Social Networking Meets Economics 101

My recent post on VentureBeat addressed analyzing venture investing trends from a suppy (of companies) and demand (of customers) point of view.

Under normal conditions, the supply of venture-backed companies is not a problem. There are only a handful of companies chasing any given market. Yet occasionally, there are categories where a slew of companies jump into a market all at once. This happens when a category with low barriers to entry takes off quickly. Seeing a market with explosive demand and little competition, entrepreneurs rush in to fill the void. Ultimately, demand is spread across so many companies no one wins.

That may be the case today with Social Networking as companies have rushed into the market behind MySpace, Facebook, and YouTube. Our Follow the Money report for Q2 showed that 25 Social Networking companies received $500K or more during the period.

The economics of Social Networking favor first movers and established players. Social Networking, like auctions and marketplaces, is governed by the network effect. The more people using a site, the more valuable it becomes, which in turn drives even more usage. This opens up a gulf between the leaders and everyone else, and once that occurs, it becomes next to impossible for anyone to succeed. Only established players who can bring their existing user base to the table to provide critical mass have a chance.

So where are the opportunities in social networking if starting MySpace or YouTube for <fill in the blank with your favorite demographic or interest niche> is untenable?

• Creating the truly differentiated offering. Where MySpace and YouTube will make their money by giving away their service to tens of millions of consumers and charging advertisers, the next round will need to be able to drive revenue from much smaller user bases. Think 250,000 users paying $20 per month each. To charge a consumer $20 per month, there needs to be a compelling and difficult to reproduce competitive advantage.
• Serving the established players. Given the consumer interest in social networking, established players will need to add these features to their site. It's unlikely that Kayak, the leading metasearch site for travel will sit back and allow the two new metasearch+social networking start ups to go unchallenged. Same goes for Match.com and other leading dating sites who are facing new competition from dating+social networking start ups. Soon, everyone will be a <category>+social networking site.  There is money to be made in serving those companies.

Comments

[charles]

It'll be big in the future. Google will bring out its cell phone and its own frequency signals, and will conquer the social network scene with it.

charles
http://www.whatis.name