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Nothing Lasts Forever

This social networking bubble is about to burst

By Peter L. Knudson

Right now I am logged into Facebook and just finished watching a Youtube video that was Tweeted to me by a Friend. How about you?

If you're anything like me, and millions of other Americans, you’ve probably been here before. It’s evident why social media are so popular from the user side, but they have also created a boon for businesses as well. Firms have caught onto the fact that adding an aspect of community to their websites can create a viral growth effect on their popularity. The poster child of such a scheme, Facebook, boasts 500 million active users, and countless other websites follow behind with millions of active users. Clearly, both users and businesses are excited about how the various forms of social media are the “big new thing” right now, as the endless list of websites riding on Facebook’s coattails suggest—maybe a bit too excitedly.

The surplus of excitement is causing these websites to be worth a lot more than they should, and the current valuations are shocking. The micro-blogging service Twitter was recently valuated at $7.7 billion, which seems ridiculous considering that this is almost 100 times its yearly revenue. Facebook was valued 83 times greater than its yearly revenue, at $50 billion dollars. The overvaluation doesn't stop here: Groupon is valued at ten times more than its yearly revenue, and social-gaming behemoth Zynga is overvalued at 12 times more.

But it isn’t the first time something like this is occurring. In the late 1990s, new Internet-based retail companies were the “big new thing” of the time, and investors starting throwing as much money at them as they could in an attempt to get in on the action. But even though these new websites were popular and convenient for consumers, they actually didn't make as much money as their buyers expected. The addition of the “.com” suffix to company names wasn't enough—the IT bubble burst, and the nation was met with an economic recession when stock prices plummeted.

Fast-forward to 2011, where history is repeating itself. The social networking bubble is growing. It should be clear that the bubble is poised to break sooner, rather than later, just given the prices of these companies. The Internet allows for essentially free entry to the social networking market, and as soon as a company decides to charge users for its services it loses its valuable user base to competition. This means that the opportunity to monetize these days is becoming harder and harder to do. The best example of this is Twitter, which can't seem to monetize off of its large user base and will probably never be profitable. It seems that making money on the Internet through a free service is becoming increasingly difficult. While some companies do it well, the others that find it unsustainable will eventually contribute to the bursting of this new bubble.

The American economy has seen the ebb and flow of various economic bubbles throughout its history. The signs of a new bubble are here, and while the first Internet bubble caught many people off guard, we can be prepared this time. The Internet is certainly here to stay, but its use changes dramatically from year to year. Large Internet firms could be worth billions one day and then nothing the next. In these uncertain times, conservative and safe investments are superior to those that try to ride the “big new thing.” Social media is definitely “it” right now, and they are certainly a successful means of getting people together online to build a community. But it could be soon when replaced by tomorrow’s next big thing. We've seen it with the housing market, and we've seen it with the Internet bubble—when upward trends suddenly stop, assets become much less valuable overnight, and the country dips into a recession. This time, however, we’ve see the signs beforehand, and hopefully we can prepare accordingly.

Peter L. Knudson ’13, a Crimson blog executive, is an economics concentrator in Eliot House.

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