Reddit’s missing business model: Embedding commerce in culture

Nathan here! If you’re interested in the business of Reddit—how it’s doing (ok), how it compares to peer companies (not great), and what they can do to fix it (embrace creators)—then you’re going to love this article. It was written by Rohit Kaul, a marketing strategist / avid Reddit user, and I had a ton of fun working on it with him. Enjoy!

If I was a stock analyst and Reddit was a publicly traded firm, it would be challenging to assign a rating to it. Their last private valuation was $10 billion, which I am fairly certain undervalues the business’s massive potential. So, it should be a “buy” rating, right? Maybe.

There’s just one problem: Reddit’s current monetization strategy (ads!) prevents it from unlocking the actual value of its 52 million daily active users. In order for me to issue my hypothetical “buy” rating, Reddit would need to recognize that it cannot follow the same path to power as Facebook and Twitter as their advertising business is clearly suboptimal. Instead, Reddit needs to enable its communities and creators to monetize their content by embedding commerce in its platform.  Businesses like Discord, Twitch, and Roblox are great case studies that prove this model works, but Reddit has unique communities, scale, and place in culture that make it indispensable.

Reddit is going through an inflection phase right now. Their decisions over the next few years will determine the long-term profitability of the business and its place in the ecosystem of digital platforms. Let’s break down what’s at stake.

The new Reddit

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

The recent growth in valuation is driven by rapid growth in revenue. Reddit has doubled down on digital ads under CEO Steve Huffman, and more than doubled revenue from $76.9 million in 2018 to $181 million in 2020. It is expected that its revenue will cross $350 million in 2021. The revenue growth represents a YoY increase of 93%, which is staggering.

Equally importantly, Reddit is working on repositioning itself as a mainstream social media website with something to offer to everyone (like Twitter). Its latest ad campaign on the theme of “Maybe together we’ll...” shows Reddit as a place for fun things such as gardening, cooking, and running. Reddit’s efforts to broad-base its audience do not stop at advertising. Recently it undertook an extensive subreddit cleansing by removing ~2,000 subreddits, based on its policy update on hate speech.

One could argue that the rapid revenue growth indicates that 16 years after launch, Reddit is finally on the right growth trajectory. But I believe that it can do much better.

Undervalued and under-monetized

As I mentioned earlier, even at a $10 billion valuation, Reddit is undervalued. To understand why, we’ll compare it with Twitter and Roblox. But first, let’s give a quick overview of each of Reddit’s three revenue streams:

• 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 premium memberships that cost $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, and means that its contribution to Reddit’s revenue is miniscule.
• Reddit Coins: Users can also buy Reddit coins and use these to award users who made a good post or comment—“gilding,” in Reddit parlance. These come in various varieties, such as a Silver Award (worth $0.4), Gold Award (worth $1.99), or a Platinum Award (worth $5.99).

So if advertising is their main business, how well is it performing? To give us some perspective we will compare it with Twitter and Roblox.

Why these two companies? Well, one good reason is they’re both public so we have data on how they’re performing. Another reason is they’re in a similar position of not enjoying massive monopoly status like Google and Facebook. Also, these companies have fundamentally similar user experiences. Like Reddit, Twitter started as a text-based social platform, and even now, text plays a significant role in 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).

So, how does Reddit’s revenue compare? Here’s the data:

It is pretty visible that Reddit is under-monetized. Twitter, for example, earns 25x more revenue per MAU than Reddit. Roblox has less than 50% of Reddit’s MAU but it makes 11x more revenue per MAU. 

The question is: why is Reddit’s advertising business so much worse than comparable companies? And, more importantly, what can they do to fix it?

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%.

There are a few reasons for this. One is that Reddit has a much smaller user base to advertise to than Google, Facebook, and Amazon. But as we saw earlier, they also make less money per user. Let’s walk through each reason why.

NSFW Content

There’s a popular (but incorrect) notion that Reddit has struggled to monetize through advertisements as advertisers and brand managers are worried about their ad being served next to NSFW content. However, Reddit put a blanket ban on NSFW ads and NSFW targeting in 2019. For instance, ads are not served on any of the NSFW subreddits. Reddit has also banned ads of adult-oriented products or services on its platform.

Like all content moderation policies, there are gaps in execution but most gaps relate to NSFW ads slipping through the cracks, rather than ads appearing next to NSFW content.

 ROI for Advertisers

The more significant issue that Reddit faces stems from the way digital advertising works. 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 potential customers

Together, these three variables 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. 

Let’s look at the “likeliness of an 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 ad’s 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 them 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 advertising: YouTube ads, TikTok ads, Facebook, Twitter, programmatic banners, etc.

Advertisers look for scale at this stage as the typical click-through rates are approximately 1-2%. Reddit loses out in scale here. Twitter has 187 million 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 more ads per session), which will harm the user experience and make their scale problem even worse.

So Reddit’s small scale makes it challenging for them to compete with platforms for TOFU advertisements, but what about the lower levels of the funnel? The next phases, Consideration and Evaluation, are 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 generally not the place where people come to look for purchase information, and hence Reddit is relegated to fight with Facebook and Twitter at the TOFU.

As advertisers find Facebook and Twitter a better TOFU platform, more advertisers bid for the available ad inventory on these platforms, driving up the prices of ads resulting in more revenue for these platforms. Reddit attracts fewer advertisers, which reduces the number of bids and the price of bids on its ad inventory, thereby reducing the revenue generated by Reddit and deflating its ARPU.   

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 don’ts, 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 and allowing community members to create and exchange value with each other. 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 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. Reddit’s culture has two key components, as mentioned earlier: Creators and communities. 

Enabling individual 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 consistently create content that is valuable for other users on Reddit. 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. Reddit should also consider providing individual creators more options to customize their profiles such as rearranging the layout, showcasing trophies/awards upfront, and sub-grouping of posts (for instance, all video posts in one easy to access group). Reddit has done a good job with the avatar creator by allowing users to customize Snoo (the Reddit mascot).

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 with 500k+ followers and YouTube with ~550k subscribers. If he wanted to monetize his online presence, he’d have to go to some other platform like YouTube, Twitch, or Substack that monetize content and share revenue with creators. So it makes sense why he probably  wanted to diversify his creator footprint. By losing out content to other platforms, Reddit loses out on opportunities to build creator profiles.

But creator profiles that facilitate engagement and monetization are only one part of the puzzle. To encourage creators to build content that can be monetized, Reddit needs to provide them with best-in class tools. 

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 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 them, and the creator gets a percentage of money paid by the buyers with Reddit taking a portion of the transaction.
• NFT: This may seem slightly far-fetched (or not!), but given the sheer amount of 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 and display ownership of NFTs in profiles, 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, gated 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.

But these are all about helping individuals create and capture value. What happens when you extend it to the natural atomic unit of Reddit: subreddits?

Empowering Communities

There are 500+ subreddits with over a million  followers. The community-based structure of Reddit provides it 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 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 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 the hypothetical ‘buy’ rating is not through ads but commerce.

Till next time,

Rohit