Are Social Networks Sinking?

Are Social Networks Sinking?

The economic downturn and uncertain business plans could result in an industry-wide shakeout.

The air seems to be coming out of the Web 2.0 bubble, squeezed by the economic downturn and the absence of many solid short-term business plans.

Dire market conditions have forced virtually all social-networking firms to scale back. In October, the third most popular social-networking site, Hi5, announced that it would cut between 10 and 15 percent of its staff. And in November, the business-focused networking sites LinkedIn and Jive said that they would slash their workforces by 10 and 40 percent, respectively.

The dominant social-networking sites are certainly better equipped to weather the storm: MySpace and Facebook have estimated revenues of $750 million and $300 million, respectively, while LinkedIn is expected to pull in between $75 million and $100 million this year. However, the overall value of these companies is still largely based on growth potential, which now seems shaky. Microsoft's investment in Facebook valued the company at a massive $15 billion. But in November, Twitter refused to be bought by Facebook for a reported $500 million of its stocks plus some cash.

The past week has also seen the demise of two prominent (and promising) Web startups: Pownce and Values of n. Pownce, which offered a microblogging and file-sharing platform, was acquired by the blog software company Six Apart, while Values of n, which produces organizational and social-networking tools including Stikkit and I Want Sandy, was sold to Twitter. Both new owners promptly announced that they would shut the original services down, suggesting that their acquisitions were more about acquiring talent and technology than about investing in viable new businesses.

Chris Alden, chairman and CEO of Six Apart, says that there simply isn't enough capital in the current market to sustain so many social-networking companies. "You'll see more consolidation in the next year or two," he predicts.

The current situation might seem gloomy, but the first signs of a coming shakeout appeared before the market took a turn for the worse. In August, for example, both the social news site Thoof and the social music site Social.fm ceased operating. Also, long before the downturn began, investors started raising concerns about how social media firms might make money.

"People don't really know how this is going to work," says Nicholas Economides, a professor of economics at New York University's Stern School of Business. Companies are trying many different approaches, but he says that a solid business model for social networking has yet to emerge. "There's no formula for success," he says. Even Twitter, for all its notoriety, has virtually no revenues.

Charlene Li, founder of the social media consultancy Altimeter Group, based in San Mateo, CA, says that it makes sense for smaller companies like Pownce and Values of n to be gobbled up by bigger players. "These companies had really interesting features and services that are much stronger being part of an existing service that has a lot of people using it," Li says.

Alden declined to say which aspects of Pownce's technology are most interesting to Six Apart, but he agrees with Li that many Web startups are largely focused around one good idea. "It's not always easy to convert that into a vibrant, self-sustaining company," he says. "When economic times are good, you have a longer runway to make that happen. When times get tougher, it dramatically decreases."

It's hard not to compare the current shakeout with the dotcom bust of 2000, but those within the industry dismiss the comparison. "That burst with a thunderclap; this'll burst with a pop," says Paul Gillin, a social media strategist based in Framingham, MA. He believes that this will be a less violent contraction cycle, less intense than that suffered, for example, by personal-computer makers during the 1980s.

At least there has not been the same profligate investing that there was during the dotcom days. There is no counterpart to the excesses of investors who put $830 million into Webvan or $280 million into Kozmo.com.

Six Apart's Alden argues that consolidation is in the nature of the startup business. He can speak from experience: his own startup, Rojo, was acquired by Six Apart in 2006. Alden also argues that no one should confuse companies shutting down or being acquired with a lack of interest in social media. "With the Web 2.0 or social media trend, we're still seeing very, very strong activity and behavioral trends," he says.