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- The Silicon Valley Dance - (by @baekdal)
For the last couple of weeks, I have been writing and commenting on the social bubble. We all know that its here. The signs are as clear as day. But there is something wrong with this bubble. It isn't actually a bubble for anyone who is in it. It is only a bubble for the rest of us, and the market as a whole.
What we are experiencing is the what I will call the Silicon Valley Dance, and here is how it goes.
First a bunch of startups all try to do something spectacular, and they pitch their ideas to angel investors hoping to get funding to get it going.
Most of these startups don't make it and are not invited to the dance - but the few that do are invited into a strange world of tech investments.
The first steps
The first few steps are simple. The startup, now monetized by their angel investments, set out to create this amazing new thing involving new technology, new ideas, and new social doohickeys. In order to attract attention, they decide to give it all away for free. They do not even put ads on it. We see statements like. "This will be free, forever". And the founders say things like, "We don't like advertising, so we won't do that, ever!"
People, of course, are very excited by this free gimmick. It's new and exciting (and everyone loves that), and it is totally free - made by people who wants to keep it free forever.
The result is an incredibly initial growth curve. And since it is build around social sharing, it very quickly explodes in size.
Soon the journalists notice this new thing and write amazing articles proclaiming that this startup grew 4,000% the last 3 months alone (which is really easy to do when you start from zero).
The next act
The startup now needs to scale. They need bigger servers, support crew, and a bunch of other things in order to support this new 'social comet'. In short, they need to raise more money.
This, however, is easy. Because with a grow curve showing a 4,000% growth, the investors see billion dollars signs falling from the skies. Based on their initial numbers, it is decided that the company will grow by some even larger number, and base on that they set a completely made-up market valuation of something in the area of a billion dollars.
They then invest $100 million into the company (10 times lower)
The result is that the investors can invest in a company at a fraction of the price that they tell the world that it is worth. What a brilliant deal, especially since all the numbers are made up.
It's like buying a car for $10,000, and then telling people it is worth $100,000.
The startup continues to focus on growth and deliberately implement things that will boost traffic even higher, while neglecting to consider anything that could produce real money.
The final act
A while later, the small startup has tens of millions of free users, and it is now ready to be sold to some big clueless company who themselves have failed to embrace whatever the startup had invented.
The investors sit down to have a meeting with a big investment bank, and they decide that the company is now worth 50 billion imaginary dollars - and they base it all on its amazing growth as well as its track record of being valuated at an ever higher price at each investment cycle.
Just look how amazing it is growing. The first investors invested just a couple of thousand, then it was valuated at $100 million, which attracted even more investors, who invested $10 million, and now it is worth $1 billion! All imaginary valuations based on a company that makes no money at all.
The next day, the company is sold for a staggering amount of billions to some big company, and the founders become billionaires - and so do the initial angel investors and early investors.
Everyone is happy. The founders turn into venture capital investors themselves, and start looking for the next free-for-all-new-amazing-social-startup-with-no-revenue to invest in.
And the cycle repeats.
As you can see. Without actually making any money, at any point, a company was formed and later sold for billions of dollars - making both the founders and the investors filthy rich. And they can keep doing this as long as there are new startups coming out with new ideas. There is no bubble here. It actually works.
Being a venture capitalist is a tremendously successful business model.
But what about the big company who just paid several billion dollars for a startup with no revenue? Well ...this is where things start to go horribly wrong. The only way to somehow get this money back is to find a way to monetized all this free traffic.
They start with advertising, which results in a massive backlash from the people using the service, who say that this big company doesn't care about them and are only in it to make money - and many other arguments like, "they are breaking with the culture that the startup was founded on".
The big company is identified as the ultimate villain. Employees drop out and post negative articles telling the world that the reason they left was because of how 'corporate development' changed everything - and that sucked, so goodbye!
A few years go by, until finally the big company simply decides to write that 'experiment' off as a failure. They never succeeded in monetizing the traffic.
Why did it fail? Part of the reason is that the big company completely failed to understand the mechanisms behind it. If they did, they would never have bought the startup at that price to begin with. But the biggest reason is that it was based on imaginary value. It made no money, and its users have been taught to expect everything for free. That is not an audience or a product that can be turned into something that will ever be profitable.
The initial founders and investors don't care about that. They already earned their billion dollars. They are currently building up new startups with, no revenue and promises something new for free, only to pitch the idea other big clueless companies for imaginary market valuations far above the amount of money the investors have actually put into it.
The cycle continues endlessly. The bubble never burst as long as there are more clueless corporations waiting inline to buy the next innovative idea.
Nevertheless, the bubble will burst the day the big clueless companies start to use their brain. That's when this whole industry will come tumbling down. The day investors can no longer make up imaginary value is when it will all fall to pieces.
Personally, I cannot wait for this to happen. Just imagine a world where startups where based on creating something people would pay real money for, generate real revenue and produce real profit. These startups would have to build something that was far better to begin with. Something far more useful, and far more valuable.
Imagine a social network that had to be so good that you would pay real money for it. We used to do that in the past, but then came the Silicon Valley Dance.
The Silicon Valley Dance is also largely responsible for the culture of free. It is astonishing how many 'ordinary' people who believe that sites like Pinterest is worth their new $1.5 billion market valuation.
Ordinary people point to the fact that billions of dollars are exchanging hands, and the constant stories of founders getting filthy rich. But they didn't do it because they made something valuable. They did it because they fooled some big company into believing that their free traffic was worth something it wasn't.
The problem is that, in this kind of environment, it is almost impossible to create a real startup that makes real money. You have to compete with a bunch of startups with fictional financial valuations who gives everything away for free.
It's time for the big companies to wake up. While I wouldn't mind having a billion dollars in my bank account (which I don't), I would much rather spend my time building something of real value. Something that generates real money because it is really worth the price!
A company is not successful if it makes no money - regardless of how much imaginary value the investors tell you it is worth. It is a simple scam, although a highly profitable one for the investors.
It's the Silicon Valley Dance.
1...2...free...grow it some more...4...5...6...valuate the floor
1...2...free...grow it some more...4...5...6...valuate the floor
Sell it to a big fool, because that's really cool.
1...2...free...grow it some more...4...5...6...valuate the floor
1...2...free...grow it some more...4...5...6...valuate the floor
Sell it to a big fool, because that's really cool....and repeat
Переслать - The Facebook IPO - A Classic Game of Hot Potato - (by @baekdal)
For those of you who are following me over at Google+, you will already know the story. The Facebook IPO is the closest thing we come to a social bubble. The numbers and valuations they throw around are just insane.
To illustrate this, I decided to compare Facebook with Ford by looking at four key metrics: Revenue, profit, assets, and market cap. And as you can see, something is completely wrong with this picture.
- Ford has 36 times higher revenue
- Ford has 8 times higher profit
- Ford has 8 times as many assets (including a much larger cash reserve)
- ...but Ford is valued at only 41% of Facebook's expected market cap.
More to the point, Ford's market cap is valued at 70% of their total assets, yet Facebook is valued 1,370% higher than what they have in assets.
This is the dot.com era all over again. Value is being determined based on activity (page views, ad impressions, users), instead of real things like ...you know ...money and assets.
My post over at Google+ went crazy after posting this graph, within 24 hours it had a ton of views, 660 +1s, 595 shares, and 170 comments.
The comments were divided into two camps. One group agreed that this was insane, the other told me that I was wrong because I forgotten about the growth potential.
But I hadn't, I just didn't mention it. As I wrote in another post:
While I agree that Facebook will grow, they are only making $1.21 per person ...and they seem to be stuck at that level (it was $1.26 in Dec 2010).
That means that in order for Facebook to earn the same as Ford, they would have to reach 7.7 billion people - 110% of the entire population of the planet, or 300% more people than there are on the internet.
If we instead compare it to Google, they would have to reach 8.3 billion people. And compared to Apple, they would have to reach 22.5 billion people....or 321% of the total population of Earth.
If we instead look at revenue, the picture is even worse. Facebook would have to reach 33 billion people to match Ford, 9 billion people to match Google, and 26 billion people to match Apple.
The problem is that people only look at the growth trend itself (which looks to be impressive). But in doing so they don't realize that Facebook already has a 40% internet penetration - worldwide. That's impressive, but it also means that its growth is somewhat limited.
The only way for Facebook to succeed, at its current market cap, is if they can raise the $ value per user, and so far they have been completely unable to do that. Facebook is not actually growing that much, which Facebook itself have illustrated clearly on several occasions.
Here is the graph showing the growth in monthly active users:
Note: Sorry for the low-res quality - out of my control.
As you can see, the US market is flattening out, and Europe is not far behind. And while Facebook is still growing overall, it is nowhere at the exponential rate that people think it is. It is a steady increase month over month, with a slowing effect in their existing markets.
For a company that only makes $4 billion in revenue, I don't see it coming anywhere close to a $100 billion market value anytime soon.
More importantly, the revenue is actually down, and the revenue per user is flat. Here are the official revenue graphs:
Notice the small numbers underneath each graph, the one that says ARPU. It is short for Average Revenue Per User. As you can see, the ARPU has been flat lined for more than a year. But more to the point, the new market (where Facebook is still growing strong) have a much lower ARPU per person ($0.37) than the old market ($2.86).
This means that even with a steady influx of new users, the new markets are not nearly as valuable as the old ones.
There is no spectacular growth here, nor is there any trend curve pointing in that direction.
Don't get me wrong, Facebook is a very financially sound company. It has very good positive cash-flow. The cost of operating Facebook is dropping compared to their revenue. In 2009, the cost was 63%. In 2011, it was 52% of the revenue. And while the cost per user is up (in 2009 the cost was $1.4 per person and in 2011 it was $2.2 per person), the revenue has grown at a higher pace.
Facebook is a financially sound company and is doing great!
The problem is the stock market valuation, which is completely out of touch with reality. They are looking for a quick-win, and Mark will soon be a fanzillionaire - literally. This is because much of the value is made-up, but also because it is based on some imaginary value of fans and not real things like actual money.
What we have is a real bubble, which is further cemented by the $1 billion purchasing price for Instagram - a company that had no revenue at all. And today we learned that Pinterest has raised $100 million at a $1.5 billion valuation. Where do they get these silly valuations from?
For years we heard that all these social signals are incredibly valuable. If you have enough signals, you can use it for targeting, and money will fall from the sky. There is just one problem. We have not seen a single example yet that this true. Not a single company has been able to monetize these social signals in any useful way that results in real money at the level that these companies are being valued at.
All the successes we hear about are happening between investors and companies buying imaginary value. Instagram is not a success. It made no money! As a person, I absolutely love Instagram. But why would I pay for it? Why would I click on random ads from brands I don't care about? Would you?
It's the same with Facebook's IPO. People say it is going to be extremely valuable because of the open graph and all the information they have about everyone. And it is valuable - Facebook earns $1 billion per year, 86% from advertising. But there is a long way from $1 billion to $100 billion that the stock market thinks it is worth, and nothing as yet indicates that Facebook can grow by that much.
Advertising click-through rates are dropping on Facebook, which they tried to solve by putting more ads on the page. That might work in the short term for Facebook, but it is an absolute disaster for the brands who now have to compete with more advertising spots.
And this week, GM announced it was dropping Facebook ads altogether but would still use Facebook to post status updates. Essentially saying they want to use the power of Facebook, but not pay for it.
Facebook has a problem. As you can see above, the new market is not as valuable as the old one, and the old market is slowing down. At the same time, the $ value per user has flat lined.
Facebook needs to come up with a way to earn much more money per user to even reach their expected growth. And they are trying with 'pay to highlight', asking people to pay $2 to have a personal post highlighted for their friends. What a strange concept. Paying Facebook for having your friends notice what you write about. If you friends ignore you, the solution is not to pay Facebook, it is to get better friends (or at least write better posts)!
One possible solution, in my opinion, is for Facebook to create a Pro version for brands. That's where the value is. More brands will do what GM did - drop advertising and focus on direct engagement.
And, of course, I haven't even mentioned mobile, where Facebook makes no money at all. Display advertising and mobile is completely incompatible. And where is the mobile trend heading? Yep, to more mobile.
I'm not saying that investing in Facebook is a bad thing. It's a game of hot potato. If you buy it now and you are capable of selling it to some poor fool for an even higher evaluation before the next earnings call, you will have earned a lot of easy money.
But by the next annual earnings call, when Facebook fails to exceed expectations, things will come tumbling down, and whoever is left with the hot potato is going to get burned - badly.
Marks Zuckerberg, of course, will still be filthy rich. He was the first one to sell the hot potato. He figured it out!
Read also: The Facebook IPO: A Note to Mark Zuckerberg or, With "Friends" Like Morgan Stanley, Who Needs Enemies? (thx avinash for the heads-up)
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