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03/01/2004

Social Networking: Partying Like It's 1999

Somebody in Silicon Valley is passing around the 1999 vintage Kool-Aid again and this time it’s going by the name of “social networking”. In just the past six months, Venture Capitalists have funded no fewer that 5 start-ups focused on social networking and more are likely to follow. The party may soon be over however, as the start-ups are forced to face some of social networking’s inherent problems as well as increasing competition from technology industry heavyweights.

Back to The Future

While there are several variations on the theme, the basic concept behind social networking is to build an electronic map of the various relationships within a group of people. The idea is that once this map or network of relationships is documented, it will enable people to leverage indirect relationships that they didn’t know they had before for some personal or business use.

Need a date? Browse the electronic relationships of your friends and your friends’ friends to see if they might know someone suitable. Can’t get an introduction to that potential business client? Perhaps someone else in your “network” knows them and will be willing to open the door for you.

Of course this kind of social networking is by no means new. People have always informally “networked” amongst their acquaintances to get recommendations or introductions. What these new online social networking companies are offering is a technology platform that promises to not only make this form of networking far more efficient and effective but to dramatically expand the scope and size of these networks.

Networks Aren’t So Easy

On its face, there’s a lot to like about online social networking companies. They take an existing activity and greatly improve it. They don’t require a huge investment to get off the ground and, thanks to “network effects”, the bigger they get, the better they get.

However social networking companies face several inherent challenges, most of which appear to have been glossed over by the investment community in its rush to embrace the latest “new, new thing”. The first is something that might be called “input-output asymmetry”. What this means is that in order to get utility out of a social networks, users must first invest significant amounts of time setting up and maintaining their networks (input) while they are likely to only intermittently make use of these networks (output). This high ratio of input to output typically leads to low utility for the average user. Another drawback of online social networks is that they are neither autonomous nor self-healing. Most online social networking companies require users to manually create their networks and then manually maintain them. It is this manual maintenance that is perhaps the Achilles heel of online social networking for without regular maintenance of one’s relationships within a social network, the reliability, and thus utility, of the network will decline rapidly. This is especially true in particularly dynamic networks, such as teenage social/dating relationships. Finally, social networks have traditionally been created and sustained as by-products of a main “application”. For example, teenage dating networks are created largely as a by-product of schools and/or geography, while professional networks are created by business dealings and/or professional associations.

It’s The Application Stupid

In many ways it is these “applications” that solve many of the inherent problems with social networks. Not only do they initiate the creation of social networks but they force constant interactions which provide a natural mechanism for updating and maintaining these networks. Thus, in order for online social networks to be successful, our analog experience suggests that they must be by-products of applications that provide both an impetus for the creation of the network and a mechanism for constantly updating that network.

The problem for pure-play online social networking companies is that they lack applications. In fact, many companies, such as Friendster or Orkut, seem to have no stated purpose beyond the network itself. These companies would likely maintain that “the network is the application” (in other words, that the socializing facilitated by the network is the application) and therefore they don’t have a problem, but let them fool you, they do. As pointed out earlier, social networking is inherently an intermittent and dynamic activity. Without some kind of application to force the regular use and maintenance of such networks, pure play online social networks are destined to become as stale and appealing as two week old bread.

Instant Competitors: Just Add Software

To the industry’s credit, most social networking start-ups have realized that they need applications and have dutifully set out to create them. For example, Tribe.net has online classifieds, Huminity offers integrated instant messaging and Spoke enhances Sales Force Automation software. However, even this may not be enough to survive. That’s because established application owners, including most of the technology industry’s biggest players, are in an ideal position to compete with pure play companies.

Just look at the major e-mail/instant messaging players, such as AOL, Yahoo and Microsoft. Each company has a huge base of users for its e-mail and instant messaging applications. These users have created address books and buddy lists which in effect provide a skeletal outline of their primary social networks. Combine this skeletal outline with some usage data and a small piece of software that links relationships across users and you can not only create the largest social networking player overnight, but you get a far superior network that is an autonomous, self-healing network that can even judge the strength of relationships between people (based on the frequency of communication). Perhaps that’s what occurred to Microsoft when they created Wallop or to Google when they created Orkut. No matter what occurred to them, it was undoubtedly clear that such networks could snuff the life out of pure-play social networking companies in a heartbeat.

In the business arena, IBM and Microsoft can update their Notes and Exchange servers to create a social network based on each employee’s individual contact database or players like GoodContacts and Plaxo can leverage their inter-enterprise contact management software to jump into the game.

The point is that the barriers to entry in social networking aren’t just low, it’s that established application vendors actually have a huge built in advantage and if social networking becomes important enough, they are highly likely to use this advantage to devastating effect.

That’s not to say that all social networking companies are doomed. Far from it. It’s quite likely that a few innovative or particularly fleet of foot companies will either firmly establish themselves as survivors or profitably sell out to a larger company (witness ZeroDegrees’ recent sale to IAC). However it is to say that two things: 1. Given the serious threats posed by existing players investing in social networking is likely to prove far riskier than many VCs might imagine. 2. While a few pure play companies may make it, it’s likely that most social networking companies will die a rather quick and painful death unless they find an application they can attach themselves to in short order. Either way, everyone in the social networking space better sober up quickly because 2004 is no 1999.


Appendix:

Here is an annotated list of social networking companies, separated into consumer focused companies, professional focused companies and posers (companies who actually do something else but are hopping on the bandwagon in hopes of selling themselves or raising money at a high valuation):

Consumer focused:

1. Friendster Social Networking’s poster child. A pure-play social network if there ever was one. Appears firmly focused on online dating, although not charging for anything yet. Invested in by Kleiner Perkins and Benchmark in 10/03 at a rumored $40M pre-money valuation after recruiting a top notch set of seed investors. Reportedly turned down an acquisition offer from Google, which went out and started its own competitor (see Orkut).
2. Friendzy Basically a friendster copy-cat but adds a classified advertising twist a la Tribe.net. No known VC funding to date, but that can’t last for long. Given it’s Texas location, Austin Ventures is a 1-2 favorite to invest 
3. Huminity (http://www.huminity.com/) Largely consumer-focused social network that integrates its network into a chat client allowing users to visualize connections between users in real time. Kind of like simulating a high school dance. Integration into chat is interesting, but hard to imagine it can compete with the IM big boys.
4. MySpace A rapidly up and coming site, MySpace just recently claimed to generate more page views than Friendster. MySpace is using a strategy of promoting the service via off-line parties that are also designed as real “mixers” for their digital members. Not clear how much of MySpace’s page views are being driven by hot blogs/racy pictures as opposed to actually member usage. No VC investment yet, but with more pageviews than friendster can an investment be far behind?
5. Orkut Hell hath no fury like a suitor scorned. Just months after Friendster supposedly turned its acquisition offer down, Google quietly launched this site in 2/04. Supposedly just some random project being working on by a few budding Googlinaires in their free time, Orkut might as well be called “Payback”.
6. Squiby Miami based late entrant into the space. Appears to be an opportunistic attempt to capitalize on social networking craze. Claims many of the same features as Tribe, but real angle appears to be Spanish language capability, sort of an Amigoster for the Latin world. Hey it worked for Star Media!
7. Tribe Networks Probably the most creative consumer site. Offers a pot puree of social networking apps including dating, classifieds, job hunting, and epinions-like recommendations. Closed a $6.3M round of funding led by Mayfield in 11/03 .
8. Wallop A less-than-subtly named offering from a little company in Redmond, WA. Supposedly run by Microsoft’s research division Wallop is just a research project for now but rumors have it either being actively integrated in Microsoft’s messenger product or into Longhorn or being abandoned altogether. Whatever the case, you can hear the elephant’s footsteps coming.

Professional Focused

1. Ecademy A European based company that gets extra “straight shooting” points for not even mentioning social networking on its pages. Pure network focus with a half-hearted attempt at some basic business classifieds. No apparent VC funding.
2. Itsnotwhatyouknow Focused on an online job posting/recruiting business model. Appears to be geographically focused on Indianapolis, IN. Wins prize for longest/most awkward URL in group. Perhaps they can use their own site to find a Corporate Naming consultant. No apparent VC funding to date.
3. Linked-In Claims to have a recruiting focused model, but that’s hard to discern from wandering through it. Unlike many of its professional competitors it, surprisingly, is not “linked in” to any enterprise applications such as Exchange or SFA apps. To paraphrase my article, no network is an island, so Linked-In is going to have to get an app and fast. Funded by Sequoia (of Google fame) in 11/03 to the tune of $4.7M. Sequoia’s funding is interesting for two reasons: 1. They did not fund Friendster which they likely had first crack at 2. They are also the backers of Plaxo which was curiously mentioned in the first paragraph of Linked-In’s funding release. Something tells me to look for closer cooperation between Linked-In and Plaxo down the road.
4. Ryze Encourages users to join industry focused groups. Closely resembles many of its consumer focused peers and even includes a classified section similar to Tribe and Friendzy. Users can purchase a premium membership to do advanced searches. Apparently no VC funding to date.
5. Spoke Spoke has more of an enterprise software feel even though it also runs a general network. Spoke boasts of integration with SFA and CRM apps and has more of a software heritage. Spoke has raised over $20M from Doll, USVP, Sierra, and Partech over several rounds.
6. Visible Path Similar to Spoke with a heavy emphasis on SFA and CRM integration. Assembled a star team of social networking scientists (yes there are such people). Received a $3.7M investment led by Kleiner Perkins in 2/04 making it Kleiner’s second bet in the social networking space. Kleiner is “overweight” on the social networking space I guess.
7. Zero Degrees Focused on both consumer and business networks with an increasing emphasis on setting up private business networks. Never took a formal round of VC funding and was sold to Barry Diller’s Interactive Commerce Corporation in 3/04 for an undisclosed price. Given Zero Degrees’ expertise in setting up and running multiple networks expect to see social networking capabilities starting to permeate the IAC empire (starting I suspect with Match.com and Evite.com) in short order.

Posers

Just a word on posers before I begin. Every hot sector gets them. They are the companies that change their Power Point presentations to claim that they are in a sector simply because investors are assigning that sector crazy valuations. While annoying from a VC perspective, I give these companies and their entrepreneurs credit for trying to surf the latest wave… just don’t expect me to invest in them.

1. Eliyon A database searching site focused on helping recruiters, salesmen, etc. find specific business people by searching big databases. Recently launched social networking capabilities feel like a cheap bolt on. Owned in part by the CardScan people.
2. Meetup Not so much a poser as a digital/analog converter. Meetup helps people arrange offline gatherings. Kind of like the digital companion to analog networking events. When you see sites like this you recognize that there is not a lot of white space left to invest in on the Internet.
3. SpecialtyMatch Originally a community site for people focused on different professions, hobbies, etc. SpecialtyMatch is now a professional “network”. I’m not picking on them in particular but SpecialtyMatch is a fairly typical example of how many sites that used to call themselves community sites are now calling themselves networking sites, all in an effort to bask in the glow of the social networking craze.
4. TheSquare A vertically focused site which is basically an elitist version of classmates.com with membership limited to a number of the top colleges and university’s in the country. Been around since 1997 and been through several business model evolutions since then. Current focus stresses the online network and includes the ever popular dating and classified apps.
5. Tickle.com Formerly know as emode.com. Tickle is now a consumer focused social network focused on dating. Their angle is that they use IQ and personality tests to help prospective mates find each other. Not a bad idea and great site traffic but I am not sure how they are a social networking company. I heard a rumor that they recently closed a big up round on the backs of a heavy “were a social network pitch” so more power to them.

For anyone who wants to spend more time on social networking I recommend the Social Software blog which does a great job following the space.

March 1, 2004 in Collaboration, Venture Capital | Permalink

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