Early Tremors: Is It Time for Another Social Network Shakeout?

Faint rumblings have begun in the social networking landscape. Facebook acquired smaller rival FriendFeed in August. Friendster, viewed as an also-ran in the U.S., has refocused its operations on the Asia-Pacific region, where it is among the leaders in traffic. News Corp., owner of MySpace, has reshuffled executives and restructured the unit as traffic growth slows. Experts at Wharton say that these moves and others may be the first hints of a shakeout in the social networking market.

Social networking sites allow individuals to connect online and share content like photos and video. The best-known social networking site currently is Facebook, which had more than 92 million unique visitors in August in the U.S., according to research firm comScore. Facebook now serves more than 300 million people worldwide.

When Knowledge@Wharton wrote about social networking sites back in 2006, experts noted that some high-fliers may go from “hot” to “not” quickly. (See: “MySpace, Facebook and Other Social Networking Sites: Hot Today, Gone Tomorrow?“) Since then, an initial shakeout has taken place. For instance, Yahoo launched an effort called Yahoo 360 in 2005, only to shut it down in July 2009 after it failed to gain traction. The once-hot MySpace couldn’t keep up its torrid growth and has been one of the few social networking sites to see traffic fall, according to comScore. (MySpace had 64.2 million unique users in August, down from 75.5 million in August 2008.) Bebo, founded in 2005, was acquired by AOL in 2008 for $850 million in cash. And in 2006, no one even knew microblogging site Twitter was coming.

What’s unclear is where social networking goes from here. Experts at Wharton say there’s still a lot of growth left in the sector, but a round of consolidation, reinvention and restructuring is likely in the not-too-distant future. “Clearly, social networking has caught on in a great way, but there’s still a lot of uncertainty about where all of this will wind up,” says Wharton management professor Saikat Chaudhuri. “The market is very dynamic.”

For instance, Facebook’s acquisition of FriendFeed revolved largely around a talent and technology grab. FriendFeed provides innovative features such as aggregating status updates from multiple social networking sites and real-time searching of social content, but failed to gain significant traffic. Research firm Hitwise noted that Facebook was the top-rated social network in August, whereas FriendFeed ranked 421 in the category. In a statement, Facebook said all 12 FriendFeed employees would join the company and its founders would have senior management roles. Facebook CEO Mark Zuckerberg said he admired FriendFeed’s ability to create “such a simple and elegant service for people to share information.”

Indeed, experts at Wharton expect the Facebook-FriendFeed scenario to play out repeatedly in the next few years. New services will emerge and be absorbed into winning platforms for their features, engineering skills or both. There is room for new entrants, but less than there was three years ago. “The appeal is narrowing for some social networks,” says Wharton legal studies and business ethics professor Andrea Matwyshyn. Why? Consumers only have time for so many social networking sites and are likely to gravitate where they already have friends, she says.

Kendall Whitehouse, director of new media at Wharton, notes that “social networking sites are still popping up” but with questionable prospects. However, these sites could be a source of new features for larger players. “I think we are starting to see the beginning of consolidation.” Adds Wharton marketing professor Peter Fader: “Clearly, there are too many social networking sites.” A number of them have evolved to aggregate consumers’ social profiles at various networks, he notes. “Just the fact that those [aggregation] businesses exist means there are too many” independent sites.

Multipurpose Sites with Scale

Eric Bradlow, a marketing professor at Wharton, says an upcoming round of consolidation may include a good bit of reinvention as social networking sites tinker with business models. “The big question today is: How will social networking and social media sites monetize themselves? Turning themselves into social commerce sites will be very difficult.”

What’s likely to emerge is a social networking market where there are multipurpose sites that have vast economies of scale, like Facebook and MySpace, and niche players, like LinkedIn, that find profitable business models, says David Hsu, a Wharton management professor. “People will go with the large social networking sites, but there will be very niche communities that will also be successful. The companies in the middle will be squeezed.”

However, these market dynamics may take time to play out. Some social networks in the middle of the pack — such as Ning and Hi5 — are showing solid growth figures, according to comScore. Meanwhile, many leading social networks fill viable roles that don’t overlap with other services, so there’s no immediate need for consolidation, says Matwyshyn.

According to comScore’s August data, the top three social networking sites in the current U.S. market are Facebook, MySpace and Twitter. Facebook (which launched in 2004) is number one, with year-over-year growth of 125%. MySpace, which is increasingly focused on becoming an entertainment portal as well as a social networking site, is in flux, but is still the second-largest social networking site, according to comScore. In third place sits Twitter, launched in 2006, which had 20.8 million unique users in August — up 1,773% from a year ago.

In addition to Ning and Hi5, the vast middle includes sites like Digg.com, Classmates.com, MyLife, Bebo and LinkedIn. Andrew Lipsman, director of industry analysis at comScore, notes that it’s simplistic to rank social networking sites based on size. For instance, LinkedIn had 8.74 million unique users in August, but that’s up 67% from a year ago. The company, which says it is profitable, has benefited from the economic downturn as people increasingly use LinkedIn to look for employment. “The business-oriented social networking site has become more important than ever for those looking for job opportunities and it has the growth to show for it,” he says.

Lipsman also highlights Ning, a service that allows people to create their own social networks based on their interests, as another niche player that has posted impressive growth with 5.48 million unique users in August — up 96% compared to a year ago. According to the company, there are more than 1.5 million Ning networks. “Even in the U.S., the most mature market for social networking, there’s user growth at every category level,” says Lipsman.

Experts at Wharton, however, question how long that growth can last. “The bubble hasn’t popped yet and there’s tremendous value in social media,” says Fader. “But it’s wishful thinking to [believe] that others on the ‘me too’ bandwagon will survive.”

Emerging Business Models

The profit potential for social networks could be impressive — as long as these companies find a working business model. Most companies in the social networking space are still experimenting with ways to generate revenue. The Holy Grail, according to Bradlow: Highly personalized advertising and word of mouth marketing.

But that prized marketing goal may prove elusive. “Can [social networks] eventually sell products tailored to the individuals on their sites?” asks Bradlow, adding that even the leading players like Facebook wrestle with the question. “I think it will be very hard for firms that are well established to make that transition. So where do they make the revenue?”

Nevertheless, that transition is happening as social networks begin to define their specialties — and as business models are refined, some reinvention will be in order. For instance, MySpace and its parent News Corp. have been quite busy in 2009. In March, News Corp. hired former AOL CEO Jonathan Miller to lead its interactive efforts. In April, former Facebook executive Owen Van Natta was named MySpace CEO with a mandate for fast innovation. In June, the site cut 30% of its workforce. Since Van Natta’s arrival, MySpace has also named new chief financial and chief technical officers. In August, it acquired iLike, a service where friends recommend music choices.

News Corp. CEO Rupert Murdoch said on an earnings conference call in August that MySpace will focus on its core competencies. “For MySpace, we think music, we think games, we think video. And we’re going to improve those in every way we can.” Indeed, MySpace also revamped its MySpace Music team and is positioning itself as an entertainment hub with original content series and an online game show. Most of MySpace’s services are ad supported.

Bradlow says that increased specialization with continued experimentation is warranted. After all, there are multiple business models to consider. According to Bradlow, social networking companies could sell applications (like Apple’s iTunes Store does), aggregate massive audiences for advertisers or target high-value consumers that are coveted by Madison Avenue. Another option: Sell behavioral data to advertisers. Many networks are using variations of those themes. For instance, Twitter, which doesn’t yet have any meaningful revenue, has been targeting businesses with tutorials on how to use its services as a customer-monitoring and service tool. Facebook, which noted in August that it has turned cash-flow positive, can aggregate a large audience, but also wants to harness its user information in what it believes is a privacy-friendly way.

While most social networks won’t become the size of Facebook, there are other options to make money for smaller, more focused rivals. Smaller players can target groups that are highly coveted by marketers. For example, Ning’s collection of niche social networks could be valuable to advertisers. By providing tools to enable targeted social networking, the site has been able to grow at a rapid clip. “Ning is carving out an interesting niche,” says Lipsman.

Other social networks are focusing on business uses and providing tools for advertisers and any company that wants to monitor its brand. “Social networking is becoming a business beyond consumer use,” says Chaudhuri. “The government and businesses are using it to communicate and companies are getting into it.” Given that trend, experts at Wharton say most social networks are likely to develop models that revolve around serving so-called “enterprise customers” — companies looking for intelligence about their products and reputation. “The challenge, particularly for enterprise customers, is to figure out how many of these sites they should pay attention to and provide content,” says Whitehouse.

Indeed, the focus on business intelligence could help some of the smaller social networks thrive. For instance, LinkedIn has a recruiter product for human resources professionals, designed to find “passive candidates,” or people not actively looking for jobs who could be good hires. LinkedIn charges a fee per user for the recruiting service and counts Allstate, eBay, Logitech and Kaiser Permanente as customers. The site also launched a survey business so customers can poll the professionals that use its social network. Forrester Research, a technology research firm, formed a survey partnership with LinkedIn in August.

Those revenue streams are in addition to advertising on the LinkedIn site. “Certainly, there are revenue opportunities that haven’t been explored,” says Matwyshyn. “LinkedIn could also facilitate conference calls and develop new business communities.”

Vast Potential and Pitfalls

As social networking companies continue to experiment with business models, the formula will be different for each one, Wharton faculty say.  

For instance, Friendster, an early social networking site with a small market share in the U.S., has revamped to focus on its strongest geographic area — the Asia-Pacific region. In January, Friendster announced plans to expand in Singapore, the Philippines and other locales in the region. In the U.S., Friendster had 2.1 million unique users in August, compared to 13.7 million in Southeast Asia, according to comScore.

However, the clock could be ticking on Friendster. ComScore data shows that Friendster may be falling behind Facebook and MySpace in Asia, too. According to the San Francisco Chronicle, Friendster disputes the comScore figures, which show a sharp drop from 2008, because the research firm undercounts activity from Internet cafes, a popular way to get online in Asia. Meanwhile, TechCrunch reported that Friendster is shopping itself in Asia to find a potential buyer.

Even the giant, Facebook, is still finding its business model. In 2007, Facebook launched a service called Beacon that was designed to track users’ activity on external sites and deliver more targeted ads. After privacy complaints, Facebook continued to tweak Beacon before ultimately shutting it down in September. “Privacy will play an increasingly important role in these models,” says Matwyshyn. “For these sites, user information is their most valuable asset, and that lends itself to being licensed or leveraged.” The real trick will be finding the balance between privacy and profit.  

Ultimately, consumers may determine how quickly the social networking industry consolidates. “It’s a race in terms of finding how much new value can be added [to social network business models],” says Hsu. “As a user, I only have the time to allocate my mindshare to one or two.”

Matwyshyn agrees. “Consumers are seeing less benefit of building out profiles on smaller networks. The choice is to gravitate toward a major player like Facebook, because it’s more efficient and you get more bang for your minute.”

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