Why Reality Will Bury Digg's Profit Dreams

Digg, the raucous online news-rating site, has laid off 8 people from its 75-person workforce. CEO Jay Adelson writes that the company will "aggressively focus on reaching profitability within the year." There's no way.

Digg, as of last fall, was losing money at the rate of $5 million a year. Its payroll has grown since then; cutting 8 people is unlikely to save it much more than $800,000 a year. At best, the layoff might get Digg back to its 2008 pace of losses.

So the site badly needs to increase its revenues. And there's the problem.

Kevin Rose, the podcast host known for his aggressive dating habits and on-air drinking who founded Digg, always wanted to focus on Digg's features and community, and let someone else figure out how to make money. That someone was first Federated Media, an online ad agency which favors quirky, ethically questionable endorsement deals, and later Microsoft, which has been so desperate to get into the social-media business that it has favored startups like Digg and Facebook with long-term, multimillion-dollar advertising guarantees. Keep in mind, though, that Digg has been running a loss even with Microsoft's guaranteed payments.

Only now, Adelson discloses in his blog post announcing the layoffs, will Digg start hiring its own salespeople. If he thinks that he will hire a salesperson and just magically add revenue, he is badly deluded. Even a good salesperson typically takes a year to get profitable. If he starts hiring now, it's reasonable to assume his expenses will rise through 2010, without revenue to offset them.

And then there's the advertising market itself. Demand is weak, and likely to get weaker; the advertising recession, if it follows past patterns, will outlast the actual recession. And in recessionary times, marketers tend to spend their budgets on direct-response ads like Google search, where the link between dollars spent and sales generated is clear. Experimental branding plays, like putting ads on an insult-laced site for Linux-obsessed fanboys, go into deep freeze.

Adelson, a veteran of several Internet businesses who saw technology's last boom and bust cycle, does not strike me as naive. He must realize that the financial scenario he laid out is utter nonsense. He is surely not promising profitability by the end of 2009 to the investors who just put $28.7 million into the company.

His fantasy profit scenario must be a message of reassurance for Digg's users, lest they panic over the layoff news. Does he think they're stupid and can't do basic math? Apparently, yes. Don't tell Digg's advertisers that.