Value Capture, Complementary Assets and Uniqueness in Social Networks

March 21st, 2008 seph250 Posted in Internet |

There’s no doubt that with the fast rise of social networks, immense value has been created. Myspace now ranks as the fifth most popular website globally and Facebook ranks seventh. It’s unclear, however, if these services will be able to capture this value in the future.

Friendster

As one of the first social networks to enjoy success, Friendster is an awesome example of failing to capture value. Today, Friendster sees considerable traffic, ranked the 17th most popular website globally. However, in December 2007, Friendster saw revenues of $700,000, with a loss of $400,000. Why, with so many users is Friendster still not being profitable? The answer is in Friendster’s user base. Today, 70% of Friendster’s traffic comes from the Philippines, Malaysia, or Indonesia. Only 4% of traffic comes from the United States. With such little traffic coming from wealthy countries, online advertising (key to social networks revenue) is ineffective and Friendster is unable to capture value.

Myspace

Friendster’s founder Jonathan Abrahms is credited with developing the idea of an online social network, however, without any real intellectual property protection, or secrecy, the idea was not unique for very long. It would seem that Myspace took the same idea and built the first successful social networking business, thus creating and capturing value. MySpace’s web pages are crammed with advertisements and MySpace is profitable. According to News Corp, MySpace, turned a profit of $10 million on revenue of $550 million for the fiscal year ending June 30, 2007. MySpace revenue is projected to surpass $800 million in fiscal 2008.

Facebook

Facebook has also created value with its social network, however so far it has captured very little. In 2007, reported revenues were $150 million, with an EBITDA of $50 million. Projected revenues for 2008 are $300 to $350 million. Facebook has only recently begun to insert advertisements in its site, and it has been very judicious in how it goes about doing this. As opposed to MySpace, Facebook shows fewer advertisements per page and they are generally more subtle.

Complementary Assets in Social Networks

Complementary assets are critical to the success of social networks, which inherently rely on network externalities to be successful. The following complementary assets play a large role in the competition between social networks and will continue to do so in the future.

User Base

Social networks are all about the people that use them. A person is most likely to join a social network that his/her friends are already in and a positive feedback loop occurs. There are also switching costs (although small) of moving from one social network to another so a new customer for one social network often means one less potential customer for a competitor.

Servers

In 2008, Facebook plans to invest $200 million in new servers. Increasing its number of servers and having servers located across the country is an expensive upfront cost, but it will allow Facebook to deliver faster loading pages to a broader audience. If other social networking sites do not take action similar to this they may be at a disadvantage. As video and interactive content on social networking sites increases, these servers will allow Facebook’s pages to load faster and deliver an improved user experience.

Third Party Applications

Facebook was the first to announce the Facebook Developers Platform, allowing third party developers to build and launch their own applications within Facebook. Since this announcement, Myspace and Friendster have made similar announcements. By allowing third party applications, social networks hope to create another complementary asset of third party developers and rich applications for users to benefit from.

Interestingly creation of this asset is another example of a social networking site passing up an opportunity for value capture. Instead of developing these applications internally and capturing all the advertising dollars, Facebook allows third parties to profit. In the first six months of launching the platform, third parties are estimated to have earned $20 million in revenue.

Uniqueness in Social Networks

There is no defensible IP in social networks (that I know of anyways). Theoretically any social network could copy another. Many startups today have taken what seem to be the best features of Facebook, MySpace and others and launched (arguably) better social networks than either of the leaders. However, without the complementary assets these startups have gotten little traction.

But, uniqueness still plays a role in Social Networks. With such a large install base (so many users) it is not always possible for social networks to copy each other. For example, it is a fundamental feature of MySpace that users can customize the HTML of their page. So, suppose MySpace decides that they prefer the clean, organized look of Facebook. To make that change they would have to make major changes to the system and run the risk of angering and losing many of their current users. Thus, they are forced to stick to more evolutionary changes to the system as demonstrated when MySpace launched a news feed very similar to that on Facebook.

Uniqueness has and will continue to play a major role in completion between existing Social Networks. The subtle differences between Facebook and MySpace may cause one or the other to ultimately prevail.