Tuesday, 6 December 2011

Will 2012 be the year of the Gigaflop?

Lord Hanson famously worked on the adage of buying companies that made the basic commodities like bricks, cement and batteries as he reasoned that they would always be in demand. He made a bob or two in the process.

In a way you could interpret that approach as one of low risk investment. If you could see that a company made products that people wanted and there wasn't a lot of clever things in between like lots of research costs then you could always make money. The simpler the business model, the easier it was to foresee a return.

Next year sees the IPO of Facebook and this year we have seen Groupon go to market - both with incredible valuations. The valuations are not just big, they are hopeful beyond all measure. They could even be described as hopeless by some measures.

The attraction of social networking for most of the 800 million subscribers to Facebook, and the same can be said of Twitter, is that we love the freedom of use that benevolently donated platforms can give us. So far, we are mildly irritated but not put off by advertising. Which is good news as this is a multi-billion dollar business in itself of which Facebook already has $3bn a year. That's sheer exploitation of the user base in no uncertain terms and it may not be long before users who attract a lot of attention start believing their own bull and think that companies like Facebook, Google and others are making a mint off their popularity and start charging these companies to use their space.

Hmmm, is there something flawed in the model here? Sticking an advert on my Facebook page is useless, frankly. I hardly ever go there and neither does anyone else. Rather like paying for the best hoarding for an advert in a Tube Station the demographics of Facebook's user base commands the price. And will those users who do get millions of page impressions suddenly wise up that it isn't about Facebook, it's about them? Are we talking users huddling together and forming a 'Premier League' style breakaway?

If that ever happens, will Facebook's value implode or will there be enough of the second tier to fill the gaps and start all over again? Could this actually ever happen?

I really don't know but I would imagine that as I write there is some enterprising individual who might actually be dreaming up this concept. It's a simple thought - some users are more valuable than others to Facebook and the likes so if they got stripped away then the calculation on which the valuation is made is skewed, possibly ruined.

The only really rock solid foundation for Facebook would be to use a 'taxation' model. If every user paid a small fee for being a subscriber every year then there would be a base revenue which would always be the core source of the profits. Losing a few users would then be not a real worry. Exploitation of the membership has an inherent flaw and it's why many of these seemingly fat golden geese may actually be plain old ducks in the end.

Mark Zuckerberg is an infinitely more clever individual than me but Lord Hanson would point out that my tiny company made more net profit last month than his company has accumulated in its entire existence. That's a sobering thought. 

2012 could be a landmark year. I honestly believe that Groupon will implode sometime in the next two years. It has a fundamentally weak business model that could even be transient at best but infinitely clonal at worst. In fact, any model predicated on believing that consumerism will only expand in the next 5 years is basically a high risk business if it is not uniquely differentiated in my small and insignificant book. And Groupon is not differentiated enough by far.

So my point today is that if you are going to invest your hard earned cash or leverage your house to do so, then don't back the IPOs of these sorts of companies and certainly not as long term investments. 

2012 could be the year of the Gigaflop.

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