Valletta Ventures

$38, the value of a user to a social network

Outside the tech world, a rule of thumb for valuing a company is four times its annual profits. The exact ratio varies according to sector, growth, and market conditions, but it never reaches the 32x annual profits figure for which Microsoft aquired Skype last month. Despite some murmuring about a new tech bubble, most commentators view this as a smart purchase. Why? Because Microsoft weren’t buying software or infrastructure, they were buying Skype’s users, and at $12.8 per user, that was a bargain. In this post I am going to explain why, by calculating the value of a user to a social network.

Valuation of a company is of course a notoriously difficult calculation, so for the purposes of this post I will either use (projected) market cap, or the (rumoured) VC valuation if they are not yet public. For the well established social networks I consider I will assume that the value of their infrastructure and software is negligible compared to the value of their userbase. It is straightforward, if somewhat naive, to calculate an approximate value per user by dividing through the publicly estimated value of a social network by its number of user to get:

• Skype = $12.8 (purchased at $8.5bn, 663m users)
• Linked in = $53.7 (market cap $6.23bn / 116m users)
• Foursquare = $60 (rumoured summer round at $600m / 10m users)
• Facebook = $125 (upcoming IPO estimated at $100bn / 800m users)
• Zynga = $43.1 (upcoming IPO estimated at $10bn / 232m users) (in progress value changing regularly)
• Twitter = $18.4 (last round rumoured at $7bn / 380m users)

These figures were gleaned from a range of news stories, press releases, blogs and wikipedia pages, and in many cases are estimates. Despite all this the results lie within a single order of magnitude, a result I am thrilled with given the naivety of the method and the unreliability of the data. On average it appears that a user is worth just over $60 to a social network, though ignoring the anomalously high Facebook we get a more representative $38.

The variation between the values also makes sense. The value of a user to a social network is based on how much money the social network can make by advertising to that user. Skype and Twitter are exceptionally popular, but users spend more time on Facebook - more impressions served - and Facebook has far more data on the users and hence can target that advertising more accurately.

Given that you probably don’t believe yourself to be suggestable, it may seem surprising that some product executive somewhere expects to extract 125$ of profit out of you over the next four or five years just by flashing you their logo on Facebook, but if just one airline, knowing the holiday plans you just posted, sells you a $1500 London-Sydney ticket thanks to directed advertising, they are almost there.

So if the valuations of these social networks are accurate, then following the old “value = 4 x annual profits” calculation, the real question is why are the profits of these companies so low? I don’t know, but my guess is that many of them are still insulated from the rough and tumble of the business world by VC money. Twitter, for example, have barely begun to extract money from their userbase. Their costs are low - during the last venture round they only had 200 employees on their books - and investor money is forthcoming, so why bother with the hassle of selling advertising right now? It is better to concentrate on integrating their service into our lives, so that when they do sell out, either privately or via an IPO, the payoff will be even higher. The social networking bubble, if it does occur, will do so because the fickle userbase of these networks moves onto another service before the investors have the chance to recoup their money through a buyout, an IPO, or even old fashioned profits. In the meantime, Microsoft appear to have made a wise purchase of 663 million users to bolster their efforts to break into the mobile computing market.