This is one of those started as a comment, but really deserves a full post type things…

My comment was in response to JP’s The new new telco where he posits that Facebook could be a very valuable business due to its telco like properties on a global scale. Here’s my original comment:

This is a great counterpoint piece to what I wrote yesterday about why I think Facebook is overvalued.

The thing that’s missing here is something that I call ‘Internet Alchemy’ – the process of turning somebody else’s pile of gold into your pile of nickles. In this case we see two piles of gold – one for the old telcos and another for the new telcos. My conjecture is that Facebook doesn’t get to grab these piles of gold. Internet alchemy will turn them into a pile of nickels, and so there is a lot less cash on the table. The canonical example here is Craigslist. It’s a phenomenally successful firm by any conventional metric, making $100m/yr with around 30 employees, and it has utterly destroyed a print classified business worth orders of magnitude more – Internet alchemy at work.

Of course Facebook is special, and it may yet find a way of making money that none of us have anticipated. But is it really 3.5x more special than Google? I don’t think so. People are calling this bubble 2.0 or whatever because we’re once again seeing a disconnect between cash flows and valuation with no substantive means of support.

Somehow this seemed to set the tone for much of the rest of the discussion there (which is well worth reading) as various people speculated about the size of piles of gold.

Internet alchemy

Definition (for an Internet based startup) – the process of  turning somebody else’s pile of gold into your pile of nickles

I’ve been meaning to write about Internet alchemy for over a year. I made a start, but got lost along the way trying to explain why it was something more than just disintermediation.

The Facebook valuation debate has got me thinking about this again, and I think there are a number of other factors (besides disintermediation) that come to bear here, though none of them are new, and I offer no fresh insights:

• Free – people like free stuff. The Internet is full of free stuff. Some say that there’s an expectation that stuff on the Internet is free (at least at the point of consumption[1]). Books have been written on the topic. It’s hard(er) to make money out of a given user population on the Internet when the expected price is free (but you get to reach a much larger population for tiny marginal cost).
• The long tail – the Internet reaches people and places that were previously inaccessible. As the Internet gets to parts of the globe that weren’t previously connected it’s expanding into what bankers call ’emerging markets’, and what the rest of us might call ‘poor people’. There are lots of nickles and dimes to be collected from the long tail, but its very nature is that there aren’t huge piles of cash.

If we look at how the Internet is disrupting traditional businesses and markets then I think we can find examples of Internet Alchemy all over the place. It’s probably also a factor in the ‘jobless recovery‘ – new businesses are emerging that destroy old businesses, but the economic value changes dramatically in the transition.

Why does this matter for Facebook?

Any traditional business with around 600m customers would be making an infeasibly large amount of money, and clearly the $50Bn (or larger) valuation being placed on facebook suggests an expectation from their (more recent) investors that the monetisation plan will come along in due course to turn those customers into cash. My conjecture is that Facebook will be a victim of Internet alchemy, that there are no pots of gold associated with those users, only a pile of nickles. I expect that the Facebook team already know this, but at this stage they’re along for the ride as other people try to get rich off their work.

If you can see some piles of gold that Facebook might grab that you think I’ve overlooked then please let me know?

Notes

[1] Though I love the statement that ‘if you’re not paying for it; you are the product‘