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By Alistair Croll

The companies that handle domain registrations have built businesses around hosting, domain speculation and wholesale billing. Domain squatters, meanwhile, make millions with the right URL. But despite the huge growth of Internet sites and the brave face they put on, registrars face hard times. Regulatory changes, price increases and free hosting offerings from Google mean the future looks rough.

The Domain Name Service [DNS] protocol is at the core of the Internet. It’s how we find a site, translating a URL like www.gigaom.com into the IP address your computer needs to reach it.

At the top of the DNS food chain is ICANN, the Internet Corporation for Assigned Names and Numbers. Formed in 1998, ICANN regulates domain name registration. Just below ICANN are the top-level domain registrars. VeriSign (NASDAQ:VRSN), for example, is currently the accredited domain-name registrar for .net and .com.

Until 1999, Network Solutions, once a part of VeriSign, had a regulated monopoly on domain registration. Then registration was opened up to new entrants. Today, in addition to Network Solutions, there are 902 companies authorized to register domain names.

The better-known registrars, such as Go Daddy and Network Solutions — as well as white-label registrars like Tucows (NASDAQ:TCX) — derive much of their revenue from domain registration. While few of the registrars provide financial information to the public, Go Daddy filed for an IPO (which it subsequently withdrew) in 2006. At that time, Go Daddy reported revenues of $139.8 million, of which domain registration was 60 percent. But plain domain registrations aren’t a high-margin business (Go Daddy also reported a loss of $13.5 million that year.)

The registrars have to pass on a substantial portion of registration revenue to VeriSign and ICANN. If Go Daddy charges $8 for a domain registration, for example, then $6 goes to VeriSign and 75 cents to ICANN. As a result, these companies have tried to broaden their offerings, seeking revenue streams that have better gross margins than that of simple registration. Two of the major sources of revenue for these companies are premium domains and hosted services. And both are under attack.

An end to tasting

Not all domains are created equal. The more attractive ones are worth serious money, either because they generate traffic that can be monetized through advertising or because they can be sold to the highest bidder. Sex.com sold for over $14 million in January 2006. That year, VeriSign estimated that 10 percent of registered .com and .net domains were registered with the sole purpose of generating pay-per-click advertising.

Several of the 903 accredited registrars spend their time doing nothing but speculating on names. They register huge numbers of promisingly named domains, stick ads on them, then see which ones get enough traffic to be profitable. Those they keep; others, they delete.

It’s a practice known as domain tasting. Registrars are able to do it because ICANN has a grace period during which a registrar can change its mind about a registration and get its money back. Get the right name, and you’ve hit paydirt. Pick the wrong one, and you don’t lose anything.

Tasting is big business. In January 2007, the top 10 domain tasters accounted for 95 percent of all deleted .com and .net domain names — 45,450,897 domain names out of 47,824,131 total deletes, according to ICANN. To try and stop this practice, ICANN is reviewing a proposal this week that would effectively end tasting by charging the ICANN annual fee at the time of registration.

There’s still money to be made from premium domains. Tucows, for example, has a name auction service that sells expired names to the highest bidder. These previously active names have a known traffic history, so when they expire it’s easy to know whether they’ll generate money without tasting. Not to be left out, Go Daddy has a revenue-sharing service called CashParking that encourages people to host their unused domains with the registrar and split the resulting (if any) ad revenue.

Other registrars have similar approaches: Network Solutions offers premium domains that it says are “priced higher than unregistered domain names based on a variety of criteria including the number of characters in the domain, the number of years the domain has been registered, relevancy and popularity of the keyword, and the traffic it generates.”

Google Apps a free alternative

Restrictions on tasting aren’t the only downer for registrars this year.

Large companies usually run their own DNS servers, maintaining control over which machines handle mail, web and other services. But millions of smaller companies rely on turnkey hosting. This is a major source of revenue for registrars, who work hard to upsell web and mail services when customers register their domain. When smaller, non-technical domain owners register, the logic goes, they want a bundle of services without having to worry about what goes where.

Network Solutions focuses on small organizations that want a turnkey Internet presence. “Our focus is really on the small business. They don’t talk about hosting,” said Susan Wade, a company spokesperson. “When you ask them, ‘Do you currently market your business on the web?’ they say, ‘Yeah, we’ve got a web site.’ The majority of our customers are very much non-technical.”

Tucows, on the other hand, focuses on white-label management and services such as e-mail and anti-spam through ISPs that resell them. Tucows manages over 7 million domains, and handles billing for an additional 1.1 million, making it one of the largest wholesalers.

For Go Daddy, its IPO filings reveal that hosting generated $30.6 million in revenues in 2005. Go Daddy targets a slightly different segment of the market, giving its somewhat more technical subscribers greater flexibility to configure their DNS records. This appeals to companies that need to split up their services, getting hosting from one company, mail from another, and using Go Daddy’s DNS to make it all work well together.

That may be the model of the future. Tomorrow’s IT infrastructure will be an archipelago of sites and servers, stitched together by a central DNS. Applications, from online collaboration to project management to sales force automation, will all be run by third-party sites using a Software-as-a-Service model. It’s an end to one-stop shopping for hosters.

Google is betting that even small businesses will unbundle their DNS from their e-mail and hosting using its Google Apps service. While Network Solutions’ traditional customer base may not be technical enough to run their own servers, Google is hard at work making it possible for them to unbundle their services by sprinkling simplicity on the business of hosting.

It’s unclear whether Google will succeed. “Google’s a threat, but they seem to have an ad-centric business model,” observes BMO Capital Markets analyst Thanos Moschopoulos. “It’s unclear how good they’ll be at providing customer support for those that need it, which is one of the value adds of a typical hosting company.”

In a recent phone interview, Mark Salerno, Network Solutions’ VP of R&D, compared his company’s offerings to Google’s. Both companies have page creation tools, web mail, control panels and calendars, he noted. “In a lot of ways their Google Apps is their play into the hosting space,” he said. “The question is, will that only attract technical users?”

Feeling the squeeze

ICANN wants to end domain tasting. Google’s eating away at hosting margins. Since most of the registrars don’t publish revenues in detail, just how much of a threat this represents isn’t clear. Some — like Tucows, wholesaler eNom, and Go Daddy’s Wild West Domains wholesale business — are better positioned to weather the storm by focusing on resellers and local ISPs.

But no matter how you look at it, 2008 will be a tough year to be a registrar.

Source: VeriSign, Tucows: It's a Bad Year To Be a Registrar