Is another Internet bubble dot com crash coming soon?

I’m not a fear monger and would have a lot to lose if Internet-based spending suddenly ceased or were severely reduced. I attend and speak at Internet conferences, read a lot, follow the Twitter headlines, and continually absorb knowledge from many sources. Lately, I’ve noticed a trend that makes me nervous, the result of which may be another dot com crash.

What is a Dot Com Crash?

First, I’d like to make it clear that for the purposes of this article, a dot com crash (aka the bursting of an Internet bubble) means that there is a sudden drop in value among tech-related stocks (i.e., the valuation of companies on the stock market) and the amount of investments put into start-ups by venture capital firms dries up.  If the money flow ceases or is minimized, it (presumably) follows that there will be a slowdown in innovation, research and development.

Clues to the Next Collapse

Here are some signs and portents.

Internet Valuations are Impossible to Predict
Just like traditional brick and mortar businesses, it is impossible to predict long-term success but generally speaking, there is a way to assess the established and potential value (at least in the short term) of a company. However, when dealing with online properties, brands are getting marked-up like crazy!

I have always been taught that a company is only worth what it earns in profit, multiplied 1-5 times at most. Yet, here are some high profile examples of valuations of companies that have barely made a profit or at least have been estimated to be worth many multiples of any (realistic) amount.

1. Facebook: Facebook has been valued at $50 billion. How much revenue did it generate last year? Not even close to that. The fact that Goldman Sachs owns a piece of the action also makes me nervous since I don’t companies that have the chutzpah to take a $12 billion bailout and then re-distribute that money as bonuses. Think about it… Pfizer and Best Buy each did about $50 billion in actual sales in 2009 and 2010, respectively. Perhaps Facebook’s true gold is based on the fact that it has access to the day-to-day information of the personal lives of up to 500 million people worldwide. Accessing that data is a dream come true for companies and the government.
2. Groupon: Google offered $6 billion and just like Nancy Reagan taught us, Groupon just said “no!”
3. Twitter: Twitter was recently evaluated at $3 billion which is a lot given that it has barely made money to date.
4. 1000memories: This website got $2.5 million… for what exactly?! The name alone is hardly brandable. It’s like having one of those clearly dated jonnysmithY2K@yahoo.com email addresses. Millions for an online memorial website? Really? I can hear the pin approaching the bubble.

These valuations seem to be pretty outrageous. With so many start-ups, lots of venture capital money being thrown around, and seemingly outrageous website valuations, a dot com bubble burst may be coming. Sure there has been a lot expansion and innovation in the online world, but it looks as though company valuations getting out of hand.

Business Model Issues
In order to get your hands on venture capital money, you have to present a business plan. I’m not naive enough to think that key investors haven’t learned from the last decade and are ignoring business models. That said, from a company perspective, it’s easy to spend someone else’s money and there are many start-ups that are getting enormous funding.

I love Dragon’s Den, watch Shark Tank, and recently attended Montreal’s Start-up Camp. I can tell you that a business model with a strategy is a key component in business plan. Yet, websites like Twitter do appear to have that. If there’s no clear business model, the strategy isn’t clear, or a company isn’t sure of their target market, then we have a problem. Add to that the fact that marketing a brand is expensive although there is better niche access these days.

People are Fickle
It’s difficult to base your future on fickleness. We saw websites like Cuil come and go in a heartbeat. All hype, all garbage. If the product sucks, people move on to the next best thing. If people get tired of a product, they also move to something else. People are fickle – I can’t say it enough. In this age of instant gratification and shot attention spans, you can’t expect consumers to stay put.

Cost Per Customer Acquisition
The cost per acquitiosn of a customer may be too high to make ventures worthwhile. New ideas are often imitated as innovation speeds up and websites launch with similar capabilities. Advertising costs a lot and so much competition, how far can it take a brand? (I don’t know the answer – do you?). Will these companies ever recoup the money spent on advertising alone?

Excessive Spending
This is a tough one but I can tell you that anecdotally that I went to some large, lavish, and expensive parties while at Ad-Tech New York last year. Don’t get me wrong. The parties were great and I very much appreciate getting invited. That said, one of the biggest ones I attended was sponsored by a company I had never even heard of until I got to New York.

Is It Going to Happen?

I’m an entrepreneur working on several projects, at least two of which have tremendous potential for growth. One is in the media industry, while the other is in the content management system(CMS) and marketing arena. It is unnerving to think that the bubble could burst again anytime soon, given what’s happening. Sure there’s the natural risk of any business venture, but this is more.

In the interest of full disclosure, I want to make it clear that I’m not a economics expert by any stretch of the imagination. What I describe below is is simply what I see. It would be naive to think that there wasn’t more to it.

I very much welcome your thoughts.

Addendum (April 12, 2012)

Facebook is going to buy Instagram for a BILLION dollars. Based on what? The fact that it doesn’t want Google or Twitter to have it? What business model does Instagram have that would make it so worthwhile? Does Instagram even make any money?!

What do you, as an intelligent reader think?