With the advent of Facebook and Twitter, social media has become a permanent aspect for most of us in our daily lives. Recently, Facebook surpassed the 500 million member mark, with the company now valued at $50 billion and earning $1 billion annually in revenue. Though smaller, Twitter, with 200 million users, is valued at $1 billion and with revenue of $150 million. Given these figures, it is of little surprise that so many angel investors are seeking to find the next great social media start-up. But before you look at privately investing in this ballooning sector, there are things you should understand about their business model and differentiating features.
The distinguishing feature of social media that differentiates it from the dot.com Internet boom of the late 1990s is the way people interact and connect with each other online. Whereas people previously made money off the Internet through the ability to search for people, companies, and sell things, social media or what some call “Web 2.0,” allows Internet users to create and publish anything they want to share about themselves. While this in itself provides zero revenue, the advertising model that it is premised on has become a lucrative business. Google for example, made $6.77 billion in the first quarter of 2010, which is made almost exclusively off its search engine capabilities that power its advertising model (because in the end, Google is just a very large advertising company).
More recently however, smartphones, have served as a platform for the selling of “apps.” Apps are third-party software programs that perform a variety of different functions (ie. suggest restaurants, turn on your car, allow you to purchase items, play games). Given the distribution system of cellphones, apps have become a relatively inexpensive product with a huge and accessible market reach.
Thus, for some, the revenue from social media is the software program itself. For others, it is the advertising revenue generated by connecting and tracking others. More recently, the emergence of ”geolocation” on cellphones has allowed us to pinpoint the specific location of users of specific apps. This in turn has resulted in highly specified targeted advertisements. These affordable advertisements have allowed both individuals and small companies and large companies to adequately target their customer base.
In general, privately investing in a social media company can mean a few different things depending on the source of revenue. With competing apps available for download, investing in what you see as a successful company has become a harder decision. While due diligence is needed when picking said company, the other thing to remember is that most companies are not going to turn out to be the next Facebook or Google. However, because of the market reach of the Internet and ability to deliver targeted advertisements, finding a good small-to-mid cap company can be an excellent pay-off. In the end, the hardest part of investing in social media is not the business model itself, but finding a company you believe in, with the pay-offs you expect from your investment.