The Financial Value of Social Networking -- is it the Emporer's New Clothes, again?

When I told people I was writing a blog, several said to me: "You have to write about social networking!" OK, I will. Here's my current view...

I've long appreciated the power of the social network. I was first introduced to it about 30 years ago by my uncle, who asked me, "How far do you think you are from contacting anyone in the world?" What a great question! It was his version of concept of "6 degrees of separation". He was fascinated by the natural chain of relationships. Over the years he kept in touch with so many people, and naturally his network turned out to be very large, influential, and global. I learned that through him I was one person away from the Minister of Education in China, thus two away from the Chinese Premier, and at one point, one person away from then President Reagan.

In the early 90s to pass the time while traveling on a business trip, a colleague and I would try to derive arbitrary chains of movie actors, by finding common films in which they appeared with other actors. Not soon afterward, much to our amusement, the Internet Movie Data Base or "IMDB" as it's known, emerged and the Six Degrees of Kevin Bacon game began (a trivia game based on the assumption that any actor can be linked through his or her film roles to actor Kevin Bacon within six connections). It now survives as the "Oracle of Bacon".

Since then Social Networking has been more formally defined and elaborated on. It's taken a number of forms -- from the business oriented "LinkedIn"

Recently I've found my wonder has increased -- I wonder if social networking sites are financially viable independent businesses? For many of these I find myself asking "Where's the beef?" (to quote a very old McDonald's commercial). There's currently a lot of excitement, hype and hyperbole about Social Networking, and for many of these sites (e.g., LinkedIn, Facebook, Twitter, Ning). I'd qualify much of the industry as going through the "Hype Phase" of the Gartner market evolution curve. That happens before it peaks, then the valley of dispair occurs, then the real growth and viable use of a technology occurs.

The power of social networking is obvious to me. To obscurely summarize and quote the sci-fi book Dune: "the Worm is the Spice the Spice is the Worm" that is, "the Network IS the power, the power is the network". Any social network has an intrinsic power and value for all its participants. It is inherent in the sharing of common interests, values, information or ideas that each individual network provides to participants, the feeling of belonging, and the relationships that exist or get freshly established.

However, I wonder about the the financial value of the social network. How does someone take this living, vital "thing", this community, and make money with/from it? Every investor in social networks believes there is money to be made there... somehow... But thus far few have really demonstrated it -- in terms of profitable and sustainable businesses.

Then this morning I came across Jim Goldman's timely "Social Networking's 'Naked' Truth" article on CNBC. He nailed my concerns almost exactly. He writes:
"Are we staring another dot com boom/bust right in the face? When it comes to social networking, that very well might be the case since it appears this emperor has no clothes.
...
Look, I don't argue the power of social networking sites. Facebook is addictive, even magical to millions. Same goes with MySpace, and Twitter, and LinkedIn, and Digg, Badoo, Classmates, Bebo, Flixster, Friendster, Orkut, and hundreds of others. They are powerful, fun, convenient. They offer value. And they build connection. Look no further than the Michael Jackson news tsunami to see how social networking affects our lives and drives information.

But with hundreds, even thousands of these sites out there already, with many attracting millions in venture capital, I simply ask, Where's the return on the investment? What's the business model to MAKE money and not merely to attract investment?

These sites generate enormous news coverage but next to nothing in profits. Somehow, we're descending into a kind of Back to the Future scenario where eyeballs and headlines become flimsy substitutes for business models and profit streams.

I don't know, but it seems like hype is eclipsing hope when it comes to social networking. We've seen this all before. And paid a dear price for the busting bubble. The valuations being bandied about for these sites defy reason. Social networking might be cool, but where's the beef?"

This summarized very clearly and succinctly most of my concerns, and I found myself in substantial agreement. There will be a lot of fall out from all of these social networking sites. As with any new technology market segment, a lot of money will have been invested, and far fewer than one in ten will be successful that is, sustainable on their own. I do believe that a few will find a way to dominate some segment of the market as has been the case with other prior internet-centric businesses (e.g., Amazon, eBay).

The valuations are mind boggling -- especially for those sites which have little or no revenue to show for the massive investment. It's very clear that what social networking sites do is make visible and tangible the "power of the network" -- the common interests, and chains of relationships between people. Outside of the Internet, these are invisible webs of people that span geography and time, and provide real power and real value. Thus the Web versions of them, make them visible, tangible, and thus accessible, perhaps moreso than when they were invisible. That has value. But whether that power and that intrinsic value can be tapped and turned into "real money" has yet to be fully determined.

Thus far, very few seem to know how to extract financial value out of these social network sites (as Jim points out with MySpace, for example). People know how to invest in them, and make a buck by selling them to someone else who will continue to invest. But like selling baseball cards to each other -- it's only worth what someone will pay for the printed player -- but in earnest has little value more than the cardboard it's printed on. Only a few have really demonstrated how to generate money from the site, from the network, and none to my knowledge, have yet shown a profit. Of course, the argument can be easily made that "it's too early..." to demand profits from them. Ummm... Ok. That too was said of the dot-com era's e-commerce sites. And, yes, the same was said of Amazon -- which lost lots of money -- until it finally turned a corner and finally became the sole and dominant virtual merchandise mart, that now turns a pretty penny as profit. But that is only one company of the multitude that started in the dot-com era. So I expect the same to hold true here.

Viable Business Models?
From a business model perspective, advertising-based is severely overrated for social networking sites. Investors are naive if they think that networks will survive and thrive with the addition of web advertising. I'd argue it's counter the social network culture: Web advertising turns people off by infiltrating, distracting and detracting from their social networking experience. The intent is to increase, enhance and expand their use and the value of the network -- not the opposite, which advertising typically does. Twitter appears to be shying away from advertising -- it would certainly destroy that medium! Facebook recognizes this and is experimenting with "engagement ads" integrated into the social networking experience. I'm still not convinced of this.

I am, however, a fan of the potential of "virtual currency". The network has value and people can exchange services within the network either in real money (e.g., dollars, pounds sterling etc.) or as virtual currency -- where the site acts as it's own virtual country and creates it's own virtual currency, (including an exchange mechanism and exchange rate) which can be bought with real money, and used within the confines of the site (or possibly other sites). Facebook is experimenting with this approach as well. Facebook has it's own internal virtual currency, growing out of its "credits" system, that is currently restricted to the company's internal "Gifts" application. At some point soon, Facebook plans to make the Facebook currency system available to developers (using Facebook APIs) which could produce a significant new source of revenue by taking a cut of the transactions as real money is used to purchase the credits or other currency usable only on Facebook. I think for this to fully work for participants there'd also have to be a way to reconvert the currency back into real money and withdraw it from the Facebook virtual world. I wonder if Facebook will allow this...real banking operation or leave it as the more advantageous, one-way, use-it-or-lose-it, gift-card approach.

It is not at all clear to me how Twitter will ultimately make money. Twitter essentially provides access and visibility to into what used to be invisible commentary on things (events, products, etc.) -- the instant communication, the messages, to participants sharing an interest. For many, it provides an instant pulse on a topic, product, service or event, and creates and sustains communities of interest. It enables people to emerge as influencers/message makers and as followers/message consumers. It allows company's to monitor sentiment of their products, brands and services -- which is a huge value to businesses. Thus it's great for building and monitoring a brand (personal, corporate, political -- doesn't matter), but how will it build revenue? From a technology standpoint, it's not unlike the Telco providers who charge for SMS messages... which is essentially what Twitter provides a short (140 characters) message service. But it would be extremely difficult for them to now charge users for it as they've established the bar at "free". Thus I expect it would be difficult to get users to pay monthly or annually to tweet. So... what do they do? Perhaps at some point they'll charge to search the tweet history, though Microsoft is now doing that with their new Bing search engine, for free. Perhaps they'll charge businesses for access to the system -- charging for the right to monitor sentiment on their products and services. It's clear that brand management and monitoring has real value to businesses, who are now increasingly using Twitter as part of both their marketing and customer service/support functions.

Other potentially viable models such as charging for membership, subscription, or for certain capabilities or services I believe are possible -- but the challenge is that the bar has already been set at "free" for most of these sites. Some sites, like LinkedIn, charge for additional services, a model which could work for a number of sites, but the additional services must offer real value to the participants and the community.

So for me, it's more a matter of timing for the larger sites, those which have demonstrated the ability thus far to grow and sustain the growth of thier networks and communities. However, until some of these sites can demonstrate a real return on investment (ROI) and sustainable business & profitable models, I cannot help but agree that social networking is powerful and useful to the participants, but to most of these investors, financially "naked" as Jim Goldman suggests.