Mark Andreessen, one of the founders of the modern web browser, said during last week's All Things D conference that there is no second coming of the tech bubble. Part of the reason he said is because everybody think there is a bubble. How convenient that his own venture capital firm is staying away from all startups that involves the internet, social networking, location, web 2.0, etc!
I am sorry Mark, but just because everybody says there is a tech bubble does not automatically mean there isn't one. Heck back in the early 2000s when the first tech bubble was in its maturity, many a people were screaming out loud that there was a bubble then (Either that or self righteous people want to toot their own horns by saying "yeah, I saw that coming, I warned them"). The first time it happened nobody listened, and now people ought not make the same mistake twice. Because in my opinion there is another tech bubble brewing, and clearly many people that are joining in my assertions.
The first tech bubble was about converting ordinary services to the online sphere (Pets.com anyone?), and this current tech bubble is all about social networking. Social networking is absolutely the next big thing, and on that I agree. It has already change they way how people interact and share with each other (and to complete strangers). Suddenly, the world gotten much smaller with social networking (hello my cousins in China!). It is indeed a paradigm shift, and thinkers and dreamers are hard at work tying to monetize it.
Except nobody knows how to monetize it yet. If it was not for various forms of ad services (looking at you Google), nobody would be making any kind of money right now in social networking (Facebook selling our information, yeah!). Because what is the one thing that most social networking services have in common? It is FREE to the end user. How on earth are you going to make money if the sole product you offer is being sold to your customers at the price of free? In traditional sense of a business, this would never work, and the only reason it has "worked" so far is the revenues from selling ad space.
And it is not like these social networking can just change their mind one day and start charging their customers. Because first of all nobody would then use the product (would you use Facebook if you have to pay a monthly fee?), and secondly pricing your products low (in this case free) and then going high is usually not the correct business strategy (you price high, and adjust down if necessary).
So if these companies and never going to make a dime off their end users (in the strictest sense), how else are they going to make money besides selling ad revenue? Well I can't tell you the answer, because I don't know the answer. If I did I would be rich. it is going to take a long time before the magic code to monetize social networking will reveal itself.
But can't these companies just earn money off of selling ads? (Or selling our information eh Facebook?). Well clearly they cannot, because by all accounts, most of these social networking companies are not profitable (yet?). So naturally these companies need to raise capital from other sources, such as angels, venture capitalists, investors, and the public. Sounds bit like the first tech bubble doesn't it? Simply giving money to companies that have no clear way of making any real profit.
Just a few weeks ago LinkedIN filed for an IPO, at an valuation of the company at $4.3 billion dollars. This is 17 times the company's 2010 revenue, and I think it is insane for a company that has only recently in 2010 turned a profit (and lied to the public saying that they have been profitable since 2007). For comparison, Apple is currently trading at something around 16 times the company's previous fiscal year revenue. But the difference here is that Apple is immensely profitable with industry leading profit margins, and they also have 50 billion dollars in straight cash reserves. There is no way LinkenIN should have a stock value to revenue ratio amongst the likes of Apple.
But of course the investors bought it up, LinkedIN's IPO was deemed successful. Outside of IPOs, venture capitalists are dumping money hand over fist at any internet startup that deals with some form of social networking, which leads to the proliferation of it on the internet these days. Not a day went by the last few years without some new cool can't miss social platform springing out of the ground. If this once again sounds all too much like the first tech bubble, it does. Capitalists and investors do not want to miss out on the next big thing (that being social network, and there is no dispute), so they invest in anything that will attract a large user base.
It is a maxim of any good business - you must have a large target market that will use your product. Any successful social networking today has that. I think investors are just dumping money into these companies, hoping that one day they will find a way to properly monetize it. It appears that the only way to do that is currently through an IPO (original LinkedIN founders and investors got a fat pay day). But guess who suffers when this second tech bubble burst and the value of these companies go for a nose dive? The public's.
The bubble is real, it is happening right now, and with the chorus of people screaming that it is, one would think the tech investment circle would be more wise.