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August 21, 2001 01:44pm
Easy Money Is Gone For Porn Sites - Online Smut Still Sells, But Not Nearly As Well Or As Easily
Source: ManNet
by: Randy Barrett, Interactive Week

In early 1997, Interactive Week published an in-depth expose on the industry and found a vibrant marketplace booming with traffic, profits and big plans. More than four Internet years later, the market has shifted radically from what one industry veteran wistfully terms "the golden age."

Despite its prurient nature, cyberporn is in some ways no different than other commercial enterprises. It's now following traditional business lines of consolidation, while facing some unique challenges in a largely stagnant market.

No official figures are available -- research firms tend to shy away from tracking online porn -- but industry executives generally agree the digital smut market is worth about $1.75 billion annually. In 1997, it stood at roughly $1 billion. While that 75 percent growth curve looks promising, the market's total value has remained largely unchanged in the past year.

"Clearly, the business has matured and growth is slowing," says Mark Kreloff, CEO of New Frontier Media [http://noof.com], one of the few publicly traded adult-content companies.

It doesn't help that the market has become deeply saturated, with an estimated 100,000 sites vying for an increasingly fickle, largely male audience. The result is a Technicolor riot of flesh -- cloying Web pages that trap visitors in an endless chain of come-ons, applets that hijack home page settings and a tsunami of porn spam clogging e-mail boxes across the planet.

It wasn't always so.

There was a time when a new adult Webmaster could put up a free site and in relatively short order enjoy revenue of up to $20,000 per month with an 80 percent profit margin. The formula was based on an "affiliate" model in which free content sites carried banner ads for pay sites. Webmasters of free sites got paid a per-click-through rate and received bounties if exit traffic funneled from their sites yielded memberships down the line.

But the vicious competition has led to plummeting profits for free sites, some of which are hanging on by a G-string. "If you make more than $1,500 [profit] in six months, you're doing well," says one adult site owner, who wishes not to be identified.

"I wouldn't want to be a free Webmaster breaking into the industry now," says Ron Levi, CEO of Voice Media, which operates Cybererotica [http://Cybererotica.com], one of the largest players in the business.

The problem is all in the numbers. While 31 million, or 35 percent, of all Web surfers visit porn sites each month, according to Jupiter Media Metrix [http://JMM.com], that traffic is being refracted thousands of ways, as a horde of free and pay sites noisily panders for attention. Search engines have become glutted with porn listings, rendering them nearly worthless as a marketing tool.

Smaller sites have particularly felt the pinch as the flow of visitors has dwindled. "There has been a gradual slowdown in traffic over the past two years," says adult site operator "Dravyk," editor of all of 'Em To You [http://AllOfEmToYou.com], an e-newsletter for porn Webmasters.

Three years ago, a new free site with minimal advertising could expect about 2,000 hits a day almost immediately. That figure has slid to about 300 hits per day, Dravyk says. And in a business where moving large volumes of traffic is the key to success; many smaller Webmasters are beginning to call it quits.

"People are getting out," says Greg Geelan, president of Ynot Network [http://YNotNetwork.com], which runs a news and information site for adult Webmasters.

Even for sites that manage to attract steady traffic streams, the surfing public has gotten choosier. The conversion rate of visitors into pay site members has taken a dive from about 1 in 100 to roughly 1 in 400, industry execs say.

"People don't buy like they used to," says John Distasio, CEO of CyberFoxes [http://CyberFoxes.com]. "They used to be very impulsive."

Industry players agree that an oversaturation of porn sites and a cornucopia of free photos are causing the problem. Piracy is rampant among cutthroat adult Webmasters, and pay content at leading shops is regularly posted almost immediately to newsgroups and rogue mirror sites.

To make matters worse, customer loyalty is at an all-time low. Until recently, the average pay site membership lasted three months. That's now down to two months, industry executives say. Adult Webmasters are having to spend more and more on marketing to keep their top line steady, and that cuts into bottom-line profits.

'Ponzi Scheme'

The shorter memberships have had another dramatic effect: The affiliate system has begun to collapse. Until recently, the standard bounty paid by a pay site to a free site for traffic resulting in a new membership was $50. With a monthly subscriber fee of $30 per month, this business model demands that a customer stay at least two months, giving the pay site owner a margin of $10. If the customer splits earlier, the pay site loses money.

The impact was been widespread. Earlier this year, Cybererotica lowered its bounties from $50 per new membership to $40. That cut the revenue of thousands of Cybererotica affiliate sites by 20 percent.

"It's sort of a game of 'last man standing,' " says Gerard Van der Leun, director of Penthouse.com [http://Penthouse.com]. "[Affiliate programs] are a Ponzi scheme."

To save money, pay operators are increasingly "shaving" down the true number of surfers who actually buy memberships - which the affiliate Webmaster who sent the traffic has no way to track. Pay operators are also opening more of their own free sites to drive traffic directly to themselves, glutting the market even more.

Add to the mix the new punitive credit card rules from MasterCard International [http://MasterCard.com] and Visa International Service Association [http://Visa.com], and the chaos is nearly complete. Last year, the two companies cracked down on the industry, demanding adult operators lower the number of declined charges -- or chargebacks -- to 1 percent of monthly transactions.

Adult sites can produce extremely high chargeback rates of 15 percent to 50 percent, because of poor service and a high incidence of credit card fraud. Many sites have been unable to meet the demands of MasterCard and Visa, and individual companies are generating fines of as much as $100,000 per month. The penalties are so high and so pervasive that Voice Media's Levi dubs the banks a new "silent partner" in the industry.

Even the big kahunas aren't exempt. For its fiscal year ended March 31, New Frontier's Internet Content Provider group posted chargebacks of $2.7 million on revenue of $31 million, despite an active in-house effort to minimize the problem. The Internet group posted operating earnings of $6.4 million for its fiscal year.

Many pay site Webmasters now outsource their credit card transaction processing to third-party vendors such as CC Bill [http://CCBill.com] or The Internet Billing Co. [http://iBill.com], but that adds another level of expense. The added scrubbing required to pass cyberporn charges drives the processors' fees up to 15 percent of each transaction.

The combined effects of bank fees and the breakdown of the affiliate system has caused a consolidation of traffic around a core group of hard-core leaders, including Cyber Entertainment Network, New Frontier, Pornication, Python Communications, RJB Telcom and Voice Media's Cybererotica.

Estimates vary, but these leading operators now account for between 60 percent and 85 percent of the overall smut traffic on the Web, industry observers say.

"Now it's a traffic game -- manipulating, cleaning and qualifying," says Tom Hymes, associate editor at AVN.com [http://AVN.com], an adult industry trade publication.

Urge to Merge

The commoditization of traffic is a precursor to a larger consolidation across the industry, say many adult Webmasters. Though mergers and acquisitions haven't started in full force, several big players are laying the groundwork.

"A lot of the nonbranded sites are imploding," says Penthouse's Van der Leun. "I'm seeing requests by several companies asking if we want to buy them."

Van der Leun says he is actively looking to make acquisitions and is currently conducting due diligence on four companies, which he declines to name. New Frontier CEO Kreloff is also poised to start buying and is looking at smaller shops he can snap up for two to three times their annual revenue.

The one exception to the chaos and consolidation trend are niche adult sites that cater to specific fleshy fetishes. As larger sex portals have grown clogged with low-quality content backed by inferior customer support, boutiques have flourished in their shadow.

David K. has operated the gay male site Nightcharm.com [http://Nightcharm.com] since 1998 and has cultivated a small but loyal customer base by offering a free Webzine as well as a paid content. David primarily depends on word of mouth to drive new traffic.

Rather than just posting a gallery of lurid thumbnail pictures and leaving it at that, David regularly updates both the visual and textual content on his site to keep visitors coming back. His goal is to be an honest entrepreneur of male erotica.

"I'm not trying to rip anybody off," says David. "I put my face on the site and there's a feeling a human is here."

The recipe works for other niche sites like WifeysWorld.com [http://WifeysWorld.com], run by a husband-and-wife team that provides content from their own boudoir. The site has attracted a steady membership of 12,000 subscriptions at $15 per month, generating $2.2 million per year in revenue -- a figure that doesn't include online video sales.

Both New Frontier and Penthouse are looking to launch their own niche fetish sites to cash in on the trend. Kreloff is also betting much of New Frontier's future on broadband smut. The company currently operates Ten.com, which for $29.95 per month offers long and short triple-X streaming video clips to suit a variety of tastes, as well as live tech support.

"People will pay a premium for better content," Kreloff says.

There is widespread agreement that chargeback penalties and consolidation will combine to clean up the industry over the next few years, as fly-by-night operators go bust. Still, the challenge for the remaining players will be to attract and keep new customers in a virtually zero-growth market. Odds are, they will survive.

"These companies are determined to stay in business," Hymes says.

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