The Social Networks

Four major trends are revolutionizing the tech sector. In previous issues of Smart Tech Investor, we’ve covered three of them – Big Data, the Cloud and Mobile Technology. This month we tackle the fourth – Social Media.

Ironically, when the first social websites such as GeoCities were started, the technology was so clunky that very little new data was created at that time (the mid- to late 1990s). When people finished building their websites, they were so tired and relieved that they did not usually go back and update them.

GeoCities actually had icons next to the front door of each of the personal websites indicating that it was either recently updated or was shown as getting old and dusty. In those pre-blog days, it took a real personal investment to even have a personal website. The visual was unpleasant to look at and was a huge marketing gaffe on GeoCities’ part because websites were very difficult to update.

As blogs and the first social websites came into existence (Myspace was an early example), personal websites such as GeoCities failed and disappeared from the web. Today search engines like Google utilize data to see if a website is being updated; if so, it is shown higher in the search results. As a result, when you type in a non-famous person’s name their Facebook, Twitter and LinkedIn pages are the first pages listed. This has been true for many years.

What is new are all the mobile tools and easily configured templates that social websites now possess. Once the light bulb finally turned on and the social sites recognized that ease of access and updating was the issue they faced, they all began to replicate the Holiday Inn and McDonalds strategies from the prior tech wave (automobiles).

Consumer chain stores burst upon the scene in the 1950s in a huge way and it was location, location, location that determined their success. If you could locate your motel or fast food chain near off the ramp of a highway, business quickly followed. The car made the U.S. mobile, which provided growth rates for hotels and motels that had been previously reserved primarily for traveling executives and salesmen of large manufacturing companies.

Social websites have replicated ease of access and standard features – similar to the ones the big chains used to supplant the mom and pop shops from the 1930s. Once social websites rediscovered the prior tech wave’s secret formula for success, something else happened. That something is remaking traditional business computing.

Today every major tech company is either building tools or infrastructure on top of their core products, or is starting the process of exiting the tech industry. Social websites create a tremendous amount of user data which today is used rudimentarily for advertising revenue. The advertising model is not the recipe for long term success. That would be like asserting that McDonalds would have grown into the behemoth it became by selling their product at cost and simply reselling the menu choices from their customers in the 1950s.

A strategy like that may have enabled other companies to become fast food category killer companies but the end result for McDonalds would have been a yellow pages type of business. McDonalds would have generated 98% less sales then they actually did. This is why Facebook (NSDQ: FB) paid billions for WhatsApp. Facebook’s strategy is not to become an advertising generator type of company, but rather a large chain for the 21st century standing at the nearest corner of the information superhighway.

So why is STI not a huge fan of Facebook? Because they are casting about in all directions to see if they can acquire the “category killer” chain utilizing a kind of shotgun approach. Some of the logic used to explain the $18 billion dollar acquisition (the price Facebook paid for WhatsApp) in messaging applications is that Facebook is trying to keep their competition from getting to the on-ramps of the information superhighway. Can Facebook ever monetize a messaging application to the tune of $100 billion in revenue? That is very unlikely.

Facebook’s approach is the number one reason why investors tend to stay away from the tech industry. No investor wants to buy a momentum stock because when the hype clears and market reality surfaces – momo stocks plummet. No one wants to be the investor without a chair to sit in when the music stops. To date Facebook has not shown us any other attribute other than that of any momo stock.

Facebook does have a tremendous amount of dry powder to get it right, however. We believe that chances are they will one day awaken from their slumber to see that they are missing the on-ramps. You may be asking yourself – is there any way for a social site to ever be relevant? We think the answer is a definite yes.

Imagine if Facebook had taken its massive market share in social media and, instead of focusing on ways to post photos of your Aunt’s latest soiree, had looked for more financially lucrative opportunities. Facebook came of age during the financial meltdown also known as the “Great Recession.” In the last Great Depression King Cullen came into existence.

King Cullen was the very first chain grocery store. It launched into the teeth of misery of the early 1930s. What King Cullen’s executives understood was that if they could provide inexpensive canned food at the time when everyone was quite literally counting their pennies – they were onto something. The supermarket industry was born and several companies have made large fortunes as a result.

Imagine if Facebook would have married Auntie’s photos with the largest source for up-to-date resumes? The core users of Facebook are now those from ages 30 to 60. These are the same people who are looking for jobs right now. These same people possess the skills that employers are specifically looking for.

Those of you who are familiar with social media know there is a company that is attempting to do just this. In the prior decade there was a site called Monster.com, which failed at taking this hill. LinkedIn (NYSE: LNKD), on the other hand, is focused on exactly this piece of real estate along the information superhighway.

LinkedIn does not have the massive presence that Facebook has, so they are executing a multi-threaded strategy. Yes, their primary mission is in linking together everyone who is looking for work, to be sure. But they are also taking on Twitter (NYSE: TWTR) at the same time. Let’s unpack LinkedIn’s strategy.

LinkedIn focused on the easiest way possible to list your resume online. For those who are serious in their use of LinkedIn they can not only post their resume and skills, but also for a fee see everyone or every company who reviews their listing. If utilized to maximum efficiency one could post their skills and see if the companies they want to work for are coming to their page. If not they can redesign and re-measure the effect of the change. If the right companies are coming to their site they can tweak their listing till they are contacted by the desired companies.

The secondary effect is that, even if the job seeker is unsure who they may want to work for next, companies can see if they have the skills they seek and offer them a job that the LinkedIn user may not have even thought of previously. LinkedIn allows their users to add tweet-like posts demonstrating understanding of the issues which face companies in their industry.

By taking this approach LinkedIn not only reduces Twitter to the role of updates from the rich and famous but also generates more data, which everyone involved in their ecosystem can draw on. Many times the most difficult aspect of finding a new job is making a personal connection at another company. With the personal posts and news updates this can occur by a link of link posting something which can make this connection accidently.

LinkedIn is not resting on individual posts, however. A year ago they released a feature where people who are linked to you can post on your page skills that they know you have. Where Facebook only provides a like button on their site, LinkedIn provides endorsed skills on theirs.

Facebook is struggling with the negative impacts in trying to monetize their generic “like” button. Facebook’s algorithms rate the value of your page by the amount of likes associated with it. The thinking is if you are Ford – you will get a ton of likes due to how many people buy your product and are passionate about it. However, what has in fact occurred is a cottage industry of the worst kind grown up around Facebook’s ecosystem.

With the knowledge that Facebook’s algorithms are fairly rudimentary, companies in the Far East have begun to market themselves as being able to move your Facebook page up in searches by liking your page. Facebook has responded by trying to weed these companies out of their algorithm. Again, due to the simplicity of their logic, they penalize likes from pages where there is no information and almost no friends.

The members of the Facebook “like” cottage industry have attempted to circumvent this by liking more companies than just the ones they are being paid to like. Now what has occurred is a company which may have been much higher in Facebook search results is now plummeting due to one of these “like” manufacturing fly-by-night companies having liked your company to disguise their true intent. If your company’s revenues are tied to eye traffic on Facebook – you now are in serious trouble.

We bring all this up to demonstrate how Facebook’s innogration strategy is not focused where it should be. Generic likes cannot become the foundation for a category killer application. Everything you see with technology since the birth of mankind is the ever-customizing ability of technology to resolve issues more efficiently. A like is a like and is not the equivalent of a post or a skills endorsement.

Facebook will wake up and one day buy companies that address this issue. Everyone who is paying attention in the marketplace will know. Suddenly, Facebook will start acquiring businesses which not only generate real revenue now but also are relevant to the current market.

When companies build strategies, they don’t use rocket science to determine where they want to go. Companies which have articulated strategies first identify where there is opportunity today and then reverse engineer their core products and services to address this market. Yes, they can buy companies but those who solely rely on the purchase of a company do so at great risk. If you look back at HP’s purchase of Autonomy, you can see that if a company is not reverse-engineered to take advantage of the company as a strategy then that is a road map for failure.

HP’s purchase marked the start of their financial troubles, which they are attempting to resolve with greater and greater layoffs. Their recent earnings report of their 11th straight quarterly decline was accompanied with the announcement of an additional 16,000 layoffs, taking the number to a whopping 50,000! This was directly tied to spending billions on a company which was not tied to their core or had the ability to get there on its own. If Autonomy could have generated $100 billion in revenue, it would have done so without HP having acquired it.

The fact that the leading social companies have not yet found the path to the long-term solution should not alarm any investor. There was a time when McDonalds and Marriott had so few outlets that no one knew they would grow up to become the category killers they became. Facebook and Twitter dallying with being the “it” social companies of the moment will not catapult them into this type of stratosphere.

Another example is Yahoo (NSDQ: YHOO). Yahoo was the “It” place as the Internet’s first real portal. Their new CEO has made the portal younger in an effort to make it more easily accessible by mobile devices. In so doing they made their portal almost impossible to navigate. I use ESPN for sports and dumped Yahoo’s enhanced email service as Google’s free Gmail is far superior. The CEO came from Google and is still thinking in those terms instead of how to build a chain of very valuable properties on the information superhighway. They are not the only company to go down this road though I suspect they will not be able to recover from the detour due to capitalization issues.

Back when the Internet first arrived in the mid-1990s, Microsoft focused on building a better browser, as they were concerned their core office and operating system business was at risk.  In the end, of course, it was – not because of browsers from competitors like Netscape but from the smartphones and cloud technologies. Microsoft has righted its ship to address these markets as they have unfolded. The time and money they wasted in browser issues was revenue they forfeit for waiting longer then they needed to. Facebook is still trying to make its website the killer browser and not the application needed to win.

What LinkedIn is working on – along with some other companies such as Groupon – might become the killer “app” for social.  We know that the category killer is coming, and only those social tech companies looking at market opportunity being leveraged in this way will enable them to win in the social marketplace.      

For that reason we do not currently recommend any of the pure social media companies in our Investments Portfolio, as we feel they are still too immature in their development for us to identify the long-term winners.