Reddit - Buy, Hold or Sell?

A deep dive into the monetization challenges of Reddit and the road to profitability it can take by embedding commerce in culture.

If I was a stock analyst and Reddit was a publicly traded firm, it would have been challenging to assign a rating to it. At a valuation of $10 billion, Reddit is undervalued (more on it in the post). So, it should be a buy rating? But Reddit is undervalued not only because it is under-monetized but because its primary path to monetization (ads!) prevents it from unlocking the actual value of its 52 million Daily Active Users. Reddit needs to recognize that it cannot follow the same path to power as done by Facebook & Twitter and instead pursue a culture + commerce route to get a buy rating.

My interest in Reddit stems from my belief that Reddit is going through an inflection phase right now, making it an exciting company to study. 

The new Reddit

In less than two years, Reddit's valuation tripled from US$ 3 billion in 2019 to US$ 10 billion in August 2021. It has done two rounds of fundraising in 2021, in February (which valued it at US$ 6 billion) and in August that valued it at US$ 10 billion.1

Reddit has also doubled down on digital ads under CEO Steve Huffman, reflecting its revenue growth. Its revenue more than doubled from 2018 to 2020, and it expects to clock US$ 260 million in 2021. It even had its first quarter of more than US$ 100 million in 2021. I will stick my neck out and say that Reddit will most likely cross US$ 300 million in 2021.

Equally importantly, Reddit seems to be changing its content spots. It undertook an extensive subreddit cleansing by removing ~2000 subreddits, based on its policy update on hate speech2

It also had its moment under the Sun recently. The GameStop episode gave it a sharp surge in popularity, as the Google Trends shows below. 

Reddit is also working on repositioning itself as a mainstream social media website with something to offer everyone (like Twitter). Its latest ad campaign is on the theme of 'Maybe together we’ll' and shows that Reddit is home to fun things such as gardening, cooking, and running.

Undervalued and under-monetized

As I mentioned earlier, even at a US$ 10 billion valuation, Reddit is undervalued. Let us compare it with Twitter and Roblox. Like Reddit, Twitter started as a text-based social platform, and even now, text plays a significant role in its user engagement. Roblox may look like an odd fit, but like Reddit, the content on Roblox is entirely user-generated. There are communities of players devoted to games, and most content reflects the amateurishness of a regular user rather than a sophisticated influencer (I am looking at you Instagram).

It is pretty visible that Reddit is undervalued because it is under-monetized. This leads us to the question: Why Reddit is under-monetized. Before answering it, let’s look at the monetization options Reddit has currently:

  • Ads: Ads are the primary revenue drivers for Reddit. It offers various ad inventories such as promoted posts, promoted videos, takeovers, and more. These are nothing different from what other platforms provide.

  • Premium membership: Reddit offers a premium membership of US$ 5.99 per month. The Premium subscription hides all advertisements on the site and gives access to an exclusive subreddit called r/lounge. It also gives users 700 "Coins" per month, which can be gifted to other users as a reward for posting comments a user likes. A quick look at SEMrush shows that r/lounge's monthly unique visitors hover around 15,000 to 17,000, which is tiny compared to Reddit's MAU means that it makes no dent in its revenue.

  • Reddit Coins: Users can also buy Reddit coins and use these to award the users (called gilding in Reddit parlance) who made a good post or comment. These come in various varieties, such as a Silver Award (worth US$ 0.4), Gold Award (worth US$ 1.99), or a Platinum Award (worth US$ 5.99).

Fundamentals are painful

Reddit is under-monetized compared to Twitter because its users are much less valuable to advertisers as a unit of production. When compared to Roblox, Reddit is under-monetized because its network effects aren't as powerful as Roblox's. Let’s unpack these further.

Reddit as an advertising platform

Reddit currently has less than 0.5% of the global digital ads market. For the sake of comparison, Google has 28.9%, Facebook has 25.2%, and Amazon has 10.7%3.

One sticky issue is NSFW content on Reddit, including porn, hate speech, racist commentary, and more. Almost 22% of Reddit is estimated to consist of porn, and no brand manager would want her ad to serve next to such content. 

However, this is not something that cannot be solved by tagging these subreddits and allowing marketers the choice to pick up SFW subreddits only. A little bit of tech can fix this. At some point in time, Reddit can also ban all NSFW content (much like Tumblr).

The more significant issue that Reddit faces stem from the way digital advertising work. Digital advertisers look for three things in a platform when placing ads:

  • The scale of the platform

  • The likeliness of an ad to be clicked

  • Accuracy of targeting their preferred TG

These 3 form a digital ad efficiency equation

Digital ad efficiency = Scale * Likeliness of ad to be clicked * Targeting Accuracy

Reddit's trouble is that there are platforms that offer a better return on investment for each of these elements. As media money is a zero-sum game (Money invested in one platform is not available to other platforms), digital ads become a losing proposition for Reddit.

Let’s look at the ‘likeliness of ad to be clicked.’ Ads on Reddit are less likely to be clicked than similar ads on the other platforms, and there is a fundamental reason for that. The likeliness of an ad to be clicked depends primarily on the ads alignment with the purchase journey of a customer

A simplistic version of the purchase journey looks like this:

Awareness and interest are the proverbial Top-Of-The-Funnel (TOFU). This is where a piece of information is pushed to the buyer without actively looking out for it. Think TV spots, newspaper ads, billboards, primarily visual media. Similarly, in digital media, most of the TOFU is made up of display-based advertising - YouTube ads, TikTok ads, Facebook, Twitter, programmatic banners, etc.

Advertisers look for scale at this stage as the typical click-through rates are approx 1-2%. Reddit loses out in scale here. Twitter has 187 DAU (3.5X of Reddit), and Facebook has 1.9 billion DAU (no point calculating the ratio). Higher DAU and higher time spent on these platforms allow Facebook and Twitter to provide more impressions to the advertisers. Reddit cannot match this scale unless it increases the frequency of the ad inventory (people see ads much more), which will cripple the user experience.

Consideration and Evaluation are the phases when the customer is searching for the information. Google and Amazon are integrated into buyer journeys at this stage, and ads on these platforms have a high chance of being clicked. Unfortunately, Reddit is not the place where people come to look for information, and hence Reddit is relegated to fight with Facebook and Twitter at the TOFU, where it loses because of lack of scale.

Reddit as a community platform

Reddit and Roblox have one fundamental similarity - the content on both platforms is created by users and is raw in look and feel. However, Roblox has an advantage over Reddit when it comes to Network Effects.

Before we go deep into this, let’s pause to understand the Fundamental Equation of Strength of Network Effects from Hamilton Helmer from his book 7 powers4. Hamilton derives the equation from the perspective that the market leader's stronger network effects allow it to earn a surplus margin than the follower platform. This surplus margin can be derived by using a limiting condition that the follower's margins are zero (the calculation is not complex, you can check it out in his book). 

Surplus Leader Margin = 1 - 1/[1+(delta/c)(NLeader - NFollower)]

Here:

Surplus Leader Margin is the additional margin that a leader with superior network effects can capture (i.e., additional value) compared to followers in the market

delta is the benefit that accrues to each existing network member when one more member joins the network

c is the variable cost per unit of production or cost per user for digital companies

NLeader is the installed base of the leader

NFollower is the installed base of the follower

delta divided by c is a measure of the intensity of Network Effects. It shows how important Network Effect is relative to industry costs and reflects the value the leader gets for every c spent. 

Roblox has two-sided network effects between the creator of games and players of games. In theory, all players can be creators and use Roblox's programming language Lua to create new games. However, as the table below shows5, a handful of meta-creators have developed games with sufficient traction. Rest is the long tail.

Coming to Reddit, it seems to have a better distribution with an even spread of users for the top 20 subreddits, as shown below:

For Roblox, the meta-creators or top games on the platform drive the delta in the Network Effects equation. This delta is easier to achieve if you have some great game makers onboard. Even if Roblox was not monetizing the players through a marketplace, the delta would have still given it an upper hand in monetization as it needed just one hit game to get a large number of players on board. 

However, Reddit is a community, and the size of the community drives the delta. This makes a strong delta relatively tricky to achieve as a community needs to hit a critical mass of engaged and passionate followers before it attracts more users. Reddit’s Network Effects scale only beyond a crucial point, and hence for at least a part of subscribers joining Reddit, there are no Network Effects benefits.

Culture + Commerce = Reddit's road to success

One of the core strengths of a community-driven social platform is the culture of its communities. It is evident in the case of Reddit, where each subreddit has its own set of values, dos and donts, enforcers of values (moderators), dissenters, and rebels (trolls). There are close to 500 subreddits with over 1 million subscribers, and Reddit claims to have over 100,000 active subreddits.

I hypothesize that the highest leverage way to monetize a culture is by embedding commerce in it. Showing ads to a culture-driven entity is a very sub-optimal way of capturing value. A very crude analogy will be businesses in Manhattan shut down all shops, restaurants, theaters, etc., and charge money for blasting ads on the giant electronic billboards. No prizes on guessing how it will turn out to be for the economy of Manhattan.

Commerce in culture needs five necessary and sufficient elements to exist:

  1. Creators who can create goods

  2. Tools for the creators to create goods

  3. Buyers who are willing to consume these goods

  4. Currency to attribute a monetary value 

  5. An exchange that can match supply and demand to discover the right price for the goods and exchange value

The table below captures the implications for Reddit on these elements.

Let’s now look at how to put these implications into action.

Individual meta-creators

Reddit needs to provide the right set of tools to users to create better goods and engage across the entire journey of buyers. The idea here is to throw open the whole suite of tools to all the users, and some of them will have the right skills, followers, and persistence to become meta-creators. One of the most fundamental aspects of this is a creator profile page that encourages commerce.

Creator profile

Roaring Kitty, who initiated the GameStop movement against large Wall Street firms, is perhaps the most popular Redditor right now. His profile page looks like a long scroll of his posts with some user information in the sidebar.

Now Here's a look at user profiles in a modern community platform like Circle.

The purpose of having a creator profile is to allow users to quickly understand if they want to follow/engage with a creator. The other purpose is to make creator monetization easier through tips, subscriptions, product-listing, etc. Reddit's creator profiles can do with a few coats of varnish in both these aspects. Also, for meta-creators, more options to customize their profiles will be hugely helpful.

Reddit has done a good job with the avatar creator by allowing users to customize Snoo. 

Reddit's home page needs more considerable intervention. When a user lands there (logged-out state), she sees a barrage of content (partially customized, I believe), but user profiles are absent in this sea of content. It could be as simple as putting a user leaderboard next to the community leaderboard based on popularity, karma points, etc.

Going back to the user The Roaring Kitty, let’s see his social footprint.

He posts on Reddit, which is the place that initiated the GameStop episode. His recent posts have 20,000 plus upvotes. 

But he also posts on Twitter (https://twitter.com/TheRoaringKitty) with 500k+ followers and Youtube (https://www.youtube.com/c/RoaringKitty) with ~550k subscribers. Amazingly, Reddit allowed such value to escape its platform. Possibly he wanted to diversify his creator footprint and hence decided to be active on Twitter and YouTube. Still, there's no denying the fact that by losing out content to other platforms, Reddit loses out on opportunities to build creator profiles.

To get meta-creators to spend more time on the portal, Reddit needs to look at the tools that can enable goods creation and value capture.

Value creation tools

Reddit allows native videos and live streams. It also recently started offering Clubhouse-type functionality through Reddit Talk that facilitates social audio in subreddits. But in line with its culture, it can provide at least two more value-creating tools to the meta-creators:

  • On-platform Premium Products: Creating premium products that can be used across Reddit is an exciting opportunity for creators. It includes the creation of custom avatars, badges, emojis, awards, and more. Users can buy these products when they need to use these, and the creator gets a percentage of money paid by the buyers.

  • NFT: This may seem slightly far-fetched (or not!), but given the sheer amount threads on Crypto and NFT on Reddit, NFTs are a natural extension of content creation for Reddit users. If Reddit can provide creators with tools to mint NFT through its platform, it will directly capture the value leaking to other platforms.

Value capture tools

Value capture tools allow creators to monetize their content. Some of these are industry standards now, such as paid subscriptions, gating premium content for paid subscribers, one-off tips, paid live events (video/audio), etc. Apart from these, I believe Reddit is uniquely positioned to provide creators with some radical value capture tools:

  • Marketplace for on-platform products: This ties back to the point above in the value creation tools. On-platform products are digital products that creators can put up for sale, and once purchased, buyers can use them in various ways. Marketplace allows listing of these digital goods and exchange of value.

  • NFT listing: We can stretch the marketplace concept and take it to the NFT listing marketplace. Currently, platforms like OpenSea allow buying and selling NFTs, a value capture waiting to happen on Reddit with its large-scale Crypto communities. 

  • Off-platform products listing: By this, I mean ebooks, merchandise, and more. Currently, if you want to sell an ebook or any off-platform product on Reddit, you will copy-paste a Gumroad link leading to the actual purchase happening on Gumroad. Thus, Reddit makes nothing from off-platform products. Instead, Reddit can facilitate creating rich profiles for these products with media previews, descriptions, testimonials, etc., ending with the payment on Reddit (Stripe/Crypto) to capture more value from the product.

Community meta-creators

Now let’s look at the 500+ subreddits with millions of followers. While I noted earlier that the community-based structure of Reddit makes the Network Effects slow to accrue, it also provides Reddit with a unique way of capturing value that other social platforms such as Facebook and Twitter do not have.

Communities in Reddit work on top of the content created by the users; hence, the value creation tools we discussed for creators also work for communities. There are other value creation tools and value capture tools that can be added at the community level.

Value Creation tools

If I consider each subreddit as a proponent of a unique culture, then there are a few missing value creation tools that are required to allow communities to create content that engages more subscribers.

  • Deep customization of subreddits: Each subreddit should have tools to create assets unique to its culture. These could be insignia, special colors, logo, unique awards, even some changes in the layout of the home page of their subreddit.

  • Live Subreddit events: Moderators or designated users can start to live audio/video events that happen on the platform (not on Zoom), with notifications going out to all subscribers

  • Deep community features: Subreddits can have deep community features such as job boards, garage sales boards, classifieds, etc. There could also be a marketplace for on-platform digital products where someone who no longer wants to use a specific product can put it up for auction.

Value capture tools

One question that pops straight up is how the value is shared when a subreddit is monetized. My view here is that the moderators and Reddit split this value. The moderators have worked tirelessly for a very long time for free, and this seems like the right incentive for them to take this maybe up full time, improving the quality of subreddits.

  • Paid communities and premium content: This seems to be the most straightforward thing to do. There can be paid subreddits that free users cannot access. Also, some content can be marked as premium inside a subreddit and can be made available only to paid users. This can be extended to paid live community events (audio/video), access to deep community features (see above), and more.

  • Collaborative commerce: Subscribers of a subreddit can collaborate their resources towards an economic goal, as we have seen in GameStop and AMC. But these transactions do not happen on Reddit, which can be changed. The good folks at PartyDAO recently launched a new product, PartyBid, that lets people form teams to bid on NFTs by pooling their resources and bid on multi-million dollar NFTs against much wealthier bidders. This is a collaborative commerce feature that should exist on Reddit. It allows the ‘collaboration’ and the ‘commerce’ to co-exist, allowing Reddit to capture more significant value and transfer a considerable value to the Subreddit subscribers.

To conclude, I believe that Reddit has a tremendous opportunity waiting to be tapped in the form of embedding commerce in a culture that it should capture aggressively. It has lost value already in many instances where subreddits have spawned multi-billion dollar companies (such as Discord). However, if it keeps focusing on ads-driven monetization, it will continue to be under-monetized as the fundamentals of the ads business are not in its favor. The path to a ‘buy’ rating is not through ads but commerce.


I hope you enjoyed reading this deep take on Reddit's path to value. Please take a moment to share this with your friends/colleagues by using the button below? The Hypothesis grows only by Word of Mouth publicity by readers like you.

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Till next time,

Rohit 

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Source: www.7powers.com