About a week or two ago, one of my housemates wondered whether it would be feasible for him to porn himself, seeing that there are many pedophiles preying on him (he looks really really really young and small, despite already doing his PhD.). Specifically, he was wondering on whether anyone would want to watch him on webcam.And so, gleefully, I embarked on a research into porn (which hot blooded 20 year old male wouldn’t?). Despite TPG throttling me, I still managed to get some data on some sites (mainly because I didn’t visit the sites themselves, other than a brief look-see).

I will be looking at the economics of porn sites (specifically here, on the adult webcam business). I will start off by first discussing the statistics of the websites, their business models, and the estimated earnings, and then I’ll proceed to discuss the economic theories behind. Mainly, the theory of contestable markets and the principle-agent problem will be discussed.

What I did mostly, was to collect empirical data. I identified a few websites as case studies and went about collecting numbers. Of course, me being the lazy one, I went for sites where numbers are the easiest to collect - websites owned by Adult Webmaster Empire (livejasmin, joyourself, liveprivates, mycam, and cameraboys). They freely provide extractable statistics.

Also, besides the data provided by AWE, I used other methods to collect other datas and statistics. One website I use is Compete. I don’t use Alexa simply because I discovered that Alexa rankings can be gamed (this means the rankings can be manipulated). Though Compete isn’t exactly useful, it serves this purpose of estimation of statistics. But first, let’s explore the business model

The Business Model
The business model of the webcam sites above is quite simple. The company starts up a webcam site, hires amateur chat hosts on a contract basis, and opens it to the world.

The customer is entitled to free viewing of all the online and available model. However, if they want to continue in private with the model/chat host, they’d have to pay for the Private Times. This is done so with a credit system. The customer buys credits (for time), and spends it on the private chat with the host/model.

Why would anyone pay and go into private chat when there is a free chat available? This mainly works because the models on the free chat are contracted to only tease until someone goes into private chat. Only in private chat does the sex happen. Basically, to be a chat host, you just wait till someone decides to pay you to perform - not unlike the coin slot stripteases.

This then leads to a few questions. How then, does the company find its target market? One way is to excessively market it themselves. Another way is to use affiliates. Most porn sites use some form of affiliates system to get traffic to their sites.

The Statistics
How much money are they making exactly? That is a good question. But because I am not AWE’s accountant, I can only estimate. Based on Compete’s information, here’s what I get:

Please do note the last row: Average conversion rate. These numbers are extremely low. Multiply the number by a hundred, and you’d get the percentage. CameraBoys, the highest of them, has only a measely 0.4% conversion rate. This means, out of every thousand visitors to the CameraBoys site, only 4 actually pay to watch.

And here, we have the average price paid by the customer over the last month. I extracted it from the available data at AWE’s website:

Click to Enlarge

Basically, the customers fall in roughly to a log-normal distribution (i.e. the blue histograms fall under the yellow line) most of the time. The X-axis is the price. Most customers, do not pay more than $20 per session (with the exception of those 3 idiots who paid $70+). Using this as a sample, we can assume all customers fall within the log-normal range. Hence we can estimate that around 90% of the people would pay less than $20 per session.

Let’s use livejasmin as an example: With 2 million unique hits, and a unique:hits ratio of 1:2, let’s assume everyone who visits livejasmin visits 2 pages each. Livejasmin has a conversion rate of roughly (rounded) 0.36%. This means out of every 10000 people who visits the site, only 36 people will pay.

So, with 4 million page hits (more page hits means more chances of paying), and only a 0.36% conversion, this leads to roughly 14400 people actually paying for the content. Only the top 12th percentile is willing to pay more than $20. Let us assume the most optimistic - that everyone will pay the maximum they are willing to pay. That means, 78% of the 14400 people are going to pay $20 - 78% x 14400 x $20 = $224640.

$224640 is a very rough amount, and I don’t intend to refine it. It represents only 78% of the paying sample. The other 12 percent may pay waay more than $20, and it’s very hard to estimate how much the actual earnings of AWE is, but I suspect it’s in the millions.

The Economics of It
Right. On to economic theory then. The adult webcam market isn’t very saturated. A simple search on Google will yield anywhere from 750000 to 1500000 pages (as opposed to 23 million pages with the search term “book store”, or gazillions more when you search “porn”). While it seems that the adult webcam business is an oligopoly (it technically is, since there are only a handful of companies), the adult webcam business is in fact very contestable.The barriers of entry for this business is extremely low. All one needs is a webserver and software. Granted, the JamOnCam software (one of the softwares used for webcam sites) costs about $12000, but this is a relatively low sunk cost as compared to the profits reaped. Also, due to modern infrastructure, a site owner doesn’t actually have to own a webserver. Server co-location (and renting of the servers) provide lower sunk costs and lower barriers to exit.

Also, when one compares barriers to exit, it is arguable that the webcam business (or in fact, almost any online business) have almost no barriers to exit at all. Because the webcam sites are mostly one-(wo)man businesses, if need be, the webcam site owners can just close their shops (figuratively), and unplug the business at no additional cost.

Both the low entry and exit barriers are factors that the adult webcam business is in fact, very contestable. And this is the reason why you don’t see any webcam sites charging higher-than-normal prices despite the relatively low number of sites offering webcam services.

Economies of scale is a must for this sort of business. If run alone with a few visitors (my site pales in comparison to the amount of visitors to the porn sites), the business would surely not do well. Due to its low conversion rate, the company must serve a larger crowd of people (hence lowering marginal costs) in order to gain economies of scale. One way to do this, of course, is to get the attention of a larger crowd. AWE has done this since by addressing the LGBT crowd with CameraBoys. In a way, this can also be seen as AWE achieving economies of scope.

Economies of scale and scope can also be achieved by having a lot of models on the site. Livejasmin has over 9000 (literally) models (LJ offers 33%-45% payment to models. [source]). AWE wouldn’t have reached so many people on the internet by offering less choices. Also on the majority of the sites, there is a mix bag of sexualities - from the LGBT crowd to the fetish crowd. By offering variety, AWE is able to achieve economies of scope.

Economies of scale and scope for webcam sites can easily be achieved, through the franchise model (specifically name licensing). As I mentioned earlier, one of the main methods these websites get their traffic is through ‘affiliates’. Whilst affliates are not franchising per se, the model is roughly similar. Because of the nature of the internet’s openness, there isn’t really a need to hire people. Instead, a sorta reversed version of the franchising model is used - affiliates (think of it as franchising + outsourcing).

A website allows ‘affiliates’ to sign up for free. In return, the affliates market the site for the owner, and the site owner pays the affiliates for their effort. This would eventually lead to some sort of principle-agent problem. How would the owner know that the affiliate is actually marketing the site for them?

To solve this, the site owners usually introduce a tracking code. If you go to AWE’s website, it lists the top referring webmasters. With the tracking code, AWE is able to track and pay comission based on conversions the website made (30% of converted sales). This would give incentives for the affiliates to actively market the site. Because of the branding licensing in effect, repeat customers would not be going into any of the webcam sites through the affiliates in the future (and because it is thoroughly embarassing to bookmark porn sites, and risk being found out that you’re a perv).

The effect of the brand licensing is that it carves a memory into the viewer’s mind. In the future, viewers will not go to affiliatewebcamsite.com to view a livejasmin webcam. Instead, the repeat viewer would search for and go to livejasmin to watch the webcam. Through co-branding (or brand licensing), AWE has ensured that repeat customers come to their door instead of going to their affiliate’s doors, eliminating the need to pay the affiliates for the repeat viewers.

There are about 1.5 million websites being affiliates to livejasmin, and only a handful are making money. Conversion rates on most of these sites are poor, but the whole idea about affiliates is rather similar to franchising - to spread the brand. Think of affiliating as franchising, but operates on the rules of outsourcing. Instead of AWE starting 1.5 million websites to promote its sites, they’ve got normal people doing it for them for a very cheap price.

In effect, AWE is paying peanuts to get a whole banana tree worth of sales.

The principle-agent problem also applies to the models on the site. How does the site owner know that the performer won’t perform sexually for free? Well, incentives play a role in this. Why would a performer perform for free when (s)he can perform for money? In fact, since the performances are charged by-the-minute, one can expect a performer to extend their performance time as well - more teasing, less stripping.

This is a strong incentive. It could even propel performers to actively seek viewership outside the website. Some performers, would, for example, go on dating sites, and lure horny people to view them on the website.

Then there is also the other side of the problem. What if the model, in knowing that more time spent on him/her = more money earned? Instead of actually doing sexual acts, (s)he could just tease entirely through the private session. Naturally, that would cause some customer anger, as they paid to watch sexual acts but all they got were teasings. To overcome that, AWE devised an ingenious way - awarding good performers. Customers will rate the performers and the company will award them based on the ratings. The usual award is cash prizes, I believe.

There is also the issue of oversexed performers who might perform outside private chats (their incentives are to fulfil their sexual desires, not earn money), and this would be bad for AWE, as then AWE would be paying a lot more for nothing (i.e. increased marginal costs). Heh, I bet if properly studied in this context, the whole Contract Theory would be revolutionized.

There are various other issues that I didn’t discuss. Offhand, I can think of is a proper discussion on moral hazards (the oversexed performers are one example), monopolies (why there are only about 47 companies offering webcam services) and the like, but I’ll discuss them later. Or maybe never.

As a final addendum to this article, I researched on this article mainly because I was bored, and because someone asked a question that I’ve been wanting to find out for a long time. I believe it somewhat echoes Cliche Guevara’s thoughts here. Well, mainstream economics won’t tell much, save that the demand is increasing, and someone would probably invoke the theory of diminishing marginal utility. :D. Behavioural economics, however, will tell more. Maybe some day I’ll actually address that question and not stray off (in case you were wondering, I did stray off).

I do not link to any of the adult sites because I do not condone porn addiction, and neither do I approve of running adult sites. Maybe it’s just me - you can call it moral fibre - I think them as vices. I think people who spend money on porn are stupid. And so do I think the running of adult-oriented sites.

I would like to thank my friends who have helped me a lot - especially cfgt (who helped me out a lot in the statistics department and in R), and Sam, who helped me collect data (you didn’t think I was able to collect data with TPG’s horrible throttling, was I?)

Cheers.

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