Web 2.0 shakeout? Now they tell us!

“Early Tremors: Is It Time for Another Social Network Shakeout?” is the title of a new article this month by Knowledge@Wharton, published by the PR arm of the highly-ranked University of Pennsylvania business school. The article was highlighted on Wednesday by a Wharton column at Forbes.com and I read it after coming home from a discussion with my MBA students about Web 2.0 business models.

The conclusion of the article is a combination of optimism and skepticism:

"Even in the U.S., the most mature market for social networking, there's user growth at every category level," says [Andrew] Lipsman [of Comscore].

Experts at Wharton, however, question how long that growth can last. "The bubble hasn't popped yet and there's tremendous value in social media," says [Wharton Professor Peter] Fader. "But it's wishful thinking to [believe] that others on the 'me too' bandwagon will survive."

In a 2006 article, the Wharton faculty were cautiously optimistic:

When it comes to placing a valuation on the social network sites, Wharton marketing professor Leonard Lodish says traditional tools, such as the discounted present value of the profit stream, apply to these new Internet networks as much as they do to any other business. He recalls an argument he had with marketing students during the Internet boom of 2000 about Internet music seller CDNow. Lodish said the firm would never be able to justify costs of $70 to attain each customer. The following year the firm declared bankruptcy.

In the case of MySpace and Facebook, Lodish points out, the cost of gaining new customers is practically nothing because users join voluntarily and provide their own content through their profiles. In addition, the cost of running the sites' web servers is relatively low. If a classic advertising or subscription revenue model is used, he says, low-cost social network sites could be highly profitable.

Yahoo must buy or develop content for its site to attract advertisers and Google has to invest in its search capabilities, Lodish notes. "Yahoo makes a lot of money selling ads on its sites. Why can't Facebook and MySpace do the same thing?"

I don’t know any of these guys, but Wharton gets its pick of each year’s graduating PhDs and every Wharton prof I’ve met has been somewhere between very smart and extremely smart. (They only keep the faculty that are good at publishing in “A” journals, a somewhat unrelated skill).

There’s no way to criticize the opinions of other academics without appearing catty, but I think these distinguished faculty are way late to the table.

I’ve been a skeptic since the earliest days of this blog — going out on a limb to say that all of these Web 2.0 firms face a challenge monetizing their traffic and that when it comes to profitability, most of them will fail to deliver on the hype. Let me summarize how I’ve argued for almost 2½ years that the Web 2.0 emperor is buck nekked.

May 18, 2007, “The looming crash in Web 2.0 hype”:

[Guy] Kawasaki’s new business is heavily swathed in Web 2.0 hype.

To me, Kawasaki’s entry is a convincing sign that the Web 2.0 fad is peaking. The hype has been promoted by a book publisher [O’Reilly & Associates] trying to sell books and conference registrations. Of course the web is changing, but it’s a silly or self-serving idea that there’s a discrete transition (2.0 vs. 1.1 or 3.2) or that all of these changes are somehow part of a unified industry change.

Once the hype/fad/boomlet crashes, then we’ll see which business ideas are sustainable and thus can survive without the hype. There is the obvious parallel to the dot-com crash, when the viable businesses dropped the “.com” and went back to selling their goods (and stock) based on a real value proposition rather than riding a web fad.

May 27, 2008, “Web 2.0 just like Web 1.0”:

Because of my master’s student 2007 project studying Web 2.0 in the mobile phone industry, I’ve been tracking Web 2.0 more closely over the past year. And there was certainly a sense of déjà vu all over again.

I’ve done consulting for a dot-com and several open source startups. With or without Web 2.0, these business are good at creating value and less so at capturing the value. In particular, if you want profits you first need to get a growing, dependable source of revenues.

August 1, 2008, “Web 2.0: deja vu all over again”:

When I was asked to speak [at USC], I decided to talk about Web 2.0 business models. … The first part summarized the use of the term “Web 2.0,” starting from the definition by Tim O’Reilly back in September 2004. …

I then summarized the Web 1.0 problems and how they apply to Web 2.0. Effectively, Web 1.0 was commoditized due to low entry barriers (compared to say retailing or radio stations), too many entires, low perceived customer value for commoditized content, and questionable revenue models. Web 2.0 has exactly the same problems.
…
How will it turn out? Clearly a Web 2.0 shakeout is coming; this seems like 1999 of the Web 1.0 (i.e. dot-bomb) era, which means that the shakeout should happen the next 2-3 years.

October 12, 2008, “Web 2.0 most likely to crater”:

A regular topic on this blog is the problem of Web 2.0 business models, and in particular that these emperors have no clothes.

To this same end, on Friday CNET published a list of 11 Web 2.0 companies most likely to run out of money and die…

In my August 1, 2008 column, I quoted this 2005 observation:

[B]ubbles and consequent shakeouts appear to be a common feature of all technological revolutions. Shakeouts typically mark the point at which an ascendant technology is ready to take its place at center stage. The pretenders are given the bum's rush, the real success stories show their strength, and there begins to be an understanding of what separates one from the other.

As I concluded then:

What makes this even more delicious is that the comment was made back in 2005 — when TIm O’Reilly was explaining what happened with end of the Web 1.0 era and how it would mark the beginning of the Web 2.0 era.

Hopefully before “Web 3.0” is coined, someone will take seriously the problem of inadequate revenue models.

As Michael Arrington of TechCrunch pointed out last month, the hype and concomitant inflated valuations make it particularly difficult for Web 2.0 companies to even attempt revenue models, for fear that they will bomb and destroy their valuations. Thus, there are perverse incentives keeping firms from addressing their most fundamental problem — until the eventual Web 2.0 crash in valuations forces all firms to demonstrate profitability or die.