eHarmony Blog.com

[Three days ago, Robert Moore wrote a highly-popularized investigation on the people behind the "Single? www.CityNameSingles.org" lawn signs appearing all over the country, tracing them to a 32-year-old $45-million-dollar-annual-revenue dating site. One section of the article is an awesome "101" to those who wish to understand financing and growing an online dating company and why eHarmony makes much profit from so little technological innovation.]

In talking to a few colleagues about this fascinating business, I learned that most private equity shops shy away from dating sites for a number of reasons:

• Dating sites are known for tremendously high churn rates (if your product works, your customers never have to come back; if it doesn’t they see no reason to come back). This means dating sites have to keep a steady flow of new customers coming into the top of the funnel in order to survive, let alone grow revenue and profit.
• High churn rates mean new customers have low, volatile expected lifetime values. This has a negative impact on the [monetary] value of each customer, making it difficult to justify the valuation multiples seen by membership-driven websites in other [website industries].
• The need to keep more and more new customers coming in creates a necessity for massive marketing budgets that often involve aggressive affiliate marketing (i.e. paying third parties to bring you new customers). This further damages the perceived value of the user base to a potential investor or acquirer.
• Like social networking, “online dating” is a natural monopoly (or, at best, a natural oligopoly). A dating site’s quality is determined by the number and quality of matches it can provide a new user, which is directly tied to the size of its membership base. This makes it extremely difficult to enter the market.

However, just because something isn’t a great investment prospect doesn’t mean it’s a bad business. Many, many people have become obscenely wealthy in this industry (both online and offline). The technology required to connect two people is trivial, meaning your only real expense is the cost of customer acquisition. If you are part of the natural oligopoly, your product quality will be high and people will seek you out. This cycle lowers your costs and sends your margins skyrocketing.

Furthermore, the online dating industry has made a lot of secondary players wealthy thanks to affiliate marketing. At times, online dating sites have paid as much as $100 per head for new paying customers, and routinely pay out at least a few dollars for new “free trial” users or other prospects. This means anyone with the power to herd single internet users can potentially tap into a strong [moneymaking machine].

With this information in-hand, I started to see some beauty in the lawn sign model. Since virtually all dating sites are national, even ones with millions of members can under-serve certain geographic regions. The “YourTownSingles.com” approach leads potential members to believe their area will be extremely well represented in the site’s population. This creates the perception of high-quality matches, even if the total user base is small.