Social networks are used by hundreds of millions of people around the world. According to their most enthusiastic proponents, they are powerful forces for global democratization. Increasingly they are displacing other means of communication, from voice calls to email, SMS, and IM.
The default approach to building a social network is to make it available at no charge to any and all comers. Try to create a social network that charges a fee for use, and observers will raise the specter of country club exclusivity and potential restriction of diversity. Why is this? Why does experimenting with the business model for social networks raise so many concerns?
It may have something to do with the way social networks have been funded thus far. For some time now the traditional wisdom in the Valley has been that social networks are a winner-takes-all business. For any given market segment, the law of network effects means that eventually one will come to dominate, driving the others out of existence. It follows that the only way to have a shot at succeeding is to grow as big as you can as fast as possible. This in turn dictates huge funding, the kind that only venture capitalists can provide.
VC firms do not make money the way most businesses do. Institutional investors give them money and hope they'll invest it in the next Apple or Google. The VCs fund a number of startups, frequently in concert with other VC firms in order to spread the risk. At any given time, the number of startups a VC firm can fund is limited by the attention the VCs can provide to those startups. To make that attention worthwhile, VCs don't want to invest unless the investment amount is large enough to provide the opportunity for rapid, substantial returns.
To a VC rapid, substantial returns doesn't mean that the company receiving funding is alive and profitable in ten years. It means a liquidity event. Either the startup has an IPO or is acquired by a larger, established company. Any serious profits a VC makes are going to come at that point. What happens to the company thereafter is of no consequence to a VC from a financial perspective.
Put another way, VCs make money by placing huge bets with other people's money and occasionally scoring a big win. This does not mean that VCs are evil. It just means that creating sustainable businesses is orthogonal to them; it has no real impact on their bottom line.
There are plenty of VC-funded Internet success stories, from Amazon to Google to LinkedIn. But there are also plenty of failures, including a lot of companies you never even heard of that received VC money and flamed out. In fact, according to a Kauffman Foundation report, only 29 percent of companies that hold an IPO survive as public companies. That figure doesn't take into account the performance of startups that are absorbed into goliaths then sold at a loss, spun out, or retired like Netscape. Then there are the VC-funded companies that are lauded as success stories, even though it is too early to tell how they will fare over the long term.
Facebook's Mark Zuckerberg comes in at #4 in Vanity Fair's 2012 New Establishment, even after the company's rocky IPO and difficulty converting its massive user base into sustainable revenue. Pinterest CEO Ben Silbermann nabs the #8 spot in the list, even though nobody outside the company knows how much revenue Pinterest generates or whether it is a flash in the pan. Twitter's leadership is justly praised for creating a popular service, but its initial foray into serious revenue generation is alienating its ecosystem partners and many of its most ardent users.
The last few years have seen the rise of a new batch of rock star startup executives, almost none of whom have proven that they can build enduring businesses. Their savvy in obtaining startup funding and putting those millions ($125M for Tumblr), or billions ($1.1B for Twitter and $2.2B for Facebook) to work is lauded, while their ability to build a sustainable business is frequently presented as an afterthought, a question reserved for the sidebar.
The executives who run Tumblr, Twitter, Pinterest and Facebook are obviously very smart and extremely capable. They are also part of a generation of tech business leaders who have been learning how to play the VC game, rather than learning how to build sustainable businesses. It's not that these leaders are necessarily incapable of building for the long haul, but the VCs who bankroll them are focused on liquidity events, not in what happens afterwards.
This matters because the VC approach rules Silicon Valley and is the dominant paradigm when we think about Internet-related businesses. Despite its volatility, we have come to accept this approach as gospel. We have even come to believe that because it is built around achieving scale rapidly, the VC approach over the long term generates greater social good than slower-growth methods built atop traditional business models.
VC-funded social networks tend to rely on advertiser-supported or freemium business models, which supposedly provide a voice to those who might otherwise not be heard online. There is no doubt that ad-supported social networks, Facebook in particular, have achieved impressive global reach. But it's possible that their ability to empower the otherwise voiceless mass of humanity has been oversold, and its negative effects understated.
The rise of social networks coincides with a massive shift in Internet access. From 2000 to 2011 the number of Internet users globally has jumped from 7 per 100 inhabitants to 35 per 100 from 2000 to 2011. This access is generally paid for directly by consumers.
In order to use the Internet, people need first need access to devices. As the affordability of Internet-capable laptops, tablets, and phones has increased, access has risen accordingly. Generally people pay to use these devices, either by purchasing them outright or renting access.
They also pay for SMS, the boring but ubiquitous service that is staggeringly expensive on a per-byte basis but is arguably still the killer app for mobile devices. Compare this to Twitter, which is still only used by 15% of the US online population.
Devices, Internet access, and SMS all are paid for by consumers. If social networks are more powerful and at least as highly-valued by consumers as SMS, is it really true that they will never pay to access those networks?
It's also worth remembering that the democratizing potential of the Internet was not first realized on Twitter or via Facebook; it was old-fashioned BBSes, blogs, and SMS that gave rise to the first smart mobs. These platforms are open in the sense that the technology behind them is not proprietary. The same cannot be said of ad-driven social networks. Nor can content posted to them be repurposed at will by the people who create it.
Twitter, for example, is grappling with the issue of who ultimately controls content posted by its users. Facebook's terms of service for developers make it clear that exporting user-generated content from Facebook to other networks is forbidden. Note that both of these cases highlight the fact that the social networks of today see themselves as content aggregators, rather than communications providers, and can't help but behave accordingly.
As for free access (with the associated connotation of freedom of expression), in an ad-supported social network access (after you've paid for your device and Internet access) costs the user no money. It is advertisers who pay for the privilege of accessing information about users and delivering ads to them based on that information. This is not an inherently bad thing. But it is disingenuous to plead that advertisements are not at the very least an annoyance. We've also repeatedly seen that online advertising leads to fiascos like Facebook Beacon. The temptation to abuse user data and sidestep privacy concerns is tremendous if your business model is built around selling that information.
Because its revenue model is not built around advertising and sales of user data, a social network that charges its users for access is also not beholden to advertisers. There is no conflict of interest either in the design and functioning of the network, or in how it generates revenue. It serves its users, who are also its customers. While it is laudable that Google and Twitter have embraced free speech principles, one cannot help but wonder if companies that are paid directly by customers would embrace those principles more stridently, given the fact that advertisers are inclined to avoid political controversy.
Even with this alignment of interests, many observers believe a social network has to be free (gratis) to access in order to attract a sufficient volume of users for growth and long-term viability. This claim is inadvertently ironic, given that so many ad-supported social networks have already failed. The argument seems to be that a network that costs any amount of money to access is doomed to failure.
This line of reasoning brings to mind the belief, prevalent in the early 2000s, that nobody would ever pay for music online when they could get it from P2P services for free. While the RIAA's insane litigation frenzy may have contributed to a shift, it was Apple's introduction of the iTunes Music Store that changed the equation. This is not meant to suggest that the criteria for a social network are the same as music and movies, but it does raise the notion that up front monetary cost is not the only determinant when people are deciding which online services to use.
It may be that any attempt to create a paid social network is doomed to failure. But the arguments against paying for access to social networks are predicated on a status quo that has been with us for almost two decades. Oddly enough, although Silicon Valley prides itself on disruptive innovation, it is stifled by the constraints of venture capital's gravity well.
Silicon Valley VCs seem to have collectively decided that social networks are no longer the new hotness. They are moving on to other things, as the long-predicted transformation of social from a product into a feature becomes a reality. In this worldview, Facebook has won the the only battle that matters, and and the rest of the field is too crowded to support any new entrants.
But what if the shiny, well-funded social networks stumble? What if the ad-driven model fails to deliver over the long haul? What if Facebook has to make its advertising more and more intrusive in order to meet its quarterly targets? What if the de facto orientation of "share everything" eventually reaches a tipping point that pushes users away from Facebook? What if Twitter's bid for brands flops, and users abandon it in droves, following on the heels of the third-party developers that helped drive the service's growth? What if Tumblr never figures out how to generate enough ad revenue to become a sustainable business? What if Pinterest follows the Zynga path and flames out early?
If one or more of those things occurs, it just may be that slow-growth paid services will gradually replace the glitzy and exciting social networks we now know.
Stranger things have happened.
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