Dot Bomb 2.0 is Coming
Over the next couple of days, I’ll be talking about the fact that it looks like we’re heading into another technology crash. With all the hoopla around the current business activity on the internet, that opinion is sure to be unpopular. Nonetheless I believe it to be correct.
Today, I’ll tell you why I think that way, and tomorrow, I’ll give you my thoughts on how entrepreneurs can best avoid being left in the pile of 2.0 refuse.
A Tail of Two Corrections
First off, a caveat - Crash 2.0 will be nowhere near as bad as 2000 was. The hype back then was outrageous IPO’s based on unrealistic profit expectations. Now, we have private acquisition based on unrealistic profit expectations. The VC’s are still there, but they’re pitching to a different audience. It’s a different environment within our industry.
It’s also a different market overall. In 2000, the market was dominated by tech. The rampant speculation that was occurring had an effect on the average investor because there was no way for him to avoid being a part of the industry - dot coms were everywhere. Today, tech is only a segment of a market that is structured differently. This means that our little piece of over-valuation and acquisitions matter less to the average man on the street; he’ll be affected likewise.
The problem for those of us who are directly involved in web 2.0 is that we are now part of a market that we have less control over. Regardless of how secure our sector is, we’re going to be affected by the events in other areas. These events, as witnessed over the last week or so aren’t all that encouraging, to say the least.
Are we staring into a recession, or even something more serious? It’s possible, but still subject to healthy debate. Even the most optimistic however, don’t suggest that we are heading into anything but a bear market. Even the slightest correction in the index however will be magnified in effect in our sector - one built on speculation and venture capital almost exclusively. When the VC’s other earnings dry up, they’ll be less likely to take a chance on your latest Facebook app.
For comparison, 1987; a strong housing sector was destroyed by a correction in a market dominated by industrials. That’s very simplistic, but it serves to illustrate the point. At the end of the day, it was better to be a part of the index than a part of a booming sector within it.
Icing on the Cake
Given the conditions outside of web 2.0, what kind of security do we have within that will shelter us from a market correction? The truth is, our industry is speculative right now - as it was in 1999. Look at the leaders - Facebook, mySpace, Digg, YouTube. Being ad based, each of these companies generate no income from those actually consuming the product.
Consumer loyalty is directly linked to the amount the consumer invests out of pocket. Apple has a fiercely loyal base partly because they feel really stupid spending an extra $300 on a product that isn’t something special. With social networking sites the amount spent is zero - and the loyalty corresponds.
Facebook and mySpace are only as valuable as the next big thing. In other words: they are fads. Now, fads can be successful if they’re managed right, but they all share one thing in common - they won’t be around tomorrow. If you need proof, look no further than Frendster. In 2003 they had 20 million users. Today, they have less than 1 million die hards. Those are fickle crowds.
So, why is this a problem? Because eventually investors - be they VC’s or acquiring organizations - want to see some growth in their investment. With a fad-based industry, all value becomes speculative and opinion based. In order to make money, investors need to assume that tomorrow, the perceived worth of the product will be higher. Let’s pick on Facebook a little. Facebook now needs the next investor to believe it’s worth $2 billion at least. - invest $1 billion, recoup $1 billion. Sorry if I laugh a little.
This whole thing works until there is a measurable instance of a product demonstrating its actual value. It doesn’t have to be the product itself, just something close enough. If, for example, it came out that Digg was in the red, or not nearly worth as much as the $200 million BusinessWeek thought, Facebook would have a tougher time convincing potential investors of its value.
Any industry built on such rampant speculation is doomed to be as temporary as boy bands and leg warmers.
Facebook Apps - Beyond Madness
Bubble 2.0 takes things a step further. Not only do we have the general investor speculation in copycats (quick, how many Technorati clones can you name in 15 seconds?) but we have investor interest in products built upon other products. Ladies and Gentleman, the folly of the Facebook application.
Let’s put this into perspective: We have a product that has a monetary value of zero to its users being used to build further products of negligible value - and these products are actually being sold or invested in!
Let’s avoid the elephant in the room - putting 100% of your chances of success into the outcome of someone else’s business plan - for a second. There is zero evidence that Facebook users value the site enough to pay to use it. There is zero evidence that Facebook advertisers value the site enough to maintain a long term relationship with it - and thus ensure that any market is there for your application. Somehow though, there’s enough money to be made on a small fraction of that user base to recoup a sizable investment, or so the thinking goes.
I just don’t get it. And Facebook only scratches the surface. I’m sure that some fool, or collection thereof will purchase Twitter - only to lose a heck of a lot of coin - any day now.
How Could This Bubble not Burst?
Let’s take a look then at situation then:
- We’re heading into a bear market, if we aren’t already there.
- The boom in our industry is fueled primarily by speculative values and notional potential future revenues
- The social network audience is fickle, investing little and demonstrating high mobility.
- We have people investing in products that are naturally restricted by the success of a product that is - as of yet - of dubious long term stability
I’m sorry to those that are caught up in the madness, but you have to have a few screws lose to think that we’re not in the middle of a bubble. There are scary signs all over the place right now, and it seems that many of us won’t be as wealthy this time next year as we are now.
So what do the smart start-up do? Tomorrow, I’ll take a look at some of the ways that an entrepreneur can avoid being left out to dry when the inevitable happens.
New here? Don't forget to subscribe, either by RSS feed or email notification to keep up with the latest articles!
It says in your about section you’re a project manager. Neither a startup founder, or an investor, or even an analist. How could you of all people possibly predict this? Highly unlikely. The most ironic thing though: shouting “bubble 2.0″ is a copycat of it’s own.
August 7th, 2007 at 7:45 amHi Robert,
I’m a PM in my day job, but I’ve got a couple of ventures that haven’t hit the light of day yet, so I’m pretty aware of what it takes to be a founder.
That being said, it’s usually the people that aren’t surrounded in the hoopla of the industry that are best able to see trouble spots.
I know it may trouble you to hear what I’m saying, but think about it a little.
August 7th, 2007 at 7:52 amExcellent article. Found it via http://www.DailyHub.com
One of the best articulated articles I’ve read on the topic.
I’m not sure I agree completely with your viewpoint that we’re approaching another tech crash, but you certainly make some good arguments.
August 7th, 2007 at 7:59 amYour points are well reasoned, of course, others will challenge whether we will enter a bear market (I will stay away from that debate
), and it has been clear that there has been a significant degree of speculation in all kinds of markets.
One important factor which is different from Bubble 1.0 for tech is that there is much more money in the Internet ecosystem so there are many more players who are generating revenue than before and I wopuld say that even for those who are not, there are more, and easier opportunities to get in the game.
Regarding Facebook, I agree that it is an unproven revenue generating platform but I think there are lots of people who are using Facebook as a kind of rent-a-viral-marketing play to leverage Facebook users. They do not plan on getting revenuue from Facebook directly but simply to gain users and buzz as quickly and cheaply as possible so they can pitch their own products and services. That may work, it remains to be seen, that is why IMO all the excitement how quickly apps are growing on Facebook, because it appears it is a potentially excellent way of getting users quickly. How to monetize them is always the problem of the app developer, and that’s the way it should be
August 7th, 2007 at 8:02 amThis is insane: a bunch of predictions lacking even a basic logic, all framed into tons of self-important “leadership-building” crap. Sounds too much like “Want to lose weight? Ask me how!”.
Sorry for sarcasm.
August 7th, 2007 at 9:44 amYou’re missing one crucial insight: there is no stock market involvement to cause a crash.
Yes, VC could pull investment and shut companies down.
So what?
A bear market could hurt, but that has nothing to do with any “Web 2.0 bomb”.
August 7th, 2007 at 10:22 am“When the VC’s other earnings dry up, they’ll be less likely to take a chance on your latest Facebook app.”
But you don’t generally *need* VC to launch an app successfully. That is one of the big breakthroughs with this boom. See plentyoffish.com as an example.
A shakeout of dumb apps, sure. That happens almost continuously, though.
August 7th, 2007 at 10:25 amYou’re baiting us. I’m falling since I don’t believe in your bubble burst theories. You’re hanging it all on Social Networking (I agree that it has no value, given that traditonal corporate collaboration products have been around forever). There are incredible amounts of advertising dollars out there. Those are paying and so are the VCs. VCs take risks. Marketing departments are tasked to spend money. Are there any Social Networking sites that are publicly held? No, not really.
So, why the crash? The bubble didn’t burst because of the internet, the bubble burst because of market forces outside of it. Essentially, people shifted their investments.
Those burned by the crash (including myself) went searching for jobs or ran away. The bubble burst when folks like Corning, 3M, and others temporarily stopped spending money on IT.
Where is the parallel?
August 7th, 2007 at 10:44 amThis is a good article David and you make good points. That being said, I think it would benefit from some more concrete examples. Friendster is an odd case and I do agree with you that Facebook apps are not a revenue source. Advertising within Facebook is a giant ponzi scheme because most of the advertising is to sell up to other apps which at some point will sell advertising to get other app installs. Who is going to generate the revenue to support this? It’ll just cascade back to the beginning as a major failure and ponzi scheme.
@ 1 Robert - please learn how to spell before you try to use logical arguments. Just because someone isn’t X doesn’t disqualify them from using logical reasoning to reach a conclusion. This isn’t the medical space or legal space where only experts are qualified to make serious arguments.
August 7th, 2007 at 10:53 am>The bubble didn’t burst because of the internet, the bubble burst because of market forces outside of it.
Jack, the bubble burst the first time because the expected profits that investors were counting on failed to materialize. It was this that caused the exodus, which in turn caused the recession that led the big boys to downplay IT spending.
Those expected profits are again sky high, and they will again (IMO) fail to be realized. The resulting decrease in VC money being thrown around will slow down the tech sector.
August 7th, 2007 at 10:56 amAll bubbles have speculators and over valuations. A fiend of mine is an independent real estate appraiser in the Atlanta area. I asked him what was his apraach is to valuation. He recited the standard practices then said he adds ten percent. I asked why do you add ten percent he said because that is how much the market will grow in the next year. That is wrong on so many levels. He said it was common practice. Talk about your bubbles. Hate to be the last one holding that bag.
August 7th, 2007 at 11:00 amI agree with many of the above commenters that Friendster was a special situation. Not saying Facebook won’t someday face a correction (perhaps to a lesser extent), but they have gone beyond Friendster with their Facebook dev platform.
Also, who’s to say where Friendster would be today if they had gotten past the performance hurdle, added features like MySpace (for bands & customization) and a Facebook-like Developers Platform. They could be bigger than MySpace.
Anyway, I digress –
Let’s say Facebook really is on track to do $100 million a year in revenue. I don’t agree that it’s all a Ponzo scheme as some above have suggested. Facebook users are more savvy than your average netizen, but that will change too.
It’s still early-going for FB, if they climb to $200 million in revenue in 1-2 years, why wouldn’t they be worth $2 billion?
To get a similar sense of what the market will bear, see Google.
GOOG is currently trading at a market cap of $160bln on 2006 revenues of $10billion, or 16 times trailing year’s earnings.
There’s definitely a correction brewing in the next 1-3 years, but an overall collapse like Bubble 1.0 — I just don’t see it. (that is, unless the IPO market goes ballistic again)
August 7th, 2007 at 11:46 amCurious about the two ventures you have cooking “sub rosa” it is hard enough to start one company, so to do two and hold down a full time job, I would assume that they are web oriented, otherwise very hard to bootstrap or self fund. So are you baiting us? As a blogger, we all know the value of a controversial headline.
August 7th, 2007 at 2:33 pm@rem: Haha, no bait, I honestly wouldn’t imagine I would have gotten this much attention on this topic if that was my goal.
My two ideas are starting to mature, albeit slowly. They are both very early stage, which is why they can co-exist One is going to take precedence, as you suggest. Lord knows time is not something I have enough of!
Keep watching here for more, I’ll start to put them forward as they develop.
August 7th, 2007 at 2:44 pmExcellent post. More people need to awaken to the fact that the no-viable-revenue-plan-let’s-hope-Google-buys-us business model cannot exist forever. One day, Google will stop buying startups and then God help us all. Related: My post about the obscene valuations companies like Facebook command.
August 7th, 2007 at 2:53 pm> Consumer loyalty is directly linked to the amount the consumer invests out of pocket. Apple has a fiercely loyal base partly because they feel really stupid spending an extra $300 on a product that isn’t something special. With social networking sites the amount spent is zero - and the loyalty corresponds.
It has been my experience that the hours upon hours that users spend building up their presence on Facebook & MySpace is worth much more to them than $300 on Mac hardware.
August 7th, 2007 at 3:02 pm@daveP, you did not answer the question. Are they web plays? Fess up now Dave……
August 7th, 2007 at 4:14 pm@rem: both web based yes, of course. Neither would probably appeal directly to the folks at news.yc though aside from passing curiosity.
August 7th, 2007 at 5:17 pm@Rich: Sure they spend a lot of time, but very few people value their downtime monetarily. To most, hours of goofing off won’t exactly be viewed as “investment”.
August 7th, 2007 at 5:20 pmMy disagreements with this post are too numerous to post in this comment space. As such, I’d encourage you to read my blog post in response at: http://advice.cio.com/c_g_lynch/web_2_0_bubble_please
C.G. Lynch
August 8th, 2007 at 10:13 amAssociate Staff Writer
CIO magazine and CIO.com
I have two central (and significant) problems with your argument (leaving aside the fact that your post was, on the whole, a pretty poorly reasoned argument).
1) You say that “these companies generate no income from people actually consuming their product.” This is patently false. Facebook generates revenue though people consuming their product every second of every day. They may not be making a monetary transaction in the traditional sense of the word (i.e. people are not giving them $5 to use the service), but instead users are saying, by choosing to use Facebook instead of doing other things with their time, that they value the service it provides and would like to “consume it” rather than do other things. From this consumption, Facebook generates revenue from ad sales.
Now, I would agree with your statement that basing your business on this type of revenue source is risky–indeed, if tomorrow there is a new hot thing, your ad revenue will go away as fast as your users do. Granted, that is a risk. But risk is a part of business and not something unique to web 2.0. Just as there is a risk that Facebook will lose its place in the social networking space, there is also the risk that tomorrow your leadership consulting services will be less valuable than they are today. But if they (and you) continue to provide a better service or product than their competitors, they will continue to generate revenue. And while the volatility in the market for things like social networking is high, that does not mean, by definition, that companies that generate revenue from ads are overvalued. It just means they need to be that much sharper to maintain their edge over the rest of the market.
2) You have apparently redefined “web 2.0″ to mean “social networking sites.” To me, web 2.0 is way more than the Facebooks and Friendsters of the world that you seem to be so focused on. A web 2.0 company harnesses the internet (which is, at its core, a network of people able to interact with each other) to provide a service which people value. In providing that service, they generate revenue. In the case of social networking sites, this revenue comes from ads, and you can argue if you like about whether this is a viable and sustainable source of income (I think it is). But take the case of ebay (which, like it or not, is a web 2.0 company). They developed a means for people to connect and transact sales of goods, and for that service, they take a percentage of every sale. They provide what is, for now, the best service of its kind on the internet, and they continue to innovate every year. If they continue to do so, they will continue to make money. To lump them into the same sentence as social networking sites who you believe to be overvalued is simply ludicrous. There are literally dozens of examples of web 2.0 companies that provide innovative and value-added services that generate real wealth for the owners that will not be impacted by this “bubble” you speak of any more than GM or ATT will be.
The bubble on social networking sites may indeed bust, but web 2.0, as a principle and as a basis for doing good business, is here to stay (reactionary blog posts intended to increase your PageRank notwithstanding…how’s that for irony?).
August 8th, 2007 at 10:20 amThe Bubble / Crash back in 2000/2001 was stock-market related. Overhyped stocks, companies that went IPO like crazy, investment companies going totally crazy etc etc - it was all about the big money for basically no value. It had to crash. Period.
Today it’s different - All that’s going on in this 2.0-era is somewhere else.. hardly any of these companies are anywhere near doing an IPO… for a good reason. There are a bunch of stocks that are way up that might crash, but that’s it.. only a few - the rest of the herd is living in their own ecosystem - Investors doing micro-investments (compared to the couple years back), start-ups can live with these way, wayyy longer than the other ones did, focus is on the customer on most business models and even though some do lack a good -business-plan, advertisement is much more interesting these day to cover the costs and the dozen employees. Most aren’t looking for getting super-rich overnight by doing some crazy shiznit, but rather focus on their own little island.. and the customers like it. Facebook is just a union of these islands…
There’s way more reasoning in it.. and I do so and talk to people who sometimes seem to have similiar tendencies we all had back in 98/99.. but these folks don’t get very far these days. The crazyness:”good stuff” ratio has shifted from 90:10 to 20:80 or something.. which is quite healthy if you asked me.
A new bubble will come - for sure…. but not from these folks you mentioned and referred to… and their companies.. Investors/VCs etc.
Now back to my sashimi…
August 19th, 2007 at 9:43 am