What could Simon Cowell teach Facebook?

16th April 2012

Social Media's got Talent

Cowell knows that most of the "stars" he discovers and then signs via his shows will have a short shelf life – and he plans for that. If any last longer than a season, then it's a bonus.

Silicon Valley could also take a hefty drag on some of Big Tobacco's finest products. For the cigarette industry, whose shares have outperformed most sectors since 2000, is expert at squeezing profitability from a dying habit.

Time after time, investors ask themselves just how long social media sites will last for. They quote here yesterday and more or less forgotten today operations such as Friends Reunited, MySpace and Bebo as well as other even further into oblivion.

Wrong question – ask a boy band

But this is the wrong question. Instead, they should ask how best to invest for something that may only last a few years or even a few quarters – the equivalent of a Cowell boy band – or something that may burn brightly for a while and then go into a low slow decline. 

There are suggestions that social media is similar to computer hardware. In the latter, Moore's Law  dictates that power doubles (or prices halve) every two years or so. The social media version might say that once a site has reached IPO, then it will halve in influence and reach in around two years. This has certainly been true for the fading and faded stars – again something a Cowell would understand intuitively.

The long decline slope is rather like the tobacco industry which, faced with falling demand in its original markets, has priced cigarettes to obtain higher profits from the remaining addicts in Western Europe and North America while leveraging their packets into developing nations. They spend only peanuts on research and development. The Silicon Valley equivalent would be to sell old technology aggressively at knock down prices.

Instagram – a cool billion for defence

Take a look at this Financial Times story. It suggests that Facebook pitched in with a cool billion dollars for Instagram – or around $70m for each employee and over $50m for each month of its life – as a defensive move. It prevents others exploiting the upstart photo-sharing site.

The article added: "The web's former giants were being humbled [at the same time]

Yahoo, which unveiled another reorganisation under its fifth chief executive in five years, and AOL, which sold a portfolio of 800 patents to Microsoft for $1.1bn, are under attack from hedge funds. Both are worth a fraction of their value during the 1990s internet bubble."

It added: "Silicon Valley was always competitive but barriers to entry in the late stages of the social network boom are so low, and capital so plentiful, that creative destruction is on fast-forward. If Facebook, which is about to launch its initial public offering, will pay $1bn to neutralise Instagram, how much are Path, Pinterest and others yet to be invented worth?"

Facebook must know that its growth has to slow. If nothing else, and even if users don't tire of it and move on elsewhere, the remaining Facebook-friendly demographic is shrinking. Yes, there are some crazy numbers around but no investor can believe them as they assume billions without even electricity or running water let alone able to afford a device, are thirsting for Facebook.

Baby has a limited life

Cowell could teach Zuckerberg that you maximise everything for the short term. And Zuckerberg needs to tell investors that his baby will have a limited life.

There is nothing new in this. Elsewhere in the investment world, investors buy and sell gold mines or oil fields with limited lives. It's just a matter of getting the valuations right. And some investment trusts are set up with limited lives – managers and investors decide later on whether to extend them, perhaps six months before the planned demise.

Like tobacco, it may be the least glamorous that score. Dear old cash rich Yellow Pages, where a majority stake picked up for a song by private equity group Cerberus earlier this month, is a good example. It is old-fashioned but advertisers pay.

Investors should not necessarily see social media companies as a whole – there may be parts which can be floated or sold off although the ownership model with founders controlling through a mix of voting shares for them and non-voting shares for outsiders does not auger well for change – it would be like killing off or amputating limbs from one's own child.

Back to Top of the Pops

Another old fashioned concept is the idea of companies going "ex-growth" when they go into decline as their original purpose is overtaken by newer ideas. There are many respectable companies in this category. When they try to regain previous glory, they tend to get it wrong (and scare investors by over-paying for acquisitions which they cannot quite justify). But when they manage for decline, and pay out generous dividends, they can become top of the pops.


More from Mindful Money:

What can investors learn from The Voice?

What Big Finance can learn from Big Pharma

What can investors learn from Dragon’s Den?

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