Experts See Parallels Between Dot-Com, Social Media Bubbles

First in a five-part series.

When you spend a week interviewing people about a social media bubble and whether it exists, one of the things you notice is that people who insist there is no bubble make little mention of revenue and business models. They talk about the depth of which social media has permeated the culture and niche markets, but rarely mention the fact that the most frequently used social networks ultimately rely on the fickle relationship between users and advertisers.

Indeed, the deal that got the whole social media bubble discussion rolling was Facebook’s $1 billion purchase of Instagram, a company that has no revenue. If you think this is starting to sound a lot like the dot-com boom in 1999, you’re not alone. And several experts say you should be worried.

“Bubbles don’t happen just because of exuberance, but also through the calculated moves of companies who know how to game the system.” – Social media podcast host Bob Knorpp.

This week, ReadWriteWeb will look at the current social media landscape and try to answer the question of whether or not we’re in a social media bubble that, like the dot-com bubble did in the 1990s, could wreak havoc on the tech sector and the broader financial markets.

We’ll check in with people raising red flags following last month’s $1 billion purchase of Instagram by Facebook. We’ll look at Facebook’s motivation for that deal, which firms are likely to emerge from the current growth period intact, and we’ll ask if now is the best time to launch a new social network. Finally, we’ll talk with people who are optimistic that social media is poised for more growth and believe the bubble fears are, well, inflated.

Bubble concerns have been whispered for months, but when Facebook acquired Instagram, people started expressing those fears out in the open.

“If you cannot deliver sufficient profits over time to justify a given valuation, it doesn’t matter how many users you have,” said Richard L. Harris, CEO of Intent Media. “The end result must be market disillusionment, followed by valuations falling to the levels justified by the underlying profits of the business.”

Is Facebook the Next AOL?

Harris draws some parallels to the current bubble and the dot-com bubble of the late 1990s, while conceding that the Internet is much bigger than it was when most of us still relied on dial-up connections. He also expects the current obsession with social media companies to produce some long-term winners – just as the last bubble gave us Amazon and Google.

“The current number of Facebook users probably exceed ALL Internet users back when AOL bought Time Warner. So yes, it’s different in that regard,” Harris said. “But it’s also worth remembering that a fixation on growing user numbers and a lack of focus on profits is actually eerily similar to the last bubble.”

Bob Knorpp, host of The BeanCast and The 2 Minute Rundown with Peter Shankman, said Facebook’s acquisition of Instagram was shrewd sleight of hand aimed squarely at bolsterings its initial public offering, reportedly set for next month.

“Facebook needs to show value to potential shareholders, but is lacking a mobile strategy and has only the core brand as an asset,” Knorpp said. “So right before the IPO, they buy a hot mobile-only company, they value it at a billion dollars, then turn around and presumably say to shareholders that they now own a billion dollar asset. They have, in essence, created a billion dollars of value out of thin air.”

“You will know a bubble when you see a brand-new social network raises $20 million, or $50 million or goes public when you’ve never heard of them” – Scott Cherkin of Complex Media.

The problem? It’s not really a billion dollars to anyone who bothers to look up Facebook’s sleeve. And the move is classic bubble blowing.

“Instagram, while being a very innovative mobile-based company, has no discernible monetization strategy, so Facebook is not generating real value for potential investors, but rather more speculation of future value,” Knorpp said. “Bubbles don’t happen just because of exuberance, but also through the calculated moves of companies who know how to game the system.”

Potential Reach vs. Real Reach

Perhaps the biggest similarity between recent valuations and the valuations of dot-com companies more than a decade ago is that they are based on “potential reach.” That, more than anything, suggests a bubble to Mike Seiman, CEO of CPX Interactive, a digital advertising company

Valuations are being based on the idea of ‘potential reach’ – which is virtually unlimited,” he said. “But when the reality of a crowded space makes this kind of scalability impossible, models are quickly discarded for the next big thing.”

The trick for investors in any industry, but perhaps particularly in the social media space, is determining which business models are viable.

“If there is a difference between the 1999 bubble and the 2012 version, it may be that in 1999 investors probably held onto models that had no real business model for too long, while today models that may have a real model are being churned through too quickly if it is perceived that they are not the magic bullet promised by the overzealous business plans,” Seiman said.

Coming Tomorrow: Who Will Survive The Social Media Bubble?

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