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Article / 16 February 2012 at 13:09 GMT

LinkedIn – paying up for new users!

Peter Bo Kiaer Peter Bo Kiaer
Strategist & Equity Analyst / Private
Denmark

One simple measure to look at when considering if a company’s business model is sustainable is its cost of acquiring a user or client and what it expects to earn on each. If the calculus is negative then the company should stop acquiring clients/users or do something drastic to rectify the situation.

Where does LinkedIn stand?
Table 1 shows the change in new LinkedIn users for each quarter of 2011. During the year the intake of new users per quarter seemed to reach a limit of about 14-15m, which is quite a nice growth rate but it is decelerating. Table 1 also shows marketing expenses, which in contrast are rising at a noticeable pace, from USD 29m in Q1 to USD 53m in Q4 - an increase of 77 percent.
 LinkedIn Acquisition Cost Analysis

Such costs take their toll on user acquisition costs which have risen from USD 2.7 to USD 3.8. In the bigger scheme of things this might seem trivial with the difference being just USD 1.1, but if you acquire 50-60m users a year and want to profit from them you must know where things are heading and why.

How does LinkedIn’s revenue look? At the moment growth in revenue per user is less than the increase in acquisition costs per user, see chart 1.LinkedIn Acquisition Cost and Revenue per User

Revenue per user rose from 93c in Q1 to USD 1.16 in Q4, an increase of 25 percent. In comparison acquisition costs have risen three-times faster. 
LinkedIn Revenue per User Analysis

So what about net income? Table 3 shows some calculations on the marginal acquisition cost of new clients.

Net Income margin has declined from 6.4 percent last year to 2.2 percent in Q4 on a 12m rolling basis. (The calculations do not use this probably (too) low margin over a longer time span.) Table 3 uses a net income margin of 5 percent. If this had been the case during 2011 then each quarter would have resulted in net income as shown in the second line in table 3.

This is the equivalent of net income per user of 5c-6c each quarter. Now it becomes a bit scary as this translates into a pay-back time of 48 to 66 years! This is not sustainable as the expected life of a user would be much less than 48 years.

What if margins are higher in the long run, for example 20 percent? Then of course the pay-back time is halved. If the marketing expenses were halved from the USD 53m level then the net income margin in Q4 would be 20 percent.

One could object and claim that for example 50 percent of the marketing expense is used to convince corporates to use LinkedIn’s hiring solution. In this case the pay-back time is halved to 7-8 years.
LinkedIn User Pay-Back Analysis
 
Why is LinkedIn still making money?
Maybe LinkedIn acquired 55m users at an unsustainable level in 2011, but the 90 million users acquired further back in time, for example during 2009 were done at a cost of USD 1.1, which is less than a third of today’s level. At the same time net income per user has risen from 3c to 6c.

Thanks to this cheap(er) backlog of users LinkedIn is able to make money today. Going forward at the current pace however will tip the balance in LinkedIn and turn it into a loss making company. The intake of new users is large compared to the cheaper users from 2009 and before. The tipping point is therefore rapidly approaching.

The positive thing is that marketing is an easy tap to regulate. By just halving the associated costs this would result in a USD 82m substantial improvement to LinkedIn’s bottom line. This will though come at the expense of new user intake as this will lose pace.

Conclusion
LinkedIn does not have a sustainable level of marketing costs versus income at the moment.  Margins are not high enough to capture the investments so LinkedIn is getting closer to the inflection point where the business model has to revert to a longer term sustainable model.

See also:
1. LinkedIn: The best candy is already gone.

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