackberrys.

The key difference between these new platforms and the PC web isn’t mobility (although that is part of it), but rather that these devices are always on and always with you. But use cases differ between the phone and the tablet.

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Phones are with you all the time, in particular when you are out of the house and out of the office. The most popular genres of app fit well with this “on the go” use case. Local information, “snacky” entertainment, music, and games have all been killer apps on smartphones. Some web incumbents made the transition well, including Yelp, Flixster (a Lightspeed investment) and Pandora. But many new companies gained ground on the phone through this disruption.

Tablets tend to live in the living room. They lend themselves more to leisure than PCs and to more protracted content consumption than phones. Killer apps might include, video, music, games, and “reading,” broadly defined. Again, some web incumbents will make the transition well, but once again I expect to see new companies gain ground through this disruption.

What do you think will happen in 2011? Leave your ideas in the comments section below.