Insight Community

There are several key aspects to a social network:

The first is whether the growth of the network is viral. When you join a site such as Facebook the system encourages you to email invites to your entire address book automatically, this is what caused the huge growth amongst college students during late 2006 and early 2007.

Any network that can sustain solid growth through viral marketing is a potential winner. 

Secondly it is important for the network to be useful. Facebook has so many strong features that the users are likely to remain loyal for years to come. Most internet users are not fickle, create something of value and they will stick around.

If a network can grow using viral marketing and word of mouth AND provide long term value so that users have a reason to keep visiting the site then it will be around for a long time. The sites that will fail are sites that need a large marketing budget to gain users - if people don't come naturally then the site clearly isn't very good. I've seen sites seeded with a good social media campaign attract hundreds and thousands of users within hours without the owners spending a cent on marketing.

Thirdly it is important that the network has the potential to expand beyond it's current feature set. Social networks are changing every day and those that stand still will quickly fall out of favour.

Niche social networks do have a place but they are very hard to launch without leveraging an existing community. Any niche network that has managed to overcome this hurdle clearly has potential.

A simple test to see how a social network is moving is to check how many other sites are talking about it. Sites like Facebook are gaining millions of links from other sites while niche networks will be attracting 10's of links from the niche websites related to them. Be wary of networks that aren't receiving commentary from blogs and other social media sites. Its very easy to fake the success of a network using fake traffic and fake user accounts. 

This is a great question, which there are really 2 or even 3 parts to answer: the failure of the Pets.com crowd, the success of the Amazons, Ebays and PayPals of this world, and how they compare with today's new kids on the block.

Pets.com failure

Firstly, to understand what happened with Pets.com, we have to look at the wider dot com boom cycle from the point of view of one of the companies involved.

Internet based business was seen as a revolutionary concept. Even in the days when less than 10% of the US was online, the general market consensus was that they would reap massive rewards. By being market leaders, as the success of the internet was seen as inevitable, they could not fail. This created an opportunity for capital investment with unprecedented returns.

Technical expertise was a requirement for running dot com businesses, the typical business people of the 80s needed technical help, which they had to pay for at high rates. Much like the guy who sold shovels in the Gold Rush, many of the people who made money from the internet bubble were not the businessmen, but the technical people advising and providing services. So when dot com businesses were set up by the technically gifted, they were able to attract a lot of investment.

The business people brought on board had no idea how to deal with dot com business, but knew they were in a highly competitive space, so spent enormous amounts of money on advertising. The technical people had no idea about business, but knew they had to get out the best product possible in a highly competitive space, so spent enormous amounts on R&D. Investors did not know how to evaluate the R&D process, even if they understood the business processes (which many investors also did not). This amount of uncertainty, the competition and the rapid burn of cash increased the volatility of the internet business.

Of course, this high volatility set the stock trading markets on fire. Share prices were pushed up and up as more was spent on advertising and research. Investors were more certain of the success of their chosen investment vehicle the more they saw products and advertisements for their efforts. Whether these products and advertisements were effective or not. This sent the spending cycle into overdrive, and managers were spending upwards of 70% of their investment in these 2 areas. Companies were even buying out their competition to gain market share, when they could little afford their own operating costs.

Of course this excessive spending eventually resulted in negative profitability, layoffs, debt and a sharp decline in stock prices. This is exactly what happened at Pets.com.

PayPal success

Where Ebay provided a simple way for anyone to buy and sell goods, and thus be a part of the internet boom, PayPal provided the means to do business. eBay's success was mainly due to its 'stickiness' - its ability to attract and hold users, the product of its ever-changing content. The one to ten day auction format ensures there is always something new to look at. eBay's competitors cannot compete with such momentum, and a growing community of buyers and sellers creates ever greater demand.

Customers came to eBay to trade collectables in the early days, but today it is used as a one-stop-shop where all needs and tastes can be satisfied. This is the foundation of Long Tail economics, one platform by which every individual experience is different. eBay is very simple for buyers to use in ways that matter to them and which are aligned with their own particular needs. The site also builds a sense of community among user groups, providing greater attraction to a customer's specific interests.

I'm glad you chose PayPal as an example of internet success, because to my mind it was one of the first examples of what we are now calling Web2.0, and Long Tail economics. PayPal's massive success was almost entirely down to its use by businesses and individuals using Ebay. Ebay had been successful in its own right, but the introduction of PayPal made exchange of money faster and more secure, ensuring the further success of both.

The next generation

There is always a gamble in investing in any company, high-tech or otherwise when they are creating products. The product must have a customer base willing to adopt the technology at all stages, innovators, early adopters, early majority, late majority and laggards. Particular points where the product may fail are at the innovation stage if the market is not ready, or too late, and when "crossing the chasm" between early adopters and early majority. I recommend reading Geoffrey Moore's book "Crossing the Chasm" to anyone thinking of investing in technology.

There are many important areas of business success including proper market segmentation, positioning, marketing strategy, choosing the most appropriate distribution channel and of course appropriate pricing. This is roughly the aim of product management, and could also have prevented many of the early dot com losses.

Generally speaking these days, technical people and business people are much closer together in understanding, lessons have been learned from the internet boom of the 90s and although this doesn't mean they cannot happen again, it should be obvious to any management team if the same patterns are in danger of being repeated. For the potential investor, due diligence is well advised.

The key areas to focus on are:

Product segmentation, does the product fill a need, can the market be targeted effectively and remain of a large enough size to make money?

Marketing, is it being pushed to the right people at the right time, this is not a static function?

Distribution, are enough people aware of it, and can it get to them?

Pricing, is the product being sold too low or too high, could there be a greater return by lowering or raising it?

For Web2.0, there is no magic formula. Facebook is a very popular platform, and there may well be many applications which can be launched from it, although so far nothing has been wildly successful. Personally I would suggest sharing of media, such as with YouTube will be popular. Search facilities designed to look for specific people, such as with spock.com may prove to be an unexpected winner, especially when combined with other applications. The real winners as always will be the people providing the tools however. Microsoft has already released Popfly, and Yahoo has its Pipes service. Building the applications to everyone's specific needs will be what moves the market forwards.

Very simple. Answer two questions: Do they have a steady core of users? Do they have a viable business model? 

And no, this is NOT the dot-com bubble over again. That time, it was FUD about so much more than e-commerce. Don't you remember? The Internet changes everything? The New Economy? Hundreds of directory sites, media outlets, you name it sites and search engines got funded, and bust. No e-commerce there. And nobody is talking about new economies today. The stupid money

In the case of social network sites, the actual area is not interesting. If the activity which users are being social around is photos, university, or how many contacts they can make is indifferent. The important thing is that there is a steady group of users who use the site to communicate with each other, and that one users network can be used by another user to reach members of that network. If users find this valuable, they will pay for it; but in most case they do not, or do not have the money (for instance, being teenagers), so they pay with their time (and consume advertising).

Social networking sites are no different from other media outlets (because that is what they are): A stable, active, tightly-knit user group drives revenue, be it from advertising or subscriptions, as long as it is big and interesting enough for advertisers - or for other users. If the company has found a way of monetizing its users, then it will work. It is not harder than that. This is also where to look for the gems: Which social networking sites have a persistent, active user community?

This also means someone will be interested in buying them. And it does not have to be Google. Cisco already did their shopping, so there should be plenty of space for those who want to be a networking site for professionals in some areas. By the way, the success rate so far seems better than the dotcom era, but VC:s still count a 1 % success rate for their investments as good.

Hope this helps

//Johan

This question is really about which new services have their pulse on today’s culture.

Looking at past failures, one thing is clear. Knowing what will succeed and won’t is not easy. But in general terms the companies mentioned such as “pets.com” are far from niche or exclusive. Even foreign foods is a vast arena. What tends to succeed is the very niche or the most technically capable.

What does this mean?

1.       Pets.com isn’t niche. Jack Russells.com or greengardenfrogs.com would be niche. Pets is too vast a category to get people to feel part of something or indeed to make a community. By trying to offer too much in the category “pets” the real value for true dog only or cat only or fish only lovers weren’t pinpointed.

2.       Looking at social networking MySpace was the first; but in Europe without a doubt Facebook is the winning in terms of appreciation and uptake. Facebook is threatening long standing networking clubs such as Linked In. Why? For the opposite reason. It’s not niche. Anyone can join, it’s easy to use and business people or consumers have a place to show their own humanity.

Why is this important?

It’s important because sometimes making contacts or approaching people in the formal environment is difficult. Sending messages via Facebook or inviting people to see pictures of your family and sign –up for certain groups is an informal way of doing business or interacting.

This brings us on to a key point. In today’s society word dominates. This means that people don’t go out or communicate. The average married couple says on seven sentences to one another each day. If you are not working, you are commuting, shopping, watching TV or sleeping. This means that it becomes increasingly difficult to interact, share or communicate with friends and family or indeed make new friends.

Enter social networking.

Social networking online is like the SMS of mobile when it launched. It’s discreet or loud. You can hide or promote anything at any particular time. But it also provides an alternative to email or calling and a way of communicating making interaction simple.

At the same time the rise of micro-blogging sites such as Twitter shows again how information can be transferred and “vital” information communicated in a simple effective way. Friends or strangers can share parts of their lives with anyone that wants to listen. Peers can share news or tell tales and consumers keep demanding the information. The micro-blogging phenomena is amazing. It provides people a channel to promote themselves and vent information. Families or parents and kids that haven’t got time to make calls or send cards anymore can spend a few minutes a day alerting people of anything major that happens in their busy lives such as “baby said gaga today”.

Now social networks such as Facebook are also interacting with Twitter and users of Facebook can also send Twitter messages across platform. So social networking services also interact with one another.

This is fun but also dangerous as since the introduction of applications on Facebook the Facebook service has seen lots of downtime. This is frustrating and unacceptable. If this continues it will be a reason for business users to find alternatives and only use Facebook for consumer purposes… or indeed look for a similar alternative.

This leads us to the answers of this question.

1.    What characteristics should an investor look for in figuring out which companies this time around will be the successes -- and how should we avoid the Pets.com of the social networking era? When assessing which companies to purchase an investor should look for the following.

1.    Simplicity and speed. Just as Orange the UK managed to move for the last time the mobile network in the UK to the market leader in less than 4 years – there is always room for another competitor in the market. But what differentiated Orange at that time was originality. A phone service for the first time wasn’t a phone service it was a way of communicating, reaching out and finding the future.

2.    So any new social networking service needs to offer more than just a service. It needs to offer the promise of something better. For example with the emphasis on the environment at the moment the social networking could be “green” or support a cause. This would differentiate it.

3.    Similarly, instead of micro-blogging a new site could play on the competitiveness of individuals and enable people to vote or promote and share the hottest comment, blog, service etc. This means that users not only communicate with one another they can communicate with the service itself… or find strangers that are similar to themselves.

4.    Paypal is a success because its easy. But its also expensive. An alternative to Paypal for small companies only or cheaper rates for business would succeed. But often investors fail to see the potential when fighting with goliaths such as Paypal. This is a shame because Yahoo! and Excite were created before Google – but its Google that currently prevails.

5.    I recently interviewed an interesting company called Anam that offers SMS payment secure transactions at nominal cost and no exchange rate fees. The #cash service is patent pending and very innovative. This could be a real PayPal alternative. 

What criteria should we be focusing on and what hidden gems or opportunities are being ignored?

There should be a marriage between micro-blogging and speed dating for the enterprise giving people the chance to get a job or promote themselves in a couple of sentences before filling out forms and lengthy applications. Often vital information can be conveyed in a few short sentences.

This would revolutionise the job market. The business market remains in the dark on social networking and this is a shame. There is a real demand for professional social networking services that can help promote the small and medium business segment. Daily companies are tweaking the internet to ban users access to Facebook or MySpace.

But what about a social network for the enterprise that users are encouraged to use. The amount of in-work problems that could be solved by clear communication or a less formal email environment. The Intranet with a soul where employees could post pictures of their family, wedding etc. These business services need to be created.  But putting business to one side, there is still a lot of cultural consumers’ services and social networking offers that can be addressed. The three main targets are:

1.    Kids

2.    Students

3.    Singles

Anything that would help children to read, Students to study or Singles to find love is a winner in the social networking space.

But of course that is also obvious.

Social networking winners for the future:

1.       Friend finder services

2.       School reunion sites

3.       Survival guides – how to get through university; study notes – share and swap tips; story telling – what happened to you before, during and after the rock concert…

I made a post on my blog today, regarding why Facebook can be valued at $10bn - please read before continuing.

My belief is that social networks will sooner or later become the next players in the contextual advertising market, in which Google is already earning $5bn/annum.  This market becomes more and more valuable as the social networks are able to deliver targeted advertising via 3rd party sites, using demographic & other data, collected via the network itself.

 When investing in the social network market, some of the criteria to focus on follows:

 1)  Growth rate and traction

When focusing on a certain niche & vertical, it is important to ensure that the offering meets the needs of the user.  Looking at growth rate of registered users is one easy measure, but it should be proportionate to the rate of content creation and active users on a monthly basis. 

 2)  Market value of that demographic

If social networks begin to start targeting their users on other sites of similar interests - it is important to understand what the size of that market is, in terms of economic value and advertiser revenues.  Investing in a social networks for cattle farmers would not make sense, as the online revenue for that market is miniscule, in comparison with say Palm Pilots.

 3)  Mobile is secondary

 The mobile market is very disparate, and having mobile access via the web is important, but not in and of itself a differentiator.  The risks in this sector are very high.

 4)   Global Access

Focus should definitely be on opening up global markets (i.e. I wouldn't invest in a social network that is limited in scope to a certain geographic area).  The Internet is the world's largest economy - Google proves that by earning around 50% of it's revenue from International markets. 

5)  Developer Network   

 Social networks should have developer network plans in the works, ala Facebook.  This market will become hotter over the next few years, and it should not be an afterthought.

Typically, new social networking enter the market with two value points: 1. differentiated user interface (nexopia.com) , and 2. targetted market segments (asmallworld.net).    Things are their own cannot sustain a long term business plan (or a VC's exit plan, for that matter!)  Despite this, SoNets are attracting substantial investments.  Case in point - Masala.com announced today that it raised $4.5 million from VantagePoint.  The company is still in early development and doesn't even have a public web site.   With such strange behaviors it's easy to start fearing The Bubble. 

 So - ignore the above value props.  The flashy presentation will become outdated in 2 weeks.  The verticals will be compromised or copied (a la pets.com)

 The true innovators will propose that the true special sauce is in the platform and that what people now recognize as social net sites is really just a GUI to the platform.  The strength of the innovation will be determined by the agility of the platform to handle complex relationships.  For example LinkedIn does a good job at tracking the degrees of separation between people.  Facebook does a poor job - it lumps all your so-called frioends in one unmanageable cluster.  Conversely, you can't do much with your connections on LinkedIn.  Once you assemble your list the site is very static.  Facebook has done well with its API encouraging application developers to build products for Facebook users. 

Despite the success of these sites, I believe the category is in its early stage - there's lots of room for dominant players.  Sites that develop powerful back-end systems to offer highly valued user experiences will win.   Areas I'd look for as an investor include:

1. Providing power and agility to search and link up:   Look to some of the bigger dating sites for amazing examples of easy browsing, searching, finding, and filtering.  Some even monitor user behavior to influence search and "recommendations". 

2. Allow users to organize themselves "organically".  Most (if not all) the SoNet sites group users into lists:  friends,  threads, groups.  These are really flat lists that don't reflect well how people view their real-world relationships.  Think of a family or work group.  These could be better represented by multiple-hierarchies and contextual clustering.  You might also look for allowing multiple views of the same user: co-worker in a different department, same co-worker part of my softball team. 

3. Take advantage of real-time context.  The value (and short-lived novelty) of services like twitter, or the annoying Facebook / Wall updates is that you get a lot of real world status information.  Unfortunately all that data isn't useful because it's not presented in the context of your current task.   It's not meaningful.   When that real-time data is integrated into other systems, it becomes more valuable.  Imagine Twitter as the mobile front-end to your SalesForce.com CRM account. 

Accomplishing any of these innovations would make for an enticing value proposition.

mitch@sensorymetrics.com

The investment firm I work at has considered this issue extensively. Our methodology begins by identifying market opportunities. We build the business case, recruit management teams, and ultimately invest $3M-$5M per concept. Our past startups range from financial services to offshore product development.

The first issue any investor must address is what market to focus on. In evaluating the investment potential of Social Networking, my firm has decided to pass for three reasons:

First, there is already strong competition - we prefer areas with weak competition.

Secondly, there are very smart investors in the Social Networking market - we prefer areas where an average investor is likely to succeed.

Thirdly, there are very smart entrepreneurs with fantastic products - we prefer areas where an average product will be can make money

In short, there are certainly some opportunities in Social Networking, but why invest in Social Networking at all, when there are so many other fantastic possibilities that can offer high returns with far less risk?

If I haven't dissuaded you yet...

Of the thousands of entrepreneurs all entering this market, only a few will succeed. If you're still set on going the high-risk/high-reward route, stay three critical issues are easy to overlook when investing in Social Networking:

Early stage investing is heavily dependent upon the management team. Some of the most profitable VC firms in the country say that they don't invest in ideas, rather they invest in management teams. Given a superstar management team, the business model will follow; but a great business will fester and fail without the right people. Rule 1: don't be awed by the concept - look at the management team's previous successes

Next, remember that the fundamentals of business will never change. Rule 2: the goal is profit. Make sure the business is targeting a market that can pay and that is willing to pay. If you're thinking of a vertically-focused social network, what is the discretionary income of that vertical? How will the company both attract users and generate revenue/profit? Is this all going to be ad-based? Who wants to advertise to this segment?

Finally, Rule 3: don't forget the exit strategy. What if Google doesn't buy the company? Can it survive as a standalone business? Can it grow large enough for an IPO? If the business doesn't have a viable exit other than selling to Google, then it's probably not a business.

Good hunting -

Daniel Berch

Concern that indicators are pointing to the possibility that activity within the social networking realm is forming a bubble, is far from fringe and/or cynical. However, the reality is that social networking is a natural outgrowth of the next shift for the technology economy. Understanding the fact that we are witnessing a growth phase of IT innovation is critical to developing a level-headed synopsis of this and the next phase. Successfully gaining a clearer picture of the future for the social networking arena will require criteria which can gauge the elements of the current set of offerings therein.

Open platforms will prosper
In order to find success as a social networking offering, it is becoming increasingly important to embrace the concept of developing an identity as an open platform. Even leaders such as Facebook have come to grips with this reality. Fellow Goliath, MySpace has yet to follow suite, and it may cost it some mindshare going forward. The catalyst, ironically, is the demonstrated success by two of the more successfully companies from the dot-com bubble era: Amazon and EBay. Both have evolved from online web sites to e-commerce hubs to full fledged platforms by embracing open Application Programmer Interfaces (API). The availability of interfaces to underlying functionality which characterizes a service has given way to the opportunity to achieve explosive relevance, where an original economy of scale is capable of spawning the existence of succeeding ones.

Despite the fact that most offerings lack the breadth and depth (plus the according valuation) of a Facebook their willingness to proactively seek to open up to the outside world is a key indicator for success. Remaining closed limits the reach and potential explosive relevancy over the short and long term, respectively. Yet it isn’t necessary to create an entirely custom API from scratch, either, as a host of web-based Application Programmer Interfaces (API) like Representational State Transfer (REST), Really Simple Syndication (RSS) and JavaScript Object Notation (JSON) has emerged.

The aforementioned make it possible to expose a wide range of functionality content and functionality in a consistent manner in which the outside world can access it. The goal is to create as many points of intersection with other that of the users and developers of applications, services and ecosystems. As API’s garner more popularity and increase in quality, the social networking sites which have already integrated them into their offerings will benefit accordingly.

Winners will enable seamless marketing
The marketing community has been struck with the daunting task of reaching social networking crowds but have yet to make significant progress in identifying tactics that are better suited than traditional ones. The following characteristics make social networking site users particularly valuable to marketers, since they:

• Are interested in connecting with brands. The movie X-Men: The Last Stand has more than 2 million MySpace users as friends. Brands which have already established mindshare in the physical world are welcomed with open arms within social networks. For brands that have yet to gain any mind share social networking provides the ability to do so virtually, building momentum there and translating it into success in the real world.

• Can serve as viral leaders. Social networking site users are also valuable as outlets for viral growth. In 1999, the studio behind The Blair Witch Project used the Internet to suggest that the events captured in the film were real. The result was a gross receipt of 248 million US dollars. Social networking provides an outlet for a brand of grassroots-driven, viral promotion that bodes exceedingly well amongst younger crowds.

• Provide access to social capital. In today’s increasingly networked world, social capital is becoming of paramount criticality. The term refers to the collective value of all people who are known within and external to a social network, plus the inclinations that arise to form norms of reciprocity. With tools like social networking, there is a budding tendency by the individual to accept and eventually come to trust what is known by those connected to his/her social network.

Successful social computing platforms will actively seek to harness relationships with marketers in order to enable users to be reached without interrupting a cohesive experience. Interaction between marketers and users should assume the form of natural occurrence as opposed to traditional marketer-consumer dialogue. The sites which recognize this will emerge as hot targets for online marketing efforts.

Usability
The criteria used to rate the usability of social networking sites is similar to that of regular web sites. However, the lifeblood (and typical user) of a social networking web site is the young adult and therefore the site must prove especially capable of facilitating such an individual in the areas of profile creation and usage. In particular, the following must be addressed:

• Privacy and security concerns. Privacy and security policies are vital in providing users with the assurance that common concerns about engaging in online activities are being capably met. These are principally critical when asking users to provide personal information which will be maintained by the web site.

• Readability. It may seem intuitive but easily readable content and field labels are a must have. All content should easy to read, characterized by charitably sized text and large buttons. Diminutive text, especially during the registration process should not be tolerated as users should be given every reason to read terms/conditions/policies. Wording should be clear and instinctively understood by the average person.

• Screen flows. An efficient sign-up process is key to establishing the basis of a user’s interaction with the site. If it is too complex, users will have reason to quit before getting starting. The registration process should only require basic information fields and should avoid prying for additional personal information like address(es) and phone number(s). If too many steps/screens are involved it will be deemed prohibitive and will deter follow through of the process. Additionally, it should be exceedingly undemanding to perform basic actions such as adding contacts to a new profile.

• Error recovery/event feedback. Clearly discernable error messages should be provided to users to aid them in correct form submission mistakes. These should, ideally, be integrated directly on the current page where users enter the information. Pop-up windows containing error messages are to be avoided and multiple errors should be displayed in close proximity to the related fields to prevent users from being forced through multiple submissions.

Stickiness as a metric for future growth
Moving forward, the ability to exhibit strong adoption rates (stickiness) will be driven by the value that users extract from social networking sites in the areas of:

• Increasingly robust personal profiles. As social networking gains more mainstream momentum, it will be necessary to enable users to expand the concept of their personal profile. This area is set to become a competitive differentiator. The concept of the simple text/image based profile will be phased out by more personalized forms of profile construction. As Web 2.0 technologies progress, the leading sites will step ahead of the pack and provide highly customizable display options and motifs.

• Mobile integration. This is an area which is extremely ripe for innovation especially as the capabilities and range of mobile devices continue to grow. Consideration of how to profitably form a cohesive mobile experience should be driven by the strengths and weaknesses of an existing social networking offering. The initial focus should be on finding a reasonable intersection of mobile device owners and current social networking users as opposed to attracting those who haven’t yet made a commitment to social networking.

• Geographical context. Different from location context, which would be included in the above section, there is a need to address the fact that users exist in one or more geographical locations. Better association between geographically relevant entities, not just Google ads for local services but a purer form of localization will provide added impetus to use social networking to facilitate offline connections.

Who is willing to pay?
At some point in time after having established a solid user base, it will become relevant to explore opportunities to introduce the option of paid services. At the current moment, this isn’t applicable for the majority of social networking sites. Yet those who provide the fundamental elements of a quality offering will be in position to capitalize on it when the time comes. Transitioning a free user into a paying one is not easy, but the companies who are consistent – adding incremental upgrades to functionality, actively integrating user feedback to provide a sense of responsiveness and remaining dedicated aligned with the needs of the user community – will have the easiest road in monetizing the notion of the paid user.

Untapped possibilities
Virtual world integration: It is going to take time for the business models surrounding virtual worlds to stabilize, but the first potential area of revenue generation lies in links between profiles as they exist online and their virtual world representations. This area has yet to attract very much thought leadership, but is set to emerge pending the solidification of virtual world business infrastructure.

User generated content integration: This area has a tremendous amount of potential to better connect the wave of non-traditional content to networked groups of people. Copyright and integration issues, however, are standing in the way of progress. The link between individuals connected through social computing platforms and the content (multimedia, blogs, etc.) they produce/consume has implications on a number of areas including search and metadata.

Product marketing 2.0: Users as marketers has yet to see its day come but is on the horizon as a possibility. Amazon has leveraged product reviews into its business model quite well and social networking has the opportunity to take the concept to another level.

Investors should consider the following characteristics when evaluating social networking companies.

1) Start with friends. While social networking offers a wide pool of potential contacts, talking to strangers or making new acquaintances isn't the main draw. Users are attracted to these sites because they want to communicate with people they already know. Therefore, job one of a successful social networking company is to facilitate interaction among a close-knit, pre-existing circle of companions. There's no doubt that users will make new connections, but a good site will be built on a foundation of existing relationships. (See point 6 for exceptions)

Facebook and Twitter exemplify the first characteristic. Users are drawn to these networks by the promise of enhanced communication with friends.

2) Enable users' narcissism and vanity. Many people—especially 18 to 25 year olds--entertain the conceit that they are unique and interesting. A compelling social network lets users construct an idealized self out of random thoughts, iPod playlists, lip-synching videos or drunken party photos, and then invites others (especially their friends) to endorse this conceit.

Facebook, Twitter and YouTube exemplify the narcissism/vanity characteristic. Facebook lets users construct paeans to their own good tastes. Twitter provides a public billboard for users' interior monologues. And Google spends millions of dollars on data storage to preserve a flood of home-made comedy sketches, skateboarding tricks and confessionals.

3) Enable users' voyeurism. The flip side of the human compulsion to gaze into the mirror is the desire to peek into windows. A successful social networking sites remove the physical barriers and social conventions that otherwise discourage our ability to sift through other people's lives.

Twitter, YouTube and Facebook exemplify the voyeurism characteristic. It's telling that neither Twitter nor YouTube require visitors to register—the unfettered ability to troll through posts keeps users coming back. Facebook, while providing some control over who is allowed to join your network, lets you see who is in your friends' networks.

4) Enable user judgments. Following closely on point 3, people love to evaluate, criticize and pass judgment on others. In addition to satisfying this urge, social networking sites can also classify and tally judgments to help direct others to the most popular—or most reviled—content on the site.

YouTube and Twitter exemplify the judgment characteristic. YouTube members don't hesitate to write "You suck" in the comments section. Twitter's "Followers" tally serves as a crude indicator of a person's status within the community.

5) Enable expansion based on common interests. Once your friends are in your network, it's time to branch out. Users will broaden their connections around common points such as shared interests or geographic proximity.

Facebook and Twitter exemplify the expansion characteristic. Facebook makes it easy to add friends, while Twitter continuously exposes users to new posters and lets users follow each other.

6) The exception to point 1 is groups that coalesce around profound experiences, such as pregnancy and childbirth or a cancer diagnosis. These groups form expressly to connect with strangers who are sharing the same experience. However, other characteristics certainly apply.

Investors should look for companies that have at least one of these characteristics. More importantly, they need to invest in originality. Facebook already exists, and there's little to be gained from applying its basic structure to niche audiences (It's like Facebook for cat lovers!). Of course, finding originality is the hard part.

Placing your Pennies Properly; Investing in Social Networks in 2007 

The question on the table is "What Social Network Investments Make Sense Today?"  There are definitely eerie parallels between the dotcom funding bubble of the late 90's and the irrational exuberance over social networks today. But if you step back and take the longer view, the parallels are not as eerie.  Every time there has been a "game-changing" innovation created by the technological of the day there have always been modern-day Carpetbaggers looking to opportunistically exploit the changes of the day. Ah, but where there are great rewards risks there are also huge risks.

Just look back at the California gold rush and the launches of the railroads, of radio, and of television; they all changed the game and they all contributed to outlandish speculation with many, many casualties along the way as the select few became obscenely rich. What's more, shortly after each period people tend to consider the period to be all downside and no up, but they fail to realize it is exactly the crazed period of investment that funded the new infrastructure that future generations will leverage spectacularly. If it were not for company's like Amazon.com sustaining huge annual losses we wouldn't have gained consumer confidence in e-commerce. And without all the telecom companies laying outrageous amounts of fiber during the dotcom boom we wouldn't have a Web 2.0 to get over-excited about. 

So a few investors lost big on the dotcom boom, but greater good was done! All in all, the bubble really wasn't such a bad thing after all!

But then that wasn't the question was it?  ;-)

Seriously speaking, the investor must look out for himself because for him it matters not whether the world benefits from his investment it only matters that his investment provide him exceptional returns. or at least avoid the intense losses frequently seen during the crashes closing the prior periods of excess funding. To repeat the question, how then can one be wise when investmenting in social networks?

My simple answer is "Don't make investments in Social Networks." 

But that's rather harsh, no? Still, I believe that after explaining myself any savvy investor will agree with my logic but more importantly find that I really didn't offer any unique insight at alll; they knew it all along. The problem is that the question "What social network investments make sense today?" is the wrong question. It's like shopping for features and ignoring benefits. Just as no level headed business person would be wow'd by features that don't accompany benefits,  no savvy investor should get excited about social networks just because. They should instead get excited about companies that generate incredible value for their constituents in a manner that wasn't previously realizable and that can mine that value via defensible business models.

See, there's really no new rules when it comes to the Web 2.0 era, just as there were really no new rules in the dotcom era; common sense still rules the day.

But it would be a serious sidestep if I were to leave it at that. So in the interest of helping guide the investor who can't break the siren's spell of social networks I'll attempt to eliminate any pretense from my remaining comments.

What should an investor look for?  To start look for passion. Look for a community that shares a passion, such as dogs [1], gothic culture [2], and shared interests offline [3]. But more than just shared passion, look for a community with passion the website that empowers its members in ways that feed the collective ethos of the community. Or better yet  look for communities that feed the collective angst of those who had previously felt disenfranchised by society. Hell, look for a community that you the investor really want to be involved in for no other reason that its your passion. For a great example or feeding the ethos look at this paperback sharing site [4] serving voracious readers on a restricted budget, a site whose customer service is performed primarily by its most avid customers!

And look for a founder with passion; somebody who would be doing if free anyway if there wasn't a choice to do it for an upside. But not passion just for growing a company and making themselves rich in the process, that's almost counter productive. Instead  look for passion in addressing the needs of the community the founder is serving. Look for someone who started their company because they saw a need no one else was addressing and couldn't stand to live in a world where there vision might never exist. Look for a company whose founder is their target member.

By the way, and some of my fellow entrepreneurs will hate me for this, but if you do find a great social network to invest in don't pour in outrageous sums of money, Web 2.0 companies are simply not very expensive to run. Give them pennies instead, and make sure they are used judiciously. Meter the funds, keep them hungry, and make access to the funds based on achieving specific business goals and/or only use them for well-vetted purposes. Nothing empowers founders to spend excessively than access to someone else's money to spend; I know this from painful experience, though I won't say from which direction. :)   In short, give them lots of funds and they will just blow it and so watch over your investmentees expenditures as if you were Clark Howard [5] paying for a haircut!

And whatever you do regarding that great social networking investment, don't even think about getting rid of the founder. Don't be so smug to convince yourself that the golden rule is fully aplicable here (i.e. "He who has the gold makes all the rules!".) Never believe that just because you provided the cash the the founder is a fool and that you can replace them with a professional manager once the company gets to a certain level. Augment them; yes, but replace them; no.

The founders of a successful social networks take on almost mythic proportions and their aura is a critical component of what makes their community thrive. A strong social network would survice its founders being hit by a bus as it's members would maintain the community to honor the founder's memories, but an investor-orchestatred outster ala Apple and Steve Jobs in 1985 will just result in a nasty backlash among the defacto "leaders" of the community. You'll most like soon have a strong competitor in the form of your company's founder and a competitor who will easily to siphon off your most passionate members and hence the lifeblood of the community. Take Mambo vs. Joomla [6] as a somewhat related analogy.

Well, I guess in reference to the importance of a social network founder's ongoing participation, the rules have changed!

So at the risk of repeating myself from ealier, don't look for social networks, think outside the box. Look for companies that may not look like social networks but that connect people while addressing a real need; the social network would likely just be the means to that end. For example, consider websites like simplephoto [7] that offload administrative and fulfillment processes so help professional photographers can focus on being better artists and connecting more with their customers and other photographers.

And yet aother very real investor concern is the fact that, as Kevin Kelly says [8]: "Them that’s got shall get."  Less obscurely, the network rewards success and it is a "winner take most" landscape. Just as the dotcom successes of eBay, Google, and Amazon made others in auction, search, and ecommerce basically irrelevent so to will MySpace, FaceBook, LinkedIn, Meetup and a few others be the alpha dogs in the social media space. Most other social networks will fall as repetetive friend requests lead to across-the-board "social network fatigue" and people decide to limit their involvement to just a few social networks. 

Still convinced that social networks are today's goldmines?  One way to combat the winner-take-most effect is to focus on the passionate-based networks I mentioned before but be aware that those too will eventually give way to the leaders in the social network space. As with the leading pre-internet online services Compuserve, The Source, Prodigy, and the early AOL whose walled gardens eventually fell to the value that the Internet's universal connectedness brought forth, so too will these walled-garden social networks open up and allow for sharing of friend lists and more.

And with it, today's affinity social networks will become the sucker fish feeding off tomorrow's great white sharks of the social network world. These passionate-based groups will become the special interest groups of the larger social networks with business models forced to evolve to ensure their survival in ways we likely can't even yet imagine. And many of today's social networks will become the analogal equivalent of today's Amazon allifiates and eBay Powersellers.

Actually, in my opinion one of the clearest opportunities in the social networking space is for integrating social networks. Companies that seek to connect the disparate social networks and make them one; as Kevin Kelly also says [9], "Touch as many nets as you can." Find companies that want to be at center of those connections. Although it's not clear there will be such a winner in this space, if one emerges it will be powerful and will have been a great investment indeed. But be aware that even if such companies do manage to establish a stronghold in this space, as with social networks themselves, anything else worth doing at scale of the Internet, and to paraphrase the lead character in the cult classic series Highlander [10], ultimately "There can be only one!"

-Mike Schinkel

[1] http://www.dogster.com
[2] http://vampirefreaks.com
[3] http://www.meetup.com
[4] http://www.paperbackswap.com
[5] http://en.wikipedia.org/wiki/Clark_Howard
[6] http://www.hosting-netexplorers.co.uk/web_hosting_uk/content_management_systems/ mambo_vs_joomla.php
[7] http://www.simplephoto.com
[8] http://kk.org/newrules/newrules-2.html
[9] http://kk.org/newrules/newrules-3.html
[10] http://en.wikipedia.org/wiki/Highlander_(film)

The internet has always been more about *people* than about computing, and the recent emphasis on Social Networking is an appropriate evolution of this key aspect of online life and the online medium. From an investment point of view the explosion of "Web 2.0" websites creates many opportunities that are going to be buried amongst a larger number of questionable approaches to capitalizing on the rise of the social internet. Also, there are many unique challenges to valuation of these new companies, most notably the ghost of Web 1.0 valuations where traffic was generally considered a good proxy for potential profitability even for companies that were not showing profits or much revenue.

Instability suggests an evolution model where companies work away from failure. Investors therefore may want to invest broadly rather than deeply in a small number of Social Media experiments since the next "big thing" is unlikely to be a function of early high capitalization. Notable examples of companies in the social Web 2.0 space that did not have high early capitalization are: Facebook, Myspace, and YouTube, all of which went on to become giants and yield spectacular returns to early investors.

Positive Investment Characteristics of Social Media Companies:

Existing traffic base that is growing rapidly. Speculative Social Media is *not* social media!
Strong, focused founders who can communicate effectively.

Strong staff who are flexible, enthusiastic, and dedicated to the project and the founders.

Strong plan for monetizing of traffic.

Lucrative niches most desirable (e.g. medical more desirable than gossip, though all traffic is monetizable so this must be factored with traffic issues)

Negative Characteristics:

No working site developed. "If we build it they will come" is a questionable premise at many levels, and low capitalization needed for social media means there is no need to invest in such companies.

Low traffic or flat traffic. Social media should be growing at a noticeable rate, though sometimes seasonality must be factored in (e.g. in Travel Sector Summer traffic can be 2ce winter traffic, in school information sector (e.g. history) summer traffic can be a fraction of winter traffic when school is in session.

Founders can't communicate effectively, inhibiting staff and growth and relationship with investors.

Staff is unenthusiastic or feeling "sold out" during the growth phases.

Recommended Investment Criteria:

All positive aspects listed above, combined with these standard metrics:

Total Unique monthly visits.

Total Subscribers/signups.

Rate of Traffic Growth.

Total Current Revenues and scaled up estimates of revenue at higher traffic levels.

Total Cost of Operations and scaled up estimates of costs at higher levels.

Comparison of the above metrics to other social media sites

Hidden Gems:

The new Startup Camps and Mashup Camps of Silicon Valley, MIT, and (coming in September) Dublin Ireland offer a detailed look at several upcoming social media companies that may be below the radar of TechCrunch and other "insider" networks of Silicon Valley.  Perhaps as importantly these conferences give some insight into the people and critical thinking in this space. More details about these conferences can be found here: http://www.mashupcamp.com http://www.startupcamp.com 

Here are some of the companies at Startup Camp 2:
http://wiki.startupcamp.org/wiki/StartupCamp2AttendeeList 

I'm also noting two potential "hidden gems" that may deserve investment and the guidance of seasoned business people:

http://www.broadbandmechanics.com/ Marc Canter's "People Aggregator" is a well-designed "build your own social network" effort. Ahead of it's time this project is a potential competitor for the heavily funded "Ning".

http://www.TechMeme.com by Gabe Rivera would be my pick for a potentially explosive social networking application.   TechMeme is used by many tech insiders to filter information from the plethora of online sources.  The algorithm cleverly ranks stories by popularity and linking relationships, and if the algorithm is scalable it may offer a path to better all around search ranking, especially for blogs and news.

Additional sources for Social Media information:

Mashable Blog by Pete Cashmore  http://mashable.com/

Programmable Web by John Musser   http://programmableweb.com

Social Networking As A Fundamental Internet Behavior

Social networking, by the nature of its growth and ubiquity, has become a fundamental behavior of the internet user, joining the ranks of search, messaging, ecommerce etc.  The early companies that are dominant in their space were key in habitualizing new fundamental behaviors in the Internet masses, and as a result were greatly rewarded in resources and market perception that feed greater growth and dominance.

Avoid Funding David

As a quick first insight into this issue (if not already obvious), once a handful of companies have grabbed the lion's share of the market in a fundamental internet behavior, it is extremely hard to challenge their positions, especially so if you are a startup. In the social networking space, it will be extremely unwise to fund any companies with a singular purpose of challenging MySpace or Facebook in social networking for the general Internet masses. Make peace with Goliath and seek opportunities elsewhere. 

The Verticals

As with each fundamental behavior, the utility of social networks is potentially broad and diverse. As users become more sophisticated, they will find the basic services provided by early companies inadequate for special purposes and niche interests. If we look at ecommerce specifically, even with the failures of Pets.com and Webvan.com, there are a myriad of healthy ecommerce businesses today in a variety of niche verticals (including pet food, foreign goods and grocery deliveries), operating at different scales with respect to their market size. The mistake that was made during the dotcom bubble stemmed from misjudging the market size for certain verticals that resulted in overfunding and unrealistic expectations. So in the social networking era, recognizing the value of each vertical is critical in not repeating the same mistakes.

Instead of exploring individual verticals here (there are too many to do so), we will explore characteristics that hint at a potentially big vertical, prior to having the metrics of exponential user growth, high return visits and long duration-of-stay that will clearly confirm the space as a valuable one.

• Existing social engagement in the real world and in old-school community sites
  There are verticals where you can find large communities already interacting socially prior to the social-networking era. We can find these communities online and in the real-world. A lot of these communities hang out at discussion forums where they have already formed cliques, have tacit reputations among their members, have rudimentary profiles etc. You might be surprised to know that some of these boards (topics ranging from sports teams to anime to faiths) have millions of registered members using relatively 'primitive' technology to connect with one another. In the real-world, we see mom's club or playgroups, book clubs, and clubs/societies in schools. We can use the growth and size of membership in these existing social networks as indicators of whether certain communities will be successful in the modern social networking era.
  
  
• Community that collaborates to better solve problems
  The need to solve problems that can be better solved collaboratively is a strong motivation to join a social network. This is in contrast to social networks that help to enhance your lifestyle or status. Examples like support group for people with serious illnesses, people who are trying to find a diet solution that work for them, people who are in research etc.
  
  
• Social networks that help you achieve life's milestones
  There are milestones in life that most people in most cultures will encounter: education/college, dating/marriage, career, pregnancy/child-rearing and retirement to name the common ones. For the first three, we have already seen online communities (in US and Asia) form around college prep/selection, career/jobs, dating and pregnancy/child-rearing. Many of these communities still exist in the form of discussion forums and might be nurtured for further growth using current social networking features.
  
  
• Social networks that help filter the noise for important and useful information
  We have seen the use of social networks for filtering news, stock tips, restaurant recommendations/reviews etc. Some of these sites have become reliable sources of information for certain verticals An example is Investopedia that was acquired by Forbes, an old-school magazine that have aggregated over the years a big audience of business and finance professionals.

The Horizontals

Again, as noted in the issue write-up, there are successful businesses that are extending and enriching the functionality of Amazon and Google for the generic masses. In the social networking space, there are a few companies that have achieved critical mass in the areas of image hosting, slide shows, layout skins and glitter text and many others trying to gain critical mass in areas like messaging, gaming, p2p payments/commerce.

In the horizontal space, the main difference is that the extensions/widgets have to be running on top of a proprietary social network. This is a risk to consider as some of these extensions are also things that Facebook and MySpace may be interested in providing themselves. Features like slide-shows, profile layout designs and messaging are closer to the core platform features of a social network. Facebook and MySpace might want to own these features as a way to differentiate themselves. As we have seen, MySpace have chosen to use their leverage to strong-arm YouTube out of their network and promote their own video feature. On Facebook, they have chosen to compete on a more 'level playing field', claiming that their own apps are developed on top of the same API as 3rd-party developers. Of course, one has to remember that they own the API as well. An example we are seeing is the case of the Superwall app (one of the most successful app on facebook) slowly becoming redundant due to Facebook improving its own Wall application.

In this space, we think that companies that already have a strong revenue stream is a wise investment. We can learn from the exit of Photobucket to MySpace. They have such deep penetration into MySpace and have such a profitable business model that it becomes an easy decision for MySpace to acquire it as an additional source of revenue driven by its own users. This is in contrast to Slide and Rockyou who also have deep penetration into MySpace and Facebook but haven't found a good business model around its apps. The build-vs-buy decision is just too skewed towards BUILD until they have something significant to contribute to the bottom-lines of the social networking companies they so dependent on.