Social Media: Trouble in Paradise …

Walled Gardens, Social Media and Toxic Value Proxies

The trouble with events is that they sometimes have calamitous confluences.

Take Facebook. Unless you’ve been lost at sea for the past several weeks you’re probably aware of the bourgeoning Greek tragedy that is currently known as the Facebook IPO, the largest IPO in the history of techdom that came out of the gate broken. Apart from the class action lawsuits that are about to ensue, one has to wonder how such a promising value proposition got entangled in so many misplaced expectations, even when the founder and CEO went out of his way to say that Facebook’s mission was to understand and influence human behavior and not make a pile of cash. Not that there is anything wrong with a pile of cash.

So where and how did things go awry?

For starters, calculating the value of a share of Facebook turns out to be one of the great financial imponderables of our time. Most valuations rely on comparables and in the world of publically traded social media there really aren’t any with the current exception of probably Facebook itself. So establishing a proxy for value, an instantiation of economic merit, an accurate volumetric is an enormously daunting task but one that most Wall Street analysts consider themselves equal to. The problem is, and this is no small fly in the ointment, that in the overall scheme of things the entity that is Facebook is largely an evolving experiment with a poorly understood value potential (see The Search for El Dorado and Life is High School– Sept 2011 and July 2010) and where it ends up is anybody’s guess. But guessing can be fun so let’s get started.

A while back, writing in the WSJ, Doug Laney of Gartner took an interesting stab at establishing exactly how one could go about valuing Facebook. He focused on a couple of interesting but potentially irrelevant data points such as the 845 million Monthly Active Users (MAU) that have produced 2.11 trillion pieces of discrete content that have resulted in 9.7 million minutes per day on-site and $3.7b in 2011 revenue. With this and a calculator you can do some fascinating and potentially irrelevant things like determine the value per minute or value per visit and then compare that to broadcast or cable TV. So roughly speaking Facebook has a value per visit of around $0.36, which, one could argue, compares to TV’s $0.25 – $0.40 value per viewer hour.

This might be a useful value metric if you assume that “media” is the most relevant description of what Facebook is about and that its primary value proposition rests in advertising. Just prior to the IPO, at least one prominent advertiser and several ad placement companies suggested that advertising might not be the most appropriate cohort with which to view Facebook’s value. They hinted that consumer insights, understanding the social aspects of buyer behavior, might be more relevant cohort and something we will come back to.

The notion that Facebook’s primary value proposition is as an advertising platform also suggests that time on-site should be considered Facebook’s primary value metric. This idea goes back to the dawn of Internet advertising where the notion of walled gardens first got introduced or what was once fondly referred to as the roach motel model, visitors walk in but they don’t leave, a veritable gold mine when it comes to time on-site metrics.

Value proxies and other deadly toxins

If you subscribe to the thesis that time on-site is the primary value proxy of Facebook, then it would be logical to conclude that the more time on-site the better. But value proxies can be tricky things. For instance, let’s take Xerox for example. For years Xerox believed that cost per page was its primary value proxy, which led it to conclude that improving the economies of scale of its copiers was vitally important which caused it to miss the entire network printer market where convenience, not cost, mattered. Chasing the incremental improvements suggested by the assumed authoritative value proxy got Xerox thoroughly and nearly terminally disrupted in text-book Christiansen style. Now let’s go back and have a look at walled gardens.

So far there have been a couple attempts at constructing walled gardens on the Internet, the first and most familiar being AOL. But there are others. Yahoo was a second-generation attempt at the same basic concept. Both enjoyed some success but then petered out. Several industry analysts have now suggested that Facebook is looking more and more like a third generation walled garden and evidence is beginning to suggest that recent moves by Facebook including acquisitions and the introduction of for fee services support that conclusion.

The problem with walled gardens is that they end up being caught in a conundrum of two immutable Internet truths both of which are rooted in human behavior and inextricably linked. The first is never underestimate the power of boredom. Boredom drives more Internet behavior than just about anything else; after all, they call it browsing for a reason. Next is that time on-site is inversely proportional to site affiliation; the longer you go to a site the more likely it is that the time you spend there will diminish. Why? Well, maybe boredom has something to do with it.

Consequently, the sweet spot for on-site duration usually occurs early in the users’ experience. The longer a user goes to a site the more proficient they become in understanding and extracting the value that originally caused them to explore it. What this means to most sites is that users are like cabbage; they have a shelf life. If the value of a 3 year old subscriber diminishes by 20% per year the value potential of even a population of 900 million users would have to be severely discounted. And at what point does the rate of replenishment or new user acquisition become saturated? There just aren’t that many new users available to bring on and start at the top of the value curve.

So, the issue becomes one of how to renew the on-site duration of existing long term users. Add more features. Add more content. Become the only place they need to go. Become a walled garden.

At bottom, walled gardens are a form of Internet incrementalism produced through the pursuit of a presumed authoritative value proxy, time on-site. How do you know when you are building a walled garden? Well, spending a billion dollars to acquire an eleven person start-up with no revenue might be a clue. The only issue here is that the costs to support this approach can in the long run become prohibitively expensive and, as new Internet experiences emerge, a user’s boredom will lead them to the next new thing.

Sustaining the Organic Conversation

There are, however, other value proxies that Facebook might subscribe to and explore, not as sexy mind you as being the world’s leading advertising platform but still valuable nonetheless and congruent with the idea of understanding and influencing human behavior.

Part of what makes Facebook attractive to consumer goods types is the ability to employ user data to understand what drives and motivates consumers to engage, what some analysts have referred to as having an organic consumer conversation. The wealth of consumer data available and the opportunities to explore consumer/supplier relationships has enormous potential. The ability of consumers to declare what means the most to them and suggest what might come next gives vendors unprecedented access and insights that might take them years and billions of dollars to acquire by any other means.

Interestingly enough, there are established firms that purport to do exactly this. For instance here is how one describes their value proposition:

“We are a leading global information and measurement company that provides clients with a comprehensive understanding of consumers and consumer behaviors…Our information, insights and solutions help our clients maintain and strengthen their market positions and identify opportunities for profitable growth.”

The quote is directly from material filed with the SEC that describes Nielsen, a $5.1b global, publically traded company. If you assume for a minute that what Facebook truly affords clients is access to consumer information and relationships then comparing Facebook to Nielsen may not be as inappropriate as it might seem at first glance. Again, the value potential of Facebook is still being sorted out and it may turn out that advertising is not its primary value proposition and time on-site may not be its most authoritative value proxy. Understanding consumers may be a better comparable. But if this proves to be the case then there will need to be some further adjustments in expectations as Nielsen trades at a 34 P/E ratio and Facebook went out at a 85-100 P/E ratio. You do the math.

About a year ago comScore collaborating with Facebook came out with a piece of research called The Power of Like in which they declared that the reach afforded brands through Friends of Fans, telling your friends you’re a brand fan and that you like something, was without a doubt the most compelling social media value proposition on the Internet.

Now I happen to “Like” Benedetto’s La Venezia, Meade’s MAX Mount, Aston Martin’s Vanquish and Facebook’s stock but the chances of me ever buying any one these is significantly less than zero.

But I wouldn’t hesitate to recommend that you do.

Graphic courtesy of Flora Grubb Gardens, San Francisco, CA