The trouble with Twitter

No business model required.

Wasn't that the lesson from Web 1.0 that was supposed to last through Web 2.0 and beyond? Well, given all the clamoring for a takeover of Twitter Inc., one might think the greatest wisdom the Internet's profit-free era has to impart is
already gone.

Gone with the bubble, you could say. Gone with Netscape Communications Corp. or CompuServe Corp. or, figuratively if not literally, Skype Technologies SA.

Actually, in a recent report from Sanford C. Bernstein & Co. LLC, leading Internet analyst Jeffrey Lindsay posits exactly just that.

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"Whoever buys [Twitter] will likely have to operate it at a loss in perpetuity, or until the next cool Web 2.0 social networking concept comes along and Twitter tweets no more," the analyst writes in his report entitled "The Ruinous History of 'Pre-Business' Internet Deals." "Sadly, this would not be the first time that a major Internet company had made a bad deal."

Lindsay is nothing if not a master of understatement. His own recitation of misguided Internet transactions includes the acquisition of Netscape for $4.2 billion and CompuServe for $1.2 billion, both by America Online Inc.

Then, on merging with Time Warner Inc., AOL saw its own $120 billion valuation vaporize to $3 billion ("if anyone can be tempted to buy it").

The analyst recognizes that this is value destruction "of spectacular proportions." Yet, in our collective memory, it seems to register not at all.

Users and backers alike, for instance, are already imploring Google Inc. or Yahoo! Inc. to "step up and 'operate Twitter as an adjunct free service,' " Lindsay writes, "or simply acquire it and 'make billions' through Twitter's search functionality." His advice to both potential prospects, as well as to any Internet wannabe with money to spare, is an unequivocal "stay well clear."

There are a few reasons for the analyst's caution, but the most compelling has to do with the resistance of users to monetization. "If they are charged subscription fees, many will quickly migrate to the next free service," the analyst says. "So that leaves advertising -- display or paid search."

But, like subscription fees, advertising of all types can drive users away from sites that were previously clutter-free. Unfortunately, so can all other ways currently known to Madison Avenue to monetize user data.

Consider the serving to users of what Lindsay calls "unsolicited Tweets from advertisers." This would appear a modest sacrifice for the Twitterati to make for a service otherwise completely free (much like the commercial-television model). But those exposed to Tweets frequently harbor disdain. And it's only a matter of time, Lindsay suspects, before these inconvenienced users steal a page from their counterparts at
Facebook Inc.

"Management recently backed down for a second time after changing Facebook's terms of service to give the company ownership of user information," the analyst says. "This dispute served to highlight two other issues. First, social networking users are adept at organizing and fighting off changes -- this should not be a surprise -- they are socially networked. It only takes one user to spot a change in the terms of service (even if carefully posted in the dead of night as some alleged) and the alarm once raised spreads across the social network like a virus.

"Second, given the number of competing social networks, it would not take long for users to migrate to another service where the offending terms or conditions were omitted -- just look at MySpace and Facebook's traffic data," Lindsay says.

Lindsay acknowledges the "large but unmonetized" status of Twitter and Facebook is a Web 2.0 phenomenon.

Web 1.0, in contrast, featured chat rooms, instant messaging and other applications that could be bundled and sold through subscription.

The subscription model has since given way to advertising models, just as the high fixed costs once associated with portals have given way to increasingly low barriers to entry. "Web 2.0 applications need no capital for printing presses, cable systems or radio transmitters," Lindsay writes. "These services can be scaled to literally millions of subscribers -- before revenues are even considered."

Millions of subscribers, however, do not a business model make. And it's Lindsay's view that the responsibility for figuring out how to monetize such a model resides not with investors or competitors but with the application's founders.

Call it Lesson Web 1.0 redux.

Richard Morgan covers media for The Deal.

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