Virtual Consumer Jul-Aug 2012

Bubble Trouble

Virtual Consumer column from Ethical Consumer magazine Jul-Aug 2012

The eagerly anticipated stockmarket flotation of Facebook (which will have taken place by the time this article goes to print), is expected to raise between $77 and $96 billion - dwarfing the IPO (initial public offering) of Google in 2004. This spectacular valuation prompts comparisons with the dot com boom at the turn of the century. That boom, which turned out to be a bubble, began with a stampede for shares in the web browser company Netscape on its IPO.

A characteristic of the first dot com boom was the rush to invest in ‘startup’ businesses that had little or nothing to show in revenues, still less any prospect of making a profit soon. Valuations were frequently based on real or projected user numbers, whether or not it was known how these users would generate revenue.

In fact Facebook does earn significant revenue from advertising and is turning a substantial profit - around $1billion. But the comparatively huge valuation is much more based on the perceived potential of the 900 million users to generate revenue. Given that Facebook cannot continue to attract new users at the same rate indefinitely, it will have substantially to increase the amount of money it makes from each user in order to realise that potential. That can only mean making more use of the information gleaned from users - what they say, who their friends are - to help advertisers target them more effectively. There may be a limit to just how much invasion of their privacy users will put up with from a network that costs them nothing to join and that has plenty of eager rivals. The rapid fall from pre-eminence of Myspace shows just how tenuous the grip that a social network has on its users. That underlines the question of what the real value of a Facebook user is - compared say with the value of a customer to Amazon (16 times the revenue of Facebook), or with one of the estimated 330 million loyal Manchester United fans.

This is the problem facing investors in Internet startups: what is the asset they are buying? The conventional capitalist model used investment to buy plant and equipment that could then be used to earn revenue. It’s not such a stretch from that to the model behind a trading giant like Amazon where years of investment have built an effective operation that offers customers an enormous range of goods and delivers them quickly and efficiently. But if the new Internet boom turns out to be another bubble and the 900 million users that Facebook has accumulated in 8 years turn out to be just as easy to lose again, it will be another sign that business fundamentals really are different in the digital era and that the conventional capitalist investment model doesn’t fit.