Where will the Domain Name Market Head from Here?

Pay-per-click, type-in traffic, social media, and valuation will all affect the domain name industry — but how?

I’m in San Francisco this week and had the chance to meet up with a long time domain veteran yesterday for drinks. We discussed some of the big players in the domain market these days and if the rewards justify the risks. He brought up some good points, which I’ve meshed with some running themes in the domain name market. Here are some things to think about:

1. Betting solely on pay-per-click type-in traffic is very risky. Some of the big players in the domain name industry are snapping up hundreds of thousands of domains based mostly on their pay-per-click multiple (i.e. paying 5-7 years current earnings). But will type-in traffic continue to grow or at least stay level? And will people continue to click on ads on boring parking pages?

At last year’s Domain Roundtable in Seattle, ICANN chairman of the board Vint Cerf gave his thoughts about the future of type-in traffic (a.k.a. direct navigation). He suggested that as search gets better a smaller percentage of people will type-in domain names, but as the internet community grows there may be a greater absolute number of people using direct navigation.

There are a couple of scenarios here that are not mutually exclusive. Regardless of what happens to the volume of direct navigation traffic, I have a couple predictions. First, click through rates on typical parked pages will decrease. People are getting smart about these sites and, unless they see a very compelling ad, they won’t click anymore. Even if they see a compelling ad they may not click. Affiliate marketers face a problem where web surfers will bypass their affiliate links to purchase a product. The surfer isn’t making any money by bypassing the link, but simply feels someone else shouldn’t get a cut of the action for his purchase. I foresee a day in which people won’t click on a parked page ad just because they don’t want to give money to one of these “domain investors” they’ve heard about.

Second, people will wake up to some of the bogus statistics about direct navigation. It’s not that the stats are wrong, it’s how people apply them. Marketers reference the conversion rates of direct navigation when they discuss type-in traffic. But most studies on direct navigation define it as bookmark visits in addition to type-in traffic. Bookmarks obviously convert very high because visitors have been to the site before and thought highly enough of it to bookmark it. Under this definition typing in ‘amazon.com’ also applies to the stats. Actual conversions from type-ins are much lower than bookmarks.

Also, some of the most profitable type-in domains right now have trademark issues. The day of reckoning for big players with trademark domains is quickly approaching.

2. Social media is hard. Some domain name owners are trying to piggyback on so-called social media to make their domains a repeat destination. Demand Media is perhaps the biggest player in this space. It’s founded by an ex-MySpace exec, so people are paying attention. But there are a lot of smaller players in this space as well.

But here’s the thing: social media is hard and domain quality matters little. Let me explain.

Creating a social community on the web requires a lot of work and luck. MySpace (NYSE: NWS) started in a niche, got some traction, and then hit a tipping point. For every MySpace.com there are hundreds of social communities with a better platform and premise that have failed. Simply throwing up thousands of community-ready sites won’t make them successful.

Second, domain quality matters little. Look at the names of a number of social sites: MySpace.com, Friendster.com, LinkedIn.com. None of these are spectacular domains on their own. They are memorable and easy to spell, but beyond that there are few requirements for a social media domain. These sites would have done no better had they been called Space.com, Friends.com, and Connections.com. They would have received some initial type-in traffic, but it takes more than type-in traffic to create a community.

3. What will happen to domain valuations? This depends on pay-per-click and how much the business community at large embraces the value of domains. But it also depends on exchange rates. And legendary domain investor Frank Schilling points out that it also depends on asset values as a whole.

Unfortunately, I don’t have all of the answers. But I do know this: the risks are high, but so are the rewards.