Technology

BusinessWeek


What a difference $580 million can make. That's what News Corp. (NWS) splashed out on the parent company of popular social network MySpace. If the notion of creating community online was popular before the deal, the appeal has surged in the aftermath, with new sites cropping up all the time.

It's not hard to see why a would-be investor would be drawn to the sites, some of which draw together millions of users all looking to connect with friends or associates -- or make new ones -- online. Other social-networking sites that have gotten backing from venture capitalists include Facebook.com and Tagged.com (see BW Online, 2/27/06, "Who Says Money Can't Buy Hipness?").

HELLO, GOODBYE. Yet as the sites multiply and investors take a closer look, questions abound concerning whether social networking makes for a wise investment. And skepticism is rising over the long-term financial health of these online destinations, with some analysts saying these are the early stages of a social-network bubble. "We have yet to see a viable long-term business model for social networks," says Nate Elliott, an analyst at Jupiter Research. "We have yet to see anyone come close."

For many sites, the challenge begins with persuading advertisers that their investment will be rewarded with sufficient views by users. What's more, with so many social networks vying for attention, retaining users can be problematic. Amid these difficulties, some observers anticipate a brighter future for smaller niche networks that bring together users with common interests.

Chris Charron, a vice-president at Forrester Research, says some advertisers aren't all that interested in social networks. User-generated content, which dominates these sites, is a tough sell to companies that can't control the material with which their brand is associated. That's all the more the case when content is racy, as personal profiles often are.

LITTLE LOYALTY. "People underestimate the difficulty of buying in this space," Charron says. "The more placements that you have on different sites, the more targeting and measurement consistency is needed."

While MySpace has become one of the most visited sites on the Web, Elliott says much of the traffic is generated by fanatical users constantly seeing the same ads. For example, teen-focused Tagged states that only 20% of its 2 million users visit the site daily.

Furthermore, Elliott says plenty of social-network users register and then never log on again. Also, members have little loyalty to any given social network and will switch if something better comes along, or when pals jump ship. After all, the fun of these networks is socializing, and there's no shortage of options.

SPECIALTY SITES. However, as long as the possibility remains that social networks will get snapped up in big acquisitions, they may continue to attract investments.

Raj Kapoor, a managing director at Mayfield Fund, which led a $7 million investment in teen-focused Tagged, concedes that no one has developed an ideal way to target ads around user-generated content. "At the end of the day advertisers want to find a way to do it," since teens spend so much time browsing their peers' profiles, blogs, and other dispatches. Tagged generates 100% of its revenue through advertising, which Kapoor believes is a sustainable business model. However, he admits that as an investor, selling Tagged to a larger company could ultimately be the more attractive exit.

Elliott, for one, is more enthusiastic about the prospect of niche-oriented networks. TripConnect, which aims to convert travel advice into a business, hopes he's right. TripConnect's 5,000 users swap travel advice. While that's fewer than some sites gain in a day, advertisers may have an easier time reaching such a targeted audience.

REAL OFFLINE OPPORTUNITIES. Though unfamiliar with TripConnect, Elliott says the idea is the right one. The site uses social networking in such a way that users are "directly influencing each other's purchase decisions," he notes. That's "not something you find when people are chatting about bands" as is the case in many larger sites, Elliott adds. Plus, at least theoretically, users log on most frequently when they're looking to buy.

Elliott also sees potential in aSmallWorld, a proudly snobbish invitation-only site that bills itself as the first-class lounge of social networks, for those jet-setters and grandees too private and important to wait by the gate.

The captive and rich audience has an obvious appeal to advertisers. However, Elliott thinks the site should also seek to create an offline community that could include parties in pricey vacation spots and exclusive clubhouses in places like New York and London. Nirav Tolia, the network's acting president, says the company is looking to expand its offerings.

"LOTTERY PHENOMENON." While the future may belong to niche networks, at least for now general interest-oriented sites are drawing investments. "The absence of a logical business model isn't necessarily a detriment," says Paul Kedrosky, a venture capitalist and executive director of the William J. von Liebig Center for Entrepreneurism and Technology Advancement. "As long as it seems like there's some liquidity on exits, people will continue to fund them."

Ultimately, Kedrosky says a "lottery phenomenon" will determine which startups get acquired. But the way it looks now, a lot of sites may well not produce many winning numbers.


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