Reduced Pressure on Profitability for Social Media Companies
Compared to established publicly traded companies, social media companies are relatively undeveloped, yet their valuations suggest otherwise.
For instance, the market capitalization (how much the company is worth) for Facebook is about $200 billion. That is more than the value of Pepsi, even though Pepsi makes money every time a customer buys a drink whereas Facebook is still developing ways to make money when a new user joins their network.
The lack of clear profitable strategies in social media companies stems from the high network externality nature of social media. The value of a social media platform is highly dependent on the number of people that use the platform. A platform would be useless to most people if they were the only one on it. As a result, the social media companies that succeed tend to accumulate vast numbers of users and dominate market share, effectively shielding them from competition.
As a consequence, unlike traditional markets, there is little pressure to be profitable. Traditional companies battle for market share and develop profitable business strategies in niche markets. Traditional companies that are not profitable are weeded out and go out of business. However, social media companies will remain dominate regardless of their profitability if they have enough users.
Thus, one must be weary of the hype surround a social media company. At the end of the day, if a company isn’t profitable, it will eventually go out of business.
Source:
http://www.wcpo.com/news/national/will-public-trade-bubble-burst-for-twitter-facebook