The Connected Web

Phil Wainewright

When Will Facebook's Bubble Burst?

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Many have detected signs of irrational bubble economics in the news that investment bank Goldman Sachs has brokered a $500 million investment in Facebook, giving the social networking website a total value of around $50 billion. It seems that excitement about social media is reaching fever pitch, leading to enormous pre-IPO valuations for the likes of Facebook, Zynga, Groupon and Twitter. With more than half a billion users worldwide, Facebook is certainly leader of the social media pack, but will the potential returns from each of those users be sufficient to repay an investment of $100 apiece?

This matters because, if Facebook does hold onto its position as the gorilla of the social media scene, then it will become a de facto standard that sets the tone for social computing among both consumers and business people.

Several observers have taken the news as a cue to reminisce back to the days when AOL was the dot-com darling, culminating in its merger in January 2000 with the Time Warner publishing conglomerate, when it was valued at $150 billion.

AOL turned out to have been hugely overvalued. Instead of remaining captive, its subscriber base rapidly drifted off elsewhere as faster broadband providers emerged along with free-of-charge web-based email accounts from the likes of Hotmail and Yahoo!. Facebook doesn't even have the subscription revenue that AOL was able to count on — nor of course does it have the cost of sending out all those CDs that AOL sprinkled across the nation during its rise to notoriety. A recent posting to the Quora question-and-answer site by AOL's former CEO Steve Case has revealed the economics underlying those discs: AOL spent $35 to acquire each subscriber (over $300 million in total, says its former CMO), but that was just 10 percent of the average lifetime subscriber revenue of $350.

A spot of mental arithmetic tells me that Facebook only needs to make a profit of $10 per user per year over the next decade to handsomely reward its latest investors — although I suspect they wouldn't care anyway as they're probably not from the Warren Buffett school of buy-and-hold investing. So long as they can offload their stock to someone even more optimistic before the music stops they'll have met their investment objective.

But how likely is it that Facebook will both retain and monetize its subscriber base on that scale? There's already a backlash in some quarters against Facebook because of its cavalier attitude to individual privacy. I'm told it is possible to lock down your privacy controls as a Facebook user, but you'll have to invest a fair bit of time. Social media is a fashion business, as Oliver Marks points out, which makes even Facebook vulnerable to a change in popular sentiment. Then there's the question of how much spending really is going to go through Facebook rather than other more targeted sites such as Groupon.

The truth here is that, just as with AOL back in the late 1990s, the dynamics of why people are flocking to social websites and how they'll be used in the future are barely discernible right now. That's the big unknown that threatens Facebook's current valuation. Goldman Sachs and its allies may be ready to bet on the future of Facebook today, but to do so is pure speculation.

Phil Wainewright blogs about how businesses are using the Web to get better plugged into today's fast-moving, digital economy.

Phil Wainewright

Phil Wainewright specializes in on-demand services View more

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