Facebook Takes a Dive: Why Social Networks Are Bad Businesses

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The business of having online sites with content created by amateurs to be viewed by other amateurs never had a reasonable chance of making money. The fact that at one point Facebook had a $15 billion valuation, that Rupert Murdoch's News Corp (NWS) bought MySpace, and that Google (GOOG) bought YouTube only proves the "greater fool" theory.

YouTube was started in 2005 and MySpace in 2003. Normally, having a social network where people go to share profiles of themselves, write blogs, and submit videos would not seem like much of a business. But MySpace has well over 100 million users. People viewed over five billion videos at YouTube last month. Investors assumed that any medium with such a large number of users has to become a huge business. Millions and millions of users must be worth something. They can't be worth nothing. That couldn't be possible. (See pictures of the meteoric rise of YouTube.)

Because Facebook and MySpace are so pervasive and such a significant part of online culture, the press is endlessly fascinated by what goes on at the companies. Word got out that Facebook was raising money. Then it fired its chief financial officer. Analysts started to speculate that the company was low on cash. Facebook, of course, said that no such thing was true. (Read "25 Things I Didn't Want to Know About You.")

What is true is that social network sites have had trouble making money. MySpace was supposed to be a big part of the revenue growth at News Corp. Wall St. thought Murdoch was a genius to buy it. Last year, News Corp had to admit that MySpace would not hit its revenue targets. That is usually not the hallmark of a property that is going to take over the Internet. Analysts believe that MySpace rival Facebook had revenue of $265 million last year. That is astonishingly low for a company that had 57 million unique visitors in the U.S. last month. And, Facebook also has a very large international user base. (Read: "MySpace Launches a Free-Music Revolution.")

The reason that social networks will never do well financially is that they break from the successful model that has brought so many marketers to the internet. Display advertising can be targeted by subject. Financial advertisers run messages on AOL Finance (TWX) and TheStreet.com (TSCM). They avoid sites for children's video games. Search sites like Google refined the model by allowing advertisers to buy search engine results pages. The Google results' pages for the search "heart doctors in New York City" is probably the best place in the world for heart doctors in New York City to market themselves. (See pictures of Google Earth.)

Social networks are bogs filled with people who are there to befriend one another, tell their stories, or voice their complaints. For those who want others to know all about them or who have unrevealed grievances about life, these are wonderful online destinations. They are a good place to leave messages for friends, propose marriage, and post the scores from the local high school football team. They are not a place where an advertiser can focus on a single group with a message aimed at those people, because no one knows exactly who those people are. For a company trying to sell products or services, Facebook is mayhem in a PC. What the advertiser wants is traditional, orderly content.

With the exception of a certain number of perverts who sneak in, there is nothing wrong with social networks, but marketers don't want the perverts and they don't want a collection of people with no common purpose other than to share with one another.

— Douglas A. McIntyre

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