Social Media as a business loser?

Business Insider, in its 18 January 2010 edition, referenced an article from September 2009 in the Washington Post by Bo Peabody, the founder of Tripod, arguably the first social networking site, founded way back in 1995. For those who do not (or are too young to) remember, 1995 was the year the Internet really took off. Morgan Stanley (where I had the great pleasure of working in IT at the time) took public a virtually unknown company, called Netscape. It has been called "the birth of the Web" (although Tim Berners-Lee might disagree). Bo argues in his article that social networking is a bad business. Social networking sites lose money, they always lose money, and so perhaps they should simply be run as non-profits, like Wikipedia.

Bo's proposition is interesting. I have always found social media very interesting, but primarily from an operational perspective. Quite simply, they need to burn oodles of cash getting very big - and thus taking advantage of the "network effect" as it is know to economists - running massive bandwidth and server operations, along with significant (and expensive) expertise. The challenges inherent in growing a business to that scale at that speed are fascinating. Nonetheless, I have always largely avoided getting involved with them from an equity perspective. I love using social media: Facebook, LinkedIn, Twitter, they all provide invaluable services... but not necessarily valuable services. I am skeptical that anyone would use them if they had to pay, which is why they rely on advertising, which does not pay off in the majority of instances. The exceptions are those sites that provide niche services - nice in terms of either target audience or purpose - like LinkedIn. Thus, these sites are a social good, but an investment waste. The challenge, of course, is whether or not anyone would have gone to the trouble of founding these sites and inventing the ideas - and sometimes the technology - without the hope of serious payoff (a.k.a. exit).

In some ways, this is similar to work I have been doing on ice skating rinks. I spend a lot of time in Israel. Israel, a tiny (about 20,000 sq km), semi-arid country, with hot summers and mild winters, has a population of 7MM, and exactly one regulation-sized ice skating rink. Over the last decade, an enthusiastic hockey and figure skating movement has grown in Israel, comprised of US & Canadian expats, Russian emigres, and some natives. Indeed, Israel is about to hold its third international ice hockey tournament, with six teams, half of whom are traveling from overseas. The tournament is being covered by European and North American news networks, including the Canadian Broadcasting Corporation (CBC), and will include two NHL Hall of Famers, Darryl Sittler and Paul Henderson. The problem is that 70% of Israel's population lives in the center of the country, but the one regulation-sized rink is at the country's near-northernmost point, the town of Metulla, on the border with Lebanon.

It is clear that ice sports will not take off substantially in Israel until facilities are built within a reasonable driving distance of the 70% of the population, somewhere around Tel Aviv or between Tel Aviv and Jerusalem. As such, over the last 5 months, I have explored the economics of building and managing a facility. The net result is that building an ice rink is good for society, but bad for business. Because of economies of scale, no commercial rink is built with fewer than two sheets of ice, i.e. two facilities in one building. The cost of such construction, fully loaded, is $8-10MM USD. In the best of years, such a facility will generate around $2MM in revenue and incur around $1.3MM in operating expenses. Essentially, $10MM in investment leads to pre-tax free cash flow of $700,000, or a 7% return on investment... in the best of years. Most sane investors can find somewhere else to put their money, and do. This is why most facilities in the US, Canada and Europe are built as single sheets by a municipality, which is in the business of providing social goods that don't make sense for businesses to provide. They view the investment as a community investment, not a financial one, and as long as the facility does not lose money each year, or at least not too much, they are satisfied (and the mayor gets re-elected).

From this perspective, social networking may be very similar to ice rinks: they provide an important social good, but are financially a waste.

As for the Israeli ice rink? I am still looking for a group of investors who love Israel, love ice sports, and are willing to donate to both at the same time.