As I often tell my friends, it’s more fun to run other people’s businesses.  In that spirit, SEC filings are a great source of entrepreneurial case studies, and recently I’ve been reading about Demand Media.

Demand Media has a mix of businesses, including a domain name registrar.  The most visible property is eHow (acquired in 2006), which you’ve likely seen in search results. For eHow, Demand Media pays authors small amounts (~$15 and up) to write focused topic articles, then decorates those articles with ads.  As you’d expect for these price points, articles are relatively low quality (see how to roast a chicken).

Their risk for Google search algorithm changes has been well-reported.  Google has gone on record they are going after low-quality content, and recent algorithm updates appear to have hit eHow hard.  Demand Media has downplayed the impact, saying:

… the Company currently expects that its year-over-year page view growth across its owned and operated Content & Media properties in the second quarter of 2011 will be comparable to, or greater than, the year-over-year page view growth achieved in the second quarter of 2010.

This will likely be true, because they’ve added lots of new article content in the past year.

But it avoids the real question:  how do Google’s updates affect the per-article ROI?   Can Demand Media make a $20 article fee back in some reasonable period of time?

On this issue, what’s most interesting is Demand Media’s accounting treatment of the article fee. Instead of treating it as an expense (as a newspaper would do with journalist salaries), Demand Media argues their articles are a capital asset, with the creation cost depreciated over 5 years.  This method makes them look more profitable (or less unprofitable) than they would otherwise:  instead of a $20 article expense in the first year, they only expense $4.

Depreciation makes sense for assets that have a relatively predictable lifespan and value:  telephones, furniture, servers, tools, machinery, etc.   In this case, it’s a stretch application of the concept.  First, things change, and 5 years is forever in Internet time.  Second,  the content’s value-over-time is heavily influenced by external factors that they can’t control:  the search rankings (which are trending the wrong way), and the emergence of competitive content.

My bet:  their per-article ROI was already on the cusp, and Google’s updates are pushing it in the wrong direction.  Their content’s asset values will decline far faster than the depreciation model reflects, and they’ll be stuck holding the remaining depreciation expense.

What am I missing?

In case you missed it, H.1731 and S.1554 are winding their way through the Massachusetts legislature.  These bills attempt to make large vendors like Amazon subject to state tax, by arguing that MA-based affiliates create an in-state presence.

I’ll concede that the US Constitution has made our in-state/out-of-state sales tax system a bit quirky.   But I object to these bills because they put Massachusetts at a competitive disadvantage in the emerging Internet economy, at a time when more entrepreneurs are eyeing NY and CA for new companies, instead of MA.

It’s also not clear there’s any material revenue benefit:  in other states, Amazon (and other vendors) have responded by canceling their affiliate programs in those states.

These bills are being pushed by Wal-Mart, other multi-national retailers, and the Retailers Association of Massachusetts (RAM), who argues:

Our local small businesses operate at a significant 6.25% price disadvantage to out-of-state, online businesses, leading to fewer sales at brick-and-mortar establishments who contribute so much to our community.

This highlights my real objection:  these bills are about protecting the status quo, without taking a rational and realistic view of the future.  Any MA-based retailer facing out-of-state mail-order competition should be considering the future of commerce.   There are 49 other states where that retailer can sell tax free!  That’s hardly a “disadvantage”.

Like many issues, it’s always helpful to understand the deeper issue.  This is really about Wal-Mart pushing around Amazon.  I can only hope that the MA legislature doesn’t rise to the bait.

I can now cross “invent a word” off my bucket list.  According to Google, “yellitocracy” is a brand new word.

What does it mean?  A yellitocracy is an organization where “he who yells the loudest, wins“.   These can sometimes occur when you gather a group of smart, hardworking, passionate, opinionated and competitive people.

Passion is a good thing, especially in startups, but sometimes the culture can become less than constructive.  I’ve seen groups that devolved into “debate club”, where ideas are judged on how well (and loudly) they’re argued, not on the merits of the ideas themselves.

Often, the best ideas aren’t screamed — they’re mal-formed (initially) & stated very quietly.  If you’re not listening carefully, you’ll miss them.  Worse, you may lose some smart & competent people because they don’t feel they fit in to the culture.

Do you have a yellitocracy?