Michael Wolff at Technology Review on what Facebook really is - an ad driven company?..
Is there a there there .?
Determining value in social networking companies is not well understood - particularly those where personal connections aren't strong as issues like trust aren't well understood (and it isn't transitive). Many companies have been experimenting with Facebook and Twitter, but I haven't seen any documented out of the ballpark success stories. I wonder if the industry will be rediscovering learnings of conventional direct marketing that were learned in the 50s and 60s or if there is any new ground?
Unless companies like Facebook can show significant improvements in the efficiency of marketing or move into entirely new areas their growth will largely be limited by the economic growth and materialism of their user base.
Lsst year Peter Cauwels and Didier Sornette of the Swiss Federal Institute of Technology in Zurich published a paper on the value of social media companies.
Quis pendit ipsa pretia: facebook valuation and diagnostic of a bubble based on nonlinear demographic dynamics
We present a novel methodology to determine the fundamental value of firms in the social-networking sector based on two ingredients: (i) revenues and profits are inherently linked to its user basis through a direct channel that has no equivalent in other sectors; (ii) the growth of the number of users can be calibrated with standard logistic growth models and allows for reliable extrapolations of the size of the business at long time horizons. We illustrate the methodology with a detailed analysis of facebook, one of the biggest of the social-media giants. There is a clear signature of a change of regime that occurred in 2010 on the growth of the number of users, from a pure exponential behavior (a paradigm for unlimited growth) to a logistic function with asymptotic plateau (a paradigm for growth in competition). We consider three different scenarios, a base case, a high growth and an extreme growth scenario. Using a discount factor of 5%, a profit margin of 29% and 3.5 USD of revenues per user per year yields a value of facebook of 15.3 billion USD in the base case scenario, 20.2 billion USD in the high growth scenario and 32.9 billion USD in the extreme growth scenario. According to our methodology, this would imply that facebook would need to increase its profit per user before the IPO by a factor of 3 to 6 in the base case scenario, 2.5 to 5 in the high growth scenario and 1.5 to 3 in the extreme growth scenario in order to meet the current, widespread, high expectations. To prove the wider applicability of our methodology, the analysis is repeated on Groupon, the well-known deal-of-the-day website which is expected to go public in November 2011. The results are in line with the facebook analysis. Customer growth will plateau. By not taking this fundamental property of the growth process into consideration, estimates of its IPO are wildly overpriced.
They came to the conclusion that Facebook might be worth abot $20B with 1.2 billion users. If they are close to being right, and their simple model assumes about $1 of value per user - a historical number that one can quibble with on either side - Facebook shares have a long way to go ... down that is. Technology Review has a non-technical summary of the paper here.