David Piccione.com

Over the next couple of days, I’ll be talking about the fact that it looks like we’re heading into another technology crash. With all the hoopla around the current business activity on the internet, that opinion is sure to be unpopular. Nonetheless I believe it to be correct.

Today, I’ll tell you why I think that way, and tomorrow, I’ll give you my thoughts on how entrepreneurs can best avoid being left in the pile of 2.0 refuse.

A Tail of Two Corrections

First off, a caveat - Crash 2.0 will be nowhere near as bad as 2000 was. The hype back then was outrageous IPO’s based on unrealistic profit expectations. Now, we have private acquisition based on unrealistic profit expectations. The VC’s are still there, but they’re pitching to a different audience. It’s a different environment within our industry.

It’s also a different market overall. In 2000, the market was dominated by tech. The rampant speculation that was occurring had an effect on the average investor because there was no way for him to avoid being a part of the industry - dot coms were everywhere. Today, tech is only a segment of a market that is structured differently. This means that our little piece of over-valuation and acquisitions matter less to the average man on the street; he’ll be affected likewise.

The problem for those of us who are directly involved in web 2.0 is that we are now part of a market that we have less control over. Regardless of how secure our sector is, we’re going to be affected by the events in other areas. These events, as witnessed over the last week or so aren’t all that encouraging, to say the least.

Are we staring into a recession, or even something more serious? It’s possible, but still subject to healthy debate. Even the most optimistic however, don’t suggest that we are heading into anything but a bear market. Even the slightest correction in the index however will be magnified in effect in our sector - one built on speculation and venture capital almost exclusively. When the VC’s other earnings dry up, they’ll be less likely to take a chance on your latest Facebook app.

For comparison, 1987; a strong housing sector was destroyed by a correction in a market dominated by industrials. That’s very simplistic, but it serves to illustrate the point. At the end of the day, it was better to be a part of the index than a part of a booming sector within it.

Icing on the Cake

Given the conditions outside of web 2.0, what kind of security do we have within that will shelter us from a market correction? The truth is, our industry is speculative right now - as it was in 1999. Look at the leaders - Facebook, mySpace, Digg, YouTube. Being ad based, each of these companies generate no income from those actually consuming the product.

Consumer loyalty is directly linked to the amount the consumer invests out of pocket. Apple has a fiercely loyal base partly because they feel really stupid spending an extra $300 on a product that isn’t something special. With social networking sites the amount spent is zero - and the loyalty corresponds.

Facebook and mySpace are only as valuable as the next big thing. In other words: they are fads. Now, fads can be successful if they’re managed right, but they all share one thing in common - they won’t be around tomorrow. If you need proof, look no further than Frendster. In 2003 they had 20 million users. Today, they have less than 1 million die hards. Those are fickle crowds.

So, why is this a problem? Because eventually investors - be they VC’s or acquiring organizations - want to see some growth in their investment. With a fad-based industry, all value becomes speculative and opinion based. In order to make money, investors need to assume that tomorrow, the perceived worth of the product will be higher. Let’s pick on Facebook a little. Facebook now needs the next investor to believe it’s worth $2 billion at least. - invest $1 billion, recoup $1 billion. Sorry if I laugh a little.

This whole thing works until there is a measurable instance of a product demonstrating its actual value. It doesn’t have to be the product itself, just something close enough. If, for example, it came out that Digg was in the red, or not nearly worth as much as the $200 million BusinessWeek thought, Facebook would have a tougher time convincing potential investors of its value.

Any industry built on such rampant speculation is doomed to be as temporary as boy bands and leg warmers.

Facebook Apps - Beyond Madness

Bubble 2.0 takes things a step further. Not only do we have the general investor speculation in copycats (quick, how many Technorati clones can you name in 15 seconds?) but we have investor interest in products built upon other products. Ladies and Gentleman, the folly of the Facebook application.

Let’s put this into perspective: We have a product that has a monetary value of zero to its users being used to build further products of negligible value - and these products are actually being sold or invested in!

Let’s avoid the elephant in the room - putting 100% of your chances of success into the outcome of someone else’s business plan - for a second. There is zero evidence that Facebook users value the site enough to pay to use it. There is zero evidence that Facebook advertisers value the site enough to maintain a long term relationship with it - and thus ensure that any market is there for your application. Somehow though, there’s enough money to be made on a small fraction of that user base to recoup a sizable investment, or so the thinking goes.

I just don’t get it. And Facebook only scratches the surface. I’m sure that some fool, or collection thereof will purchase Twitter - only to lose a heck of a lot of coin - any day now.

How Could This Bubble not Burst?

Let’s take a look then at situation then:

1. We’re heading into a bear market, if we aren’t already there.
2. The boom in our industry is fueled primarily by speculative values and notional potential future revenues
3. The social network audience is fickle, investing little and demonstrating high mobility.
4. We have people investing in products that are naturally restricted by the success of a product that is - as of yet - of dubious long term stability

I’m sorry to those that are caught up in the madness, but you have to have a few screws lose to think that we’re not in the middle of a bubble. There are scary signs all over the place right now, and it seems that many of us won’t be as wealthy this time next year as we are now.

So what do the smart start-up do? Tomorrow, I’ll take a look at some of the ways that an entrepreneur can avoid being left out to dry when the inevitable happens.