Friday, June 13, 2008

How I See It

Social networking bubble just beginning to inflate

Is Web 2.0 headed for Bubble 2.0? Business runs in cycles. All big booms have been followed by painful busts. The market is ruled by two things: Fear and greed. Greed fuels the boom, and fear prolongs the bust. Fear is very powerful. Everyone starts to question their own beliefs. But, fear is temporary, greed is permanent. We have all pretty much forgotten the dot-com bubble. Greed and optimism always overcome fear, and lead to a new economic boom.

Hundreds of smaller successes
Facebook and MySpace get all the headlines, but hundreds of smaller Web 2.0 companies with $50 million in revenue and $20 million in profit will be successful. But will venture capitalists invest in these companies? Lots of VCs look at Web 2.0 companies and say, “I like the concept, and I like the team, I’m just not convinced it will generate VC-level returns at exit.”

Is advertising the only revenue model? Too many startups point to Google Inc. and Facebook Inc. as evidence that advertising is the best path to success. They fail to understand the scale (users and page views) required to make it work. Most social network sites generate CPMs of 40 cents or less. To generate $1 million in ad revenue would require 2.5 billion page views. Not many sites attain that scale.

‘Freemium’ model
Web operations like Flickr, TypePad and others provide a free service with premium paid upgrades for more storage, more features or other services. This model works as long as the marginal cost of providing the service is close to zero. Conversions from free to paid run about 3 percent to 5 percent, so the revenue from paid subscribers must cover the cost of all the free service, plus provide a profit. Think of the cost of free service as marketing costs, and make sure it fits your business model.

New models
Social networks and word-of-mouth recommendations are powerful. All the demographic data, ratings, attention data, profiles and social connections will enable new ways to target advertising and e-commerce. Advertising is annoying when it is irrelevant but very helpful when it is timely and relevant.

Facebook’s Beacon program attempted to leverage the social network and user intentions into a new advertising and revenue model. It didn’t work, but something like it will emerge to strike the right balance between privacy and convenience. Being able to selectively opt in or out is critically important.

One pundit said, “Privacy doesn’t matter anymore. If it did, Facebook, MySpace, and YouTube wouldn’t exist. This is the ‘Full Monty’ generation.” The trend is certainly moving in that direction, but the Facebook Beacon experience suggests we aren’t there yet.

Web 2.0 and social networks have already changed the way we interact on the Internet. There have been some successes like Facebook, MySpace and YouTube, but future successes are likely to be smaller.

Valuations and expectations are reaching “bubble levels.” New revenue models will emerge that leverage our social interactions. Most business cycles run for 10 years, and we are in the early stages of this social network cycle.

“MacroMyopia”, the tendency to overestimate the short-term impact and underestimate the long-term results, is evident today. It is similar to the hype cycle; a period of early hype, followed by disillusionment, followed by real payoffs and impact. It happens in every business cycle. The question is, where are we now in the cycle?

 

Don Dodge is director of business development for Microsoft Corp.’s Emerging Business Team. He writes a blog, “Don Dodge on The Next Big Thing,” which can be accessed via Mass High Tech’s new blog roll, found at www.masshightech.com.