Social Media Investment Bubble: Watch-Out! Advertising is Limited.

The Atlantic Wire recently published an article concerning the existence of a new bubble in the stock investment community. Facebook's recent purchase of Internet company Instagram for $1 Billion highlights The Atlantic's thesis, and I would have to second their opinion. Now, this is not to say that Facebook and other social networking corporations like LinkedIn cannot increase in valuation, but simply that sooner or later they have to come crashing down if they do not better learn how to profit from their users.

Instagram has no clear source of revenue, and at $1 Billion is valued far beyond its current earnings. As a business owner, one should expect a reasonable return over a reasonable period of time. Of course, proponents of many social media businesses would say that future earnings and future growth are coming, but investing based purely on expectations of future profitability with no clear path how to get there is a fools game and makes one inherently susceptible to market crashes irrecoverable losses.

Revenue comes from getting customers to buy something, or by selling advertising. Every social media company is largely claiming that their earnings will simply come from advertising, but it is not that simple. AOL, for instance, for years had an established network of users, but only recently by selling its patents to Microsoft, was it able to realize any significant value for shareholders. If all AOL had to do was simply rake in money from advertising, it would have made its investors a fortune by now. Remember GeoCities? Yahoo paid almost $3.6 Billion for GeoCities in 1999, and it is now defunct and shuttered. Why didn't Yahoo just utilize the magic of Internet advertising to make everyone rich? Because company's already have pre-existing advertising relationships that are often difficult to break. Ford, for example, cannot advertise via every medium, it has to select what it thinks will realize it the largest return. This often means it shells out lots of money to traditional outlets like CBS, but not necessarily to Instagram, which it might see as a flash in the pan.

Essentially, resources are limited and social media sites have to compete with other forms of media for advertising dollars. In tough economic times, this is not easy!