Those who cannot remember the past are condemned to repeat it.  With the recent media frenzy over Facebook raising $500M in private capital, and companies such as LinkedIn, Groupon, and Zynga set to enter the public markets, it’s not hard to draw parallels to the dot com bubble that took place a little more than a decade ago.

Investors who get the chance to flock to this latest fad will hope to cash in on the social media boom.  But is social media just a giant bust waiting to happen?

Much like in the late 1990’s, once the big players start the trend of going public, everyone will want a piece of the social media action.

We may start to see ridiculously high valuations on companies you’ve never heard of because they will supposedly become the next Facebook or Twitter.  Even the valuation given to Facebook at $50 billion seems crazy when they had approximately $1 billion in revenue in 2010.

Social Media: The Problem is that it’s Free

Facebook, Twitter, and LinkedIn are all great websites in their own way, each building and sustaining huge online communities.  There is little doubt that social media has changed the way we communicate and do business in the 21st century.

However, the problem with social media as a business model is that the membership and user generated content is absolutely free.  The only way to make money is to sell advertising and try to seamlessly integrate it into these online communities without turning off its users.

You can argue that Google is the ultimate free internet tool, and they managed to generate a market value of over $160 billion.  But Google acts as a portal to the rest of the web, users go there first to get answers on where to go next.  You can build a business off of that kind of demand.

Facebook is meant to keep users on its own site, engaging with friends and family or just mindlessly wasting time.  People spend more time on Facebook than on any other website.  Facebook is well aware of this and is still trying to work with advertisers to find the best way to leverage this into a sustainable revenue model without ruining the user experience.

So How Will They Make Money?

To quote my favorite Dragon’s Den investor Kevin O’Leary, “So how do I make MONEY?”.

How many businesses do you know that have a Facebook fan page?  Or a Twitter account that hasn’t been updated in months?  Advertisers continue to struggle with social media because the communities and individual users were not built to be sold to.

Perhaps the more sustainable revenue model would have been to charge businesses to set up Facebook fan pages or Twitter business accounts.  Or perhaps they could also get a percentage of revenue from any links to or sales made from that account.

I believe that Groupon has the most potential as a public company, with a proven revenue model that has estimated sales at $800 million in only 2 short years.  The users obviously expect to be sold to since they are looking for a deal when shopping online.

So Groupon has the benefit of building a loyal group of subscribers which will attract more merchants who want to sell their products through Groupon.  And by pocketing a percentage of each deal, Groupon can be the middle man without having to make a difficult choice on how to connect advertisers to subscribers.

Social Media Bubble?

Either way you look at it, these social media companies are going to attract a lot of money and a lot of attention over the next year or two.  But for those investors who were burned during the dot com bubble, this situation must look eerily familiar.

Time will tell if the social media phenomenon will become the next big boom or the next big bust.  All I know is, some people will get rich off of these companies in the short term, but not me, I won’t be playing.

Print Friendly, PDF & Email

20 Comments

  1. addicted2dividends on February 7, 2011 at 6:53 am

    Great post. I always wondered how facebook is worth so much money when it’s free to use. The problem with advertising is that it only works when the people actually buy the items advertised. The majority of facebook users are teenagers with no money. I remember there was a company back in the late 90’s called Ad Advantage. It would pay you to look at advertising on the bottom of your browser, and the more people that signed up under you, the more money you would make. I got a check for $50 US and I never bought anything from seeing all the ads. People created bots to click the links all the time, even when they were not home. Ad Advantage isn’t around any more ….

    • Echo on February 7, 2011 at 7:58 am

      Yes I remember Ad Advantage, I’m surprised people actually got paid (good for you!).

      Just look at YouTube, Google bought them for $1 billion and they have yet to even become profitable.

  2. Sustainable PF on February 7, 2011 at 6:58 am

    We may “play” but the entry cost will likely be prohibitive.

    Having been using the Internet since the mid/late 80s (when it was essentially university computers networked together and BBS’s were king) i’ve seen a lot of change, some rises and falls, so I like to fool myself into thinking I know a thing or two about this “sector”.

    The big warning flag for me w/ Facebook is that MySpace was supposed to be “all that” and look where it is now. Do you know anyone over the age of 15 who still uses MySpace? Facebook could potentially be over run as well if say, Google wanted to “play”.

    Now Groupon … silly Groupon. You were offered billions – TAKE IT! Why? Your product is not that hard to duplicate and the BIG G can certainly (and most likely will) do so.

    Just my $0.02.

    • Echo on February 7, 2011 at 8:04 am

      @SPF
      I am also sceptical on how long Facebook will last as THE place to go on the internet. Inevitably they will need to tweak the model in order to make more money and it will turn its users against them.

      As for Groupon, yes it may be easy to duplicate this model and Google will certainly try with “Google Offers”, but Groupon has a 2 year head start and “first to market” has a lot of weight. That being said, turning down $6 billion is insane (in my opinion).

  3. Balance Junkie on February 7, 2011 at 9:39 am

    Who knows? Maybe Facebook will be the next Google. But, as Sustainable PF points out, there’s no guarantee it won’t be the next MySpace. I had a Facebook account for a couple of months. I didn’t like it, so I deleted it. I like Twitter, but I would like it a lot less if a lot of ads started popping up in front of me. I see the dilemma.

    There were survivors of the dot com bust, but many of them are still trading at much lower prices than they were a decade ago. It’s hard to pick winners in advance, and, as always, timing is everything.

    Thanks for the great analysis!

    • Echo on February 7, 2011 at 10:07 am

      Thanks Balance Junkie! Yes there were a few survivors from the dot com era (Google and Amazon are the big ones that come to mind). And as you pointed out, timing is everything and the average investor probably won’t get the chance to get in at the initial stages which means buying at high valuations.

      I don’t have any problem with advertising, but if that is your only revenue stream then there may be some serious issues with your business model. And introducing paid subscriptions AFTER the fact will not work (look at online newspapers). The users will revolt.

      • Sustainable PF on February 7, 2011 at 10:21 am

        Forgive me my ignorance, but how do television networks in Canada make money aside from advertising dollars?

        • Echo on February 7, 2011 at 10:45 am

          They don’t, which is part of their problem. However, the Canadian networks are all owned by big cable companies (Shaw, BCE, Rogers) who can leverage the networks into their multiple media streams. Bell claims that their television business unit now makes more than their home phone business unit.

  4. Money Smarts Blog on February 7, 2011 at 10:53 am

    Interesting article – not sure if I would include Groupon as “social media”.

    You are right that it’s hard to monetize social sites (Facebook, Twitter) etc. I do think it’s possible, but the valuations won’t be super high.

    Mike

    • Echo on February 7, 2011 at 11:05 am

      Hi Mike, Groupon is a social buying site and has built a community of like-minded users. They found a way to make a coupon cool, by making it social. To me, that puts them in the social media category, but you could call it web 2.0 I suppose. They will all be lumped together in the same conversation along with Four Square, etc.

      • Money Smarts Blog on February 7, 2011 at 11:21 am

        Can’t disagree with you.

        I don’t get the Four Square thing – although that might just ignorance on my part.

        • Echo on February 7, 2011 at 11:38 am

          What, you don’t want to be the ‘mayor’ of your local Starbucks? 🙂

          I don’t use it myself, but I can see its popularity as a loyalty based program. But as a former customer service trainer I would just cringe if my front line employees stared blankly or shrugged their shoulders at someone who showed their cell phone and requested the Foursquare deal. I can see this happening frequently, given the state of the service industry. To me, that’s the trouble with their business model, relying on front line employees to deliver the benefit.

  5. brokeprofessionals on February 7, 2011 at 3:49 pm

    Interesting thought. I haven’t seen this comparison (dot.com v. social media bubble) burst anywhere else.

    • Echo on February 7, 2011 at 8:46 pm

      @BP
      I just think when these IPO’s come out some of the smaller sites will seize the opportunity to jump on the band wagon, and investors who missed the Facebook/LinkedIn/Groupon party will try to buy in just to get a stake in the action

  6. Brandon on February 12, 2011 at 9:36 pm

    One of the first revenue generating opportunities for Twitter was created through deals with Google, Yahoo and Bing, who bought the rights to display live Twitter feeds in their web search results. Twitter earned millions of dollars in revenue by selling the rights to publish live tweets on any trending topic. It’s a win-win deal, as it brings more users to Twitter and provides search engine users with live data.

    The major revenue generating model for Twitter now is its ‘Promoted Tweets’ advertising model. Advertisers pay for promoting Tweets related to their product. Any search query related to the advertiser’s product will be listed at the top of the search results. Also the name of the company promoting the Tweet is displayed below it.

    Then there is the related concept of ‘Promoted Trends’, where the advertiser’s product related trends are prominently featured on the website. Twitter has also created ‘Promoted Accounts’ for advertisers, which will be shown in the ‘Suggestions for you’ section, presented for Twitter users to follow. This advertising model is expected to increase Twitter’s revenues to up to $125 million in 2011. Companies like Coca Cola, Disney and Starbucks have already made deals with Twitter for promoting their products. Check out some more of these Buzzle articles related to Twitter.

    While Twitter keeps growing and adding new users everyday, its revenue generating potential is only going to rise with time. If it keeps growing at the same rate, eventually Twitter will go past the billion dollar mark in revenues as its monetization plan goes in full swing and gains popularity.

    • Echo on February 12, 2011 at 9:51 pm

      Hi Brandon, thanks for your insightful comments. While I agree that Twitter has come along way towards building a sustainable revenue model, the issue I have is the estimated value of their business at $8 billion. When you are only making $100M a year in revenues that just doesn’t add up.

      I think people are looking too narrowly at the huge number of users that Twitter and Facebook have, and thinking that there must be some correlation to a huge revenue potential as well.

      At some point, too much monetization on these websites will cause a backlash from the users, who are already upset with the lack of privacy and intrusive targeted ads.

      • Brandon on February 12, 2011 at 9:57 pm

        Several recent stock purchases on the private markets imply that Twitter’s value is more than $6 billion. While these smaller transactions aren’t a definitive basis for defining Twitter’s value, they are a benchmark that can help determine whether a private company’s value is trending up or down.

        • Echo on February 12, 2011 at 11:47 pm

          That’s true, the precedent has already been set. I guess we’ll see what happens. Personally I think the valuation is crazy and I wouldn’t invest my own money in this sector.

  7. selena on March 23, 2011 at 6:14 pm

    one thing you should take into account is that facebook is kinda trying to become ‘the new google’. they are branching out far beyond their own page, establishing partnerships with sites all over the web (allowing you to log in to those sites with your facebook-id, to share content, etc).

    and don’t underestimate the ‘grandma’-factor: there are still lots of people for whom the internet is a big scary place. they actually *want* to be ‘safely’ confined to just a few sites.
    of course you don’t see those people commenting on sites like this one, but don’t let that fool you into thinking they don’t exist (just look at apple’s sales-figures to see how much those people are willing to pay). and one of the sites they know and trust is facebook.

    all that being said i still think that facebook is way overpriced considering it’s current revenues. they have yet to find a good way to turn customers into cash.

    • Echo on March 24, 2011 at 10:42 am

      @selena
      I would argue that Facebook is definitely NOT a place that people trust as far as their privacy is concerned. Most users know that Facebook is trying to somehow profit from all of the personal information that they hold. Once they push too far they might be surprised by how quickly people flee.

Leave a Comment