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Social Media and Bubble Economics

The rapid rise and fall in share prices for Facebook’s initial public offering (IPO) has fueled speculation about a new economic bubble, a social media bubble. In the excitement of being able to invest in the most popular social media platform on the web, many smaller investors had hoped for an early spike in prices as demand for shares pushed the price of Facebook’s stock upwards. What actually happened resembled a mini-bubble that has called the real market value of social media sites into question.

Put simply, an economic bubble is a period when commodities are selling at prices that are much higher than their real monetary value1. There are a number of factors that can create these bubbles, such as artificially limited supply or a perception of value that is greater than the company’s real equity, and it is a combination of these that saw the pre-IPO price of Facebook climb to $38 per share for the launch. As the initial demand for shares was high because of the number of speculative investors, the share price rose quickly on the day they were issued, reaching a high of $45 before the bubble began to deflate, causing share prices to tumble well below their IPO price. Since opening for their first day’s trading at $42.05 the price of Facebook shares has now fallen to a more modest $27.27 only a few short weeks later, wiping billions off of the value of the company2.

Investors have been burned by Internet stocks before and the rapid fall of Facebook’s share price, representing a loss of value of 21% of the IPO price and a whopping 40% from the highest share price, is reminiscent of the 2000-01 dot com bubble collapse when 86% of the market value of Internet companies was lost in a short time and never recovered3. That time a lot of small investors took considerable losses on their investments and, as much of the interest in Facebook’s IPO were those same small investors, it suddenly seemed as if history was repeating itself, albeit in a smaller way. In the end many of those small investors have lost a considerable sum on the falling share price of Facebook.

The deflating social media bubble hasn’t been restricted entirely to Facebook even though the falling prices of their shares has been a major contributor to the falling value of social media companies on the stock exchanges in general. LinkedIn and Groupon have also been struggling to grow their stock values and there has been a 25% drop in value across the industry since the Facebook IPO in May4. As the emphasis on these shares has shifted to the more pragmatic approach of considering the business model instead of the buzz that caused prices to spike in the first place, the earning power of social media sites has been called into question.

Initially social media looked like a marketers’ paradise with billions of potential customers to advertise to, but as we have become more familiar with using them and our behavior on social media has been analyzed more carefully, it has become apparent that the advertising models that work on other parts of the Web are failing dismally on most social media sites. Investors are beginning to doubt whether Facebook can find an advertising model that will continue to offer value to businesses that are beginning to scale back their social media advertising budgets in favor of using these sites just to raise brand awareness. For a business that relies on advertising for the bulk of its income, this is a considerable obstacle to overcome just to prove to investors that the company really has an intrinsic value that makes it a good investment.

References:
1. http://en.wikipedia.org/wiki/Economic_bubble

2. http://www.cnbc.com/id/47805333

3. http://en.wikipedia.org/wiki/Dot-com_bubble

4. http://www.marketwatch.com/story/social-media-industry-continue-to-struggle-after-facebook-ipo-2012-06-13


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