Money from friends: Finding the right revenue model for social media

Mark Zuckerberg’s honeymoon with Wall Street did not last long. Since Facebook’s initial public offering in mid-May, shares have fallen by 58% to $40.8 billion. Last week, its stock dipped below $20 a share with the expiration of a lockout barring the company’s initial investors from selling their holdings. Mobile games developer Zynga also has fallen off a cliff since its IPO; the company’s market cap has plunged by 81% from its peak as flaws in its business model emerged. Groupon, whose shares have struggled amid questions about its viability, fell even further — down 85% to $3.1 billion. CEO Andrew Mason might be kicking himself for turning down Google’s $6 billion buyout offer.

Investors, it would seem, are giving a collective thumbs’ down to social networks. Yet investors across the board also tend to move in tandem, often throwing away the proverbial baby with the bath water. For example, a single piece of bad news about a company can tank shares of competitors in the same industry – a malady that has afflicted social networks as well.

While investors might lump Facebook, Zynga, Groupon and their ilk together, these companies are not replicas of each other. All offer an element of social networking, but only Facebook is a pure social network and, with its nearly one billion users, is a unique entity unto itself. As such, experts suggest caution when making generalisations regarding the plight of social networks based on Facebook alone.

What is a social network?

At its most basic, it is a group of individuals wishing to connect to each other digitally in order to socialise. Facebook users want to know what their friends, relatives and acquaintances are doing. Zynga is a developer of games that use social networks to connect players. Its main purpose is gaming, not socialising, although that can occur through games. Groupon uses the power of the collective to get bargains. But the purpose of joining Groupon is to purchase products and services, not to socialise. Twitter is more similar to Facebook, although its follower approach makes it a quasi-social network. LinkedIn members use the platform to socialise and network professionally.

Investors might be punishing most of these companies too harshly for not getting their financial ducks in a row as they test different ways to monetise their businesses. Wall Street does hate uncertainty, experts point out. But the decline could be merely a short-term effect, given that the concept of social networks is fairly new, and business models are still being fleshed out. “It’s clear Facebook and other social networks haven’t figured it out yet,” says Wharton management professor Ethan Mollick. “Things are stacked against them in the short term.”

The Facebook model

Typically, the early focus of social networks is to build up a base of users quickly by offering their services for free. But once these networks gain traction, costs to serve the users escalate. The companies then face the dilemma of figuring out how to make money from their many followers without alienating them with too many ads or suddenly charging for basic services. It can be a tricky balancing act.