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Social Networks: Building Empires, Not Businesses


Wall Street still likes social media, even though the sites are mostly still operating at a loss.

At first, Facebook's (NASDAQ:FB) growth was organic. In 2004 the social networking website expanded to universities across the US, quickly saturating its target market: college students. I was one at the time, and remember clearly that what made it so addictive, and so sure of early success, was the complete absence of parents, public figures, professors -- anyone in a position of authority, and everyone whose judgment we cared about. College life is the ultimate inside joke; it not only falls flat, but becomes embarrassing (or worse) when told to the wrong person. Facebook caught on because there was never any doubt about which social network we were dealing with.

Momentum carried the website forward as it was opened first to high-school students, and then by 2006, to everyone. Bar room jokes and last night's photos gave way to family pictures and benign status updates. Facebook was maturing, and while that wasn't necessarily a bad thing -- the user base was also growing up -- it was still a change, and as it turns out, only the first of many.

The social network has evolved into a gaming platform, an Internet-meme echo chamber, a professional network, a dating service (it may have always been that), a public identity for Web users, and finally, a billboard for advertisers -- anything and everything that might increase the number of accounts or create new ways to monetize them. This growth has pleased investors at the expense of customers; a Pew study found that more than half of current users have, at some point, taken a break from Facebook. Maybe they got tired of untagging photos and declining friend requests from strangers, or perhaps they no longer had time to read about the life drama of every person they'd ever met. Regardless, 34% of them claimed they were spending less time on the social network versus a year ago, while only 13% said more.

Advertisers, meanwhile, are rushing into a deteriorating medium. Eight years ago, Facebook offered a tightly defined audience of American 18- to 22-year-olds. Now, the user base has become such a melting pot that in order for the company to run a targeted ad business, it must turn to "big data": leveraging the personal information that users entrusted to it, and even the information they didn't. The New York Times reports that Facebook has partnered with outside firms -- digital detective agencies -- in an attempt to accumulate even more data on its users. This can't be expected to improve customer loyalty at a time when commercial content is displacing an increasing amount of the social content in Facebook's news feed.

The company's incredible growth, which is usually interpreted as success, may have blinded us to the possibility that smaller can be better. They may not help us find a childhood friend, but little networks like Path and FamilyLeaf can offer a more genuinely social experience. Meanwhile, themed social media provide a more natural, less intrusive environment for advertisers. Goodreads -- just acquired by Amazon (NASDAQ:AMZN) -- is a social network framed around reading, with some 16 million members. Fitocracy offers a similar environment for those trying to get into shape. Ads on these platforms are guaranteed to reach a community with a shared interest, and more importantly, a certain degree of motivation.

The greatest threat to Facebook may not be that users will abandon it for a large competitor, but that they'll simply spend less time on it in favor of smaller, focused networks that most people have never heard of -- and that advertisers will do the same thing.

Either way, the large networks are doing a poor job of monetizing. Facebook has done a better job than anyone at creating a revenue stream, and with a billion users the network only managed $5 billion in revenue for 2012. Wall Street might see this as untapped potential – Facebook's $60 billion market cap presupposes a healthy growth rate – but the company's plan to tap it is, at best, a work in progress, and it isn't clear how customers will respond to an increased ad presence, when indications so far are that social media advertising is both mistrusted by consumers and less effective than spam as a marketing platform.

Meanwhile, according to Techcrunch, Twitter isn't yet cash flow positive, much less profitable. MySpace proved to be a six-year headache for News Corp (NASDAQ:NWS). These are (or were) industry leaders, full-grown companies with mature user bases and a heavy ad presence. Only in tech would investors be willing to tolerate such a fetal adulthood, or wait patiently while global brands stumble towards a business plan -- that is, a plan for making money and not simply growing at a loss. In any event, Wall Street likes social media; the question now is whether consumers, faced with more ads and more burnout, will continue to feel the same way.
No positions in stocks mentioned.
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