Umair Haque’s An Open Challenge to Silicon Valley put it in even stronger terms as he labels the current crop of Web 2.0 startups and their incrementalist approach “trivial” and “banal.” I certainly could see the banality of the Web 2.0 echo chamber. Say a company creates a service for users to share picture slideshows online. The next competitor provides a widget for picture slideshows with better transition effects. Then the next entrant will provide the ability to incorporate simple audio effects into slideshows.

Haque’s answer to “what’s next?” is to challenge revolutionaries or entrepreneurs to solve bigger problems. What are some huge problems facing this world? Haque mentions skyrocketing food prices, unstable financial systems, and a worsening energy crisis. To this list I would add terrorism, a deteriorating and increasingly costly healthcare system, global warming, and war.

Pieter van der Heyden – Sloth

The incrementalism Nolan and Haque decried is alive and well. Petty, self-appointed social networking gurus argue about the incremental virtues of Identi.ca over Twitter, Facebook over Myspace (NWS-A), FriendFeed over Twitter, Twitter over Facebook, and countless other variants of this rock-paper-scissors silliness. The other 99.9% of the world’s population couldn’t care less.

At the time I read Nolan’s and Haque’s posts, I was mired at SocialOptimize creating social networking applications for clients. My former partner and I collected exorbitant dollars per hour for our work but I felt as if we drastically overcharged for our services. I came to realize that what we produced were inconsequential products that added little to no value to the economy and society. Even the companies that employed SocialOptimize derived scant value from the apps we delivered. Don’t get me wrong – I enjoy games and distractions as much as anyone but these apps constituted neither good games nor good distractions. They were merely companies’ halfhearted and “me too!” attempts at having a presence on social networks. The companies didn’t really even want these apps; they just got caught up in all the Web 2.0 hype.

As an investor, I’ve always been a contrarian but my entrepreneurial endeavors started to look like a vapid run with the herd. Haque’s and Nolan’s posts landed profound psychological kicks to my posterior. So I immediately interrupted my usual programming and have since been obsessed with searching for opportunities to address bigger problems.

My search for meaning has turned out to be fortuitous and delightful. It has taken me many months as I tried to vigorously filter noise from signal, short-term cash grabs from sustainable opportunities. Opportunities never appear scarce; the trick lies in carefully identifying and selecting the ones I can have the most impact on and the most fun with.

So I was ecstatic when I decided to join Design Engine Lab, a leading industrial design firm, as partner and chief strategist. Industrial design is an entirely new world to me and I’ve jumped in with complete enthusiasm. I am steering the firm gradually away from servicing clients and toward developing our own internal products and spin-off companies.

We have designed a new, patented interface technology that we will first apply to the lighting market. Our technology has the potential to curb energy usage drastically wherever it is installed. Some of Haque’s big problems are beyond the scope of my circle of competence, but global warming is one which Design Engine Lab’s greener and cleaner technology can have a very positive impact. Our technology will also affect the delivery and efficacy of healthcare, another big problem, by mitigating the environmental risk factors attendant in hospitals and other healthcare facilities. Our technology will be used in hospitals across the United States and that specific segment alone represents a multi-million dollar market.

We’re also forming a joint venture with another company to develop a portable landing zone that will dramatically improve the success rate of emergency extractions of injured people via helicopter. I’ve accompanied helicopter pilots on test flights and have received nothing but the most eager feedback. I’m very excited about this product because it will actually save lives in the real world.

At Design Engine Lab, we conduct serious play looking for ideas that have global implications. Sometimes, that means huge ideas requiring complex execution. But we also engage in what I coined Bite-Sized Innovation®. Small does not have to mean incremental if the result is drastic. We attempt to make small changes that lever up to create huge consequences. Some of our upcoming medical device projects will reflect this Bite-Sized Innovation model. The best part of all this is the intensely joyful feeling of play that permeates all our brainstorming and experimentation sessions.

I don’t want to stray too far from the software world. So I’ve been fortunate to have also gotten involved with Sendside Networks as a consultant helping with research, marketing, business development, and fundraising. Sendside is creating technology that will change the way companies communicate with their customers. It is a highly risky strategy as we are trying to forge a brand new category in the Enterprise 2.0 market. But highly risky strategies are the ones that capture or create enormous value if executed well. In this case, the risk is vastly mitigated by a fantastic executive team and boards of directors and advisers filled with quality individuals. The team is the primary reason I wanted to get involved in the first place.

Without giving away the recipe for the secret sauce, Sendside has the potential to replace a sizable portion of the physical mail stream. In our vision, at its most revolutionary extreme, only junk mail and parcels will flow through the mail stream. Successfully bringing about this vision would make Sendside one of the greenest companies in the world, lightening the global burden on our forest lands forever. I have to give a shout out and thank my friend Jeff Barson, Sendside’s evangelist, for turning me on to this opportunity.

I’ve been lucky to have had the luxury of putting a halt to my daily grind to look for game-changing opportunities. I was especially lucky to have come across the two thought-provoking and ego-shattering pieces by Haque and Nolan. Umair Haque wrote in the end of his post that he’d put his money where his mouth is and advise five organizations trying to solve big problems. Umair, if you’re reading this, please get in touch with me. If not, I’ll be in touch shortly.

When Microsoft (MSFT) bought a small stake in the wildly popular social network, the price paid implied an overall value of $15 billion. The rumored prices at which Facebook insiders are trying to unload some shares carry an implied overall value of as low as $3.75 billion to $5 billion.

It is clear that Facebook currently cannot be worth $15 billion. The Facebook Apps platform that attracted so much attention from independent software developers has lost a lot of momentum. Independent developers who invested a lot of time, money, and energy into creating Facebook Apps have found it increasingly difficult to attract a significant audience. While finding users has been tough, monetizing their creation has proven to be a Herculean task. Special venture funds created to fund Facebook apps have not been able to deploy much of their capital as most Facebook apps are ill-conceived or frivolous with no clear business model. I would return that money to limited partners rather than hope a genius comes along to battle for market share owned by early movers like Slide and RockYou!

Advertising, the main business model of free social networking platforms, continues to disappoint, with click-through rates and conversion rates declining alarmingly. While international growth remains strong, domestic growth is decelerating noticeably. This could be spun as a positive, but I don’t think the youth of other countries have spending power approaching anywhere near that of American youth.

Will this mark the end of the current cycle of funding exuberance on the part of venture capital firms for all things Web 2.0 or social? The pace of venture funding in this sector of the Internet really picked up when Myspace sold for close to $600 million to News Corporation (NWS-A). Since then, millions have been poured into all flavors of social networks and social networking apps. It reminded me of the fin de siècle bubble that burst so painfully for all involved. Below is an essay I wrote for an investment letter published in June 2007 distributed high net worth clients.

Irrational Exuberance 2.0

We are not calling a bust of the current bull market. As much as we admire Barron’s editor Alan Abelson’s wit and literary style, we are cognizant of the ravages that might befall our track record if we were permanent bears. Still, we can’t help but imitate his dour tone of the 1990s when he repeatedly called too early for the bursting of the dot com bubble. Mr. Abelson eventually got it right when we entered the new century and collectively blinked at the stratospheric levels we had taken the market to. Then as now, venture capital funding of cockamamie business ideas served as a reliable indicator of an impending rinsing out of “frothiness.”

As we once again witness new highs in the stock market, it may be wise to examine the shenanigans our friends in the venture capital world are participating in. Are they helping to start companies “built to last” or are they throwing money at silly business ideas “built to be sold?” After a quick survey of recent startup financings, we think a strong sense of déjà vu might visit us.

While yesteryear’s absurd venture deals were justified as the obsolescing of brick and mortar business models by an online nirvana fueled by UPS (UPS) and FedEx (FDX) trucks, today’s venture activity centers around “social networking” and the wisdom and power of crowds, also known as Web 2.0 in geeky circles.

Take NaturallyCurly.com for example. It proclaims itself as the social network for people with curly hair. Purportedly, individuals with curly locks need an online support network for all their hair maintenance difficulties. Don’t forget the most important feature of any social networking community, the ability to make friends with similar interests. We delight at the prospect of spending all our time discussing hair. A technology industry veteran who sold his company to Compaq invested $600,000 into this dandy of a site.

A little less silly but nonetheless vacuous is a website called Flixster. This is the social network for all things cinematic. Users rate movies, join fan clubs celebrating famous thespians, read up on news regarding upcoming films, and make friends.

Websites that allow people to rate movies and chat about their favorite scenes already exist. They just don’t allow people to make friends. This ability to make online friends convinced Lightspeed Ventures, a very reputable venture capital firm, to invest around $2 million into Flixster.

If the dollar amounts involved look nothing like the wasted mega-millions of the late 1990s, we present Geni.com, a website for constructing family trees. The premise revolves around getting relatives to help by emailing them a digital “widget” with which they could plug themselves in the appropriate branch of the family tree. It is the wisdom of crowds, albeit a familial one here, that makes this a very compelling idea indeed. Unfortunately, it occurred to us that great great great grandpa Bob of many years before cannot respond by email from Heaven. That did not prevent Charles River Ventures from injecting $10 million for 10% of the company, effectively valuing the then seven week old company without any revenues at $100 million. We believe the large valuation might have something to do with being able to turn relatives into online friends.

The Big Bang that gave rise to all this Web 2.0 insanity occurred when Rupert Murdoch’s News Corporation bought the top dog of all social networks, Myspace, for $580 million. Users of Myspace could create their own web pages and browse around the online community to make friends. Google (GOOG) soon followed by buying YouTube for $1.6 billion. YouTube users upload their homemade videos for the whole world to watch. One of the key principles of Web 2.0 is getting the community to contribute user-created content. Did we mention that YouTube users could also make friends with fellow wannabe Spielbergs?

Almost overnight, lemming-like venture capitalists funded dozens of Myspace clones with typically cute techie names like Tagworld, Bebo (TWX), Facebook, Facebox, Multiply, and Gather. Of course, all of these allow users to make friends.

YouTube copycats receiving venture funding include Veotag, Kyte, Mogulus, VideoJug, YeboTV, and Brightcove. Although we haven’t used these sites personally, we’re quite sure you could make friends on all these websites. How many News Corporations and Googles remain to stuff the coffers of venture firms by buying their portfolio companies? It seems as if entrepreneurs and venture capitalists in this space are banking on many more buyouts to come.

It isn’t just the private venture capital world that has fallen to the seduction of easy profits. When flimsy businesses with short operational histories try to tap the capital markets by going public through an initial public offering and find a receptive market, we are treated to such delicious examples as GoFish (GOFHE.OB) , a video sharing website in the spirit of YouTube. Debuting last October on the over-the-counter “bulletin boards”, the fishy company achieved a peak market cap of $147 million. With only $45,580 in revenue and no profits to speak of, investors in GoFish are swimming in a foamy sea of hope and greed.

Our favorite new social network? Stockalicious, a website that allows users to keep track of their portfolios and compare their performances against the market and each other. We wonder if Alan Abelson might jump on the Web 2.0 bandwagon and become a member of this Internet community. We could sure use a friend or two.

Last week, I attended Zions Bank’s (ZION) 7th Annual International Trade and Business Conference. Most of the speakers were very interesting. John Howard, the former Prime Minister of Australia, gave a lively keynote speech and subsequently fended off with aplomb the inane question of a clearly wide-eyed political science student from the university. Christopher Padilla, the United States Under Secretary of Commerce for International Trade (that’s a mouthful), spoke about the opportunities in a world featuring an emerging power in China.

The one speaker that intrigued me most was Matthew Simmons of Simmons & Company International. He spoke about “peak oil” and a world vastly transformed by the essential “drying up” of oil fields in Saudi Arabia in particular and the world in general. In a world of peak oil, we would not travel as much. Everything becomes more expensive because everything is less accessible and less transportable. New political and cultural shifts will take place that will reshape the globe as we know it. Simmon’s book, Twilight in the Desert: The Coming Saudi Oil Shock and the World Economy, which Zions was handing out free at the tables, is a sobering argument for why oil prices are so expensive right now. Of course, Simmons is an investment banker to the energy industry so everything he says must be taken with a grain of salt. For that matter, anything anyone says should be taken with a grain of salt. Always consider the incentives of the messenger.

Nevertheless, crude oil cooperatively jumped nearly 5% last week. Over the past year, black gold has doubled in price. Traders cite the falling dollar as one major driver of escalating spot prices, but Simmons would argue that exogenous factors such as foreign exchange rates assert much less influence than long term shortages of oil.

Two weeks ago, the markets turned in a defiantly strong performance. Equities in particular were bought up furiously by institutions like the latest Grand Theft Auto installment. Everyone loves a bull market and only the most strident bears and short sellers could lament upwardly trending indexes. But the economic indicators were still trickling out rather bleakly and thus I reasoned that the rally was overdone. The equity markets proceeded to give back all their gains and then some last week. Luck was a lady last week.

Macro

Back to oil. In the face of oil’s ascent, I dubbed our current era the Black Bubble. I attributed a good portion of crude’s rise to the influx of speculators and momentum investors/traders looking to ride the bubble to even frothier levels. It isn’t easy to make a contrarian call, so it was with great relief to find that George Soros, the billionaire hedge fund trader, philosophical political activist, and philanthropist, recently spoke of an oil bubble. He’s certainly a lot better at extracting alpha from the market than I am.

“Speculation… is increasingly affecting the price,” he said. “The price has this parabolic shape which is characteristic of bubbles,” he said.

The comments are significant, not only because Mr Soros is the world’s most prominent hedge fund investor but also because many experts have claimed speculation is only a minor factor affecting crude prices.

However, Mr Soros warned that the oil bubble would not burst until both the US and Britain were in recession, after which prices could fall dramatically.

Mr Soros also warned that the Bank’s inflation report represents a “Faustian pact”, obliging it to keep interest rates high to control inflation, even as the economy is starting to slump.

He said: “The dislocations will be greater [than in the 1970s] because you also have the implications of the house price decline, which you didn’t have in the 1970s.”

Soros is speaking of the Bank of England here, but that is essentially the same “rock and a hard place” I expected Ben Bernanke and our own Federal Reserve would have to contend with. Not only is oil a key component of rising inflation, but food is the twin prong in the vice that is squeezing the consumer’s wallet.

The government likes to exclude oil and food from “core” inflation measurements. It is as if the pinheaded bureaucrats don’t think people buy food and oil. The last time I checked, food and oil are both very “core” elements of our budgets and lives.

So indeed, I believe we are in a Black Bubble. George Soros would know better how to express that outlook with an optimal trade. I’m much more of a long term investor and quite incompetent at finding the optimal trading vehicle.

Micro

Grand Theft Auto IV on Track to Set New Sales Records – Take-Two Interactive Software (TTWO), the publisher of GTA IV, is currently being courted by the much bigger Electronic Arts (ERTS). According to some reports, GTA IV will pass Microsoft’s (MSFT) Halo 3 as the best selling console video game of all time. Seems to me there is no GTA fatigue despite many different installments since the “game-changing” GTA III. Also seems to me that TTWO ought to hold out like Yahoo! (YHOO) for a higher price.

Travel Appears To Be Next Up For Google – Travelzoo (TZOO) has been a fashionable pick by some value investors. What’s not to like? The company essentially traffics in information, one of the most scalable and profitable business models ever invented by man. The company has healthy margins and return on equity (ROE), an unencumbered balance sheet, and a flock of short sellers ready to be squeezed. Heavy insider buying adds a cherry on top. But something wicked this way comes; Google (GOOG) is expected to extend its tentacles into the online travel information industry.

Mindray Medical: Strong Report and Fast Growth – Mindray Medical (MR), one of the leading medical device companies in China continues to hum along with breathtaking growth. More than half of the company’s revenues come from outside of the Middle Kingdom, but the recent humanitarian disasters brought on by earthquakes and aftershocks may send demand skyrocketing in the homeland.

A Wrench In The Machine? – Conventional wisdom says the United States is losing its manufacturing sector. Mostly true. Badger Meter (BMI) is one of the few companies thriving as a manufacturer of specialized industrial equipment. BMI makes water, oil, and fluid meters. ESCO Technologies (ESE) competes directly against Badger Meter in pushing the next generation of networked utility meters that will eliminate the need for the local utility company to send a technician out to read your water meter. Full Disclosure: I currently have a long or short position in BMI in one or more of my private investment partnerships.

Blackboard Application on Facebook – Having operated Web startups involved in the social networking space for over 3 years, most news items involving Facebook or Myspace (NWS-A) usually register a blah on the blah-bam scale. The new Facebook application by Blackboard (BBBB) is a bam. This web application will not change Blackboard’s fortunes much, but the idea that social networks, unlike the banal uses self-proclaimed social networking gurus foist on unsuspecting clients, can actually be used to facilitate something robust sends chills up and down my spine. The megatrend of online education cries for an intelligent implementation of an educational social network.

Natus Medical prices public offering of 4M shares – Shareholders reacted allergically to Natus Medical’s (BABY) registration of secondary offering shares. Turns out demand for the secondary offering was stronger than expected and the company’s stock rebounded. Natus Medical’s recent acquisitions make sense. Company management has shown an ability to allocate capital intelligently. The capital raised through the secondary offering will allow the company to bolster its competitive position as weaker competitors exit the industry by selling. Full Disclosure: I currently have a long or short position in BABY in one or more of my private investment partnerships.

A few days ago, I wrote about the commoditization of social networks or rather the social networking feature sets that currently make Myspace and Facebook so unique and neat. Pioneers in social networking like Friendster and Myspace introduced a new data and software architecture that, at the same time clumsily and elegantly, met Internet users’ desire to interact and share content with each other. Finding old friends, connecting with new friends, sharing music and videos, playing collaborative games, and expressing oneself to virtual audiences of thousands all were groundbreaking features or functions that captivated a whole new generation of Web users.

These features generated higher levels of engagement (or stickiness) many times greater than traditional web properties. This stickiness in turn attracted marketers and advertisers who wanted to be where the people were. This stickiness premium netted the founders of social networking startups wealth reminiscent of the dotcom bubble. Myspace sold for nearly $600 million in a buyout by News Corporation (NWS-A), Facebook was valued at $15 billion by Microsoft (MSFT), and Bebo’s owners sold out to AOL (TWX) for $850 million.

With great rewards come hordes of wannabes and copycats. Many people are staking their future on social networking. Some are attempting to create me-too social networks. Others are pimping themselves as “experts” in social networking and offering their “consulting” services. I did the same with my SocialOptimize startup. Although my now defunct startup was able to deliver good social networking applications to prominent venture-funded startups, I soon realized that social networking would become a game with few winners and many losers. I argued that once Web 2.0 methodologies become widely adopted and social networks become a feature set rather than destinations, those same Web 2.0 methods will become standardized commodities.

That march to commoditization may occur faster than anticipated. Google (GOOG) recently announced its Friend Connect program, which allows virtually any website to plug in a turnkey social networking suite. Owners of websites can, like Google’s AdSense product, embed a snippet of code in their webpages and immediately enjoy the benefits of offering social networking features to their site customers or visitors. Think of Google Friend Connect as a more powerful Google AdSense, but instead of offering relevant text ads it offers your site visitors the ability to connect with their friends, connect with new friends, interact with each other with messages, and share content.

Here are the search engine giant’s stated high-order benefits of Google Friend Connect (GFC):

• Anyone with a basic understanding of the Web can implement GFC, no need to hire an expensive programmer or self-branded “social media guru.”
• Drive traffic: people who discover interesting sites can bring their friends with them, and can opt-in to publish their activities on those sites back into their social network, attracting even more visitors.
• Increase engagement: access to friends and OpenSocial applications provides more interesting content and richer social experiences.
• Less work: any site can have social components without hiring a programming team or becoming a social network.

That last point is key. Google doesn’t want more “social networks” per se – it just wants more websites to have social features. A while ago, it signed a deal with Myspace to serve Google ads. At the time, Google paid a huge premium and there are reports that claim the Mountain View, CA behemoth has not recouped its cost. Signing advertising deals with mass market social networks can be expensive. Helping mom and pop sites to have social networking features will, in the long run, give Google a cheaper alternative. Google is simply facilitating the creation of more web pages (places to serve its ubiquitous ads), pageviews, and advertising inventory.

The message is clear. You don’t need to become a social network; social networking features are a commodity. Here, have a few social networking features for free.

First, Anderson argues that social networking should be a feature, not a destination. I agree wholeheartedly. The ability to interact with friends, share content, and engage in self-expression should be standard features on most websites. The unique methods of encouraging creative online behaviors known as Web 2.0 will filter through the rest of the Internet and, soon, your grandfather’s favorite website will allow him to engage in “social networking.”

Second, Anderson cites stats regarding advertising revenues or costs from Myspace (NWS-A), Facebook, and Ning. He shows that monolithic social networks like Myspace and Facebook, which attempt to be all things to all people, are having immense struggles with selling advertising at worthwhile rates. He also implies that Ning’s niche vertical social networks built by customers command higher advertising rates. Some marketers happily pay the higher rates because the engagement level is greater on these niche vertical networks. Advertisers also prefer the more intelligent targeting of relevant audiences. Myspace, Facebook, Bebo (TWX), and other undifferentiated mass networks are actively trying to improve their targeting abilities so it will be interesting to watch this competition evolve.

Finally, Anderson asks a pointed question about Facebook’s implied $15 billion valuation when Microsoft (MSFT) bought a small percentage of the company a few months ago. If Facebook is struggling to target its advertising and improve its advertising revenues, does its gargantuan valuation make sense? I think Zuckerberg should take the money and run. I also think that Lee Lorenzen, a venture capitalist, and his prediction that Facebook is worth $100 billion is a case of shrewd exaggeration. What I think is most funny is the fact that all of Lorenzen’s fanboys, the self-branded “social app gurus” and developers of tiny Facebook apps are all eagerly drinking the spiked punch. There are few better examples of confirmation bias in action.

My main problem with Anderson’s analysis is his implied assumption that the currently high advertising rates the niche vertical social networks enjoy will stay relatively high. Based on his personal experience, he concludes that Ning’s advertising rates are greater than Facebook’s and Myspace by at least a factor of ten. I don’t think this will last. Web 2.0 methods are precisely that, methods. They can be products, but they are also methods or general, conceptual best practices. As such, the ability to create robust social networks for different verticals will diffuse to a critical mass of software engineers. As that process accelerates, social networks and features of social networking will become commonplace or commoditized. I’ve alluded to the commoditization of social networking applications, which is a related problem. When this process nears its peak, advertising rates for all social networks will have diminished drastically. Self-proclaimed “social app gurus” and “social network gurus” who have staked their futures on social networking will ultimately prove themselves as less than prudent.

Another report by the National Venture Capital Association found that only five venture-backed startups achieved an IPO in Q1 2008. We’ve never seen levels this low since the bottom of the bear market in Q2 2003. A public market with a healthy appetite for new issues is essential for the venture capital industry. It drives the lucrative exits that VCs are looking for and also, in a roundabout way, cycles money back into venture fund coffers for the next generation of startups. In a market wary of IPOs, the only remaining exit opportunity is acquisition by strategic buyers.

We know that VCs are frustratingly lemming-like in behavior. As with all investment activities and fields, it is much safer to follow the crowd or herd than to venture out, pardon the pun. But as with all investment activities and fields, it is much more profitable to invest with a contrarian framework.

Bull market vintage funds usually pay top dollar in terms of valuations. It is notoriously difficult to time the markets, but a good or lucky venture fund could exit handsomely on a few investments while valuations are still rising. However, most investments will have been made at the most expensive valuations. This is not usually a recipe for success.

Bear market vintage funds usually buy equity in startups at favorable valuations. It is still notoriously difficult to time the markets, but the depressed valuations paid by venture funds make it more likely their exits will be profitable. Investments made now while we are in a bear market will take several years to harvest. When portfolio companies are ripe, if history is any guide, the markets will have turned for the better and exit opportunities will abound.

What would I do if I wore the shiny shoes of a VC? As I said before, I would resolutely shun the second-tier ideas that are social networking apps built by self-styled “social networking gurus” or “social app gurus” because these toy ventures will never achieve noticeable success. If I had to play in the Web 2.0 playground, I would concentrate on “primary platforms” that will compete directly against existing social networks like Myspace (NWS-A) and Facebook in a unique way. I’m sure there are entrepreneurs frantically trying to figure out different ways to address the social networking space. I would not fund any social networking apps that would need to exist within Myspace, Facebook, OpenSocial (GOOG), or other platform ecosystems. In the big picture, the cost to build a primary platform versus a secondary web application, or even networks of secondary web applications, differs little. The reduced cost of building consumer Web 2.0 businesses means perhaps we should be allocating less capital to this space anyway.

Of course, not everything is Web 2.0 – let’s not be myopic here. Enterprise 2.0 looks promising as it actually has a potential revenue model around it. I’m crossing my fingers that the clean tech guys will launch something truly revolutionary and world-changing. The already significant attention given to that space by VCs will pale in comparison to the resultant capital flooding to clean tech if some genius scores a big hit.

What would I do if I wore the worn-out sneakers of an entrepreneur? I would try and do what Marc Andreessen did with Ning and raise more money than I need to weather the coming slowdown. Giving up a bit more equity in this environment makes sense in order to ensure that my startup makes it through alive. This is exactly what I’m trying to do with my new stealth mode startup. Now I’m no Andreessen and my deal is so new, but I’ll just have to keep pitching to see how far we get.

I co-founded a tiny little agency a few months ago called SocialOptimize that was focused on producing Facebook apps. At the time of founding, my partner and I received almost overwhelming demand from companies who were desperate to gain a presence on social networking site Facebook. Facebook was already quickly turning into a cultural phenomenon as everyone and their grandmother started registering for the site and “poking” each other.

Essentially, it was this mass of humanity in digital form that attracted advertisers and marketers to jump on the bandwagon and either buy ad space on Facebook or better yet, create “Facebook apps” that users could install on their personal pages. Early on, application developers found great success as the novelty of “Facebook apps” compelled millions of new Facebook users to add and share these apps with their friends. This network effect fed upon itself and created this great bubble of excitement around the “limitless” potential of Facebook.

Soon enough, the money men of the technology world, the venture capitalists, wanted to ride the coattails of Zuckerberg & Company. Venture firms like Bay Partners created Facebook-only funds to invest in startups that focused on building Facebook apps. Alas, the application ideas in the Facebook ecosystem and, for that matter, most of the social networking universe were not quality ideas and few investments have been made. Most of the Facebook apps out there are inane, simple apps, easily duplicated and without any clear path to revenue. Why would any sane venture capitalist invest in what I call a “secondary” strategy? Social networks have been great investments because they are the “platforms” with which all that valuable activity takes place. Social networks are what I call “primary” strategy investments. Social networking apps built for Facebook, Myspace, OpenSocial, Bebo, Orkut, or otherwise are “secondary” instruments and can rarely achieve any real value.

As a technology entrepreneur, I could have continued to make a good living off of naive companies that just “needed” to be on social networks because everyone else was establishing a presence. However, I knew that eventually, the novelty would wear off and “Facebook Fatigue” would set in. This fatigue will spread and we’ll soon have an epidemic of “Social Networking Fatigue.” Only a select few application development companies and social networks will survive the coming shakeup. Already, savvy corporations are looking at different approaches to social networking. So unlike the lemming-like companies that just “had to be” on Facebook who comprised the bulk of my client base, I will be leaving the party a little early. I did the best I can for those companies while the attention was still high, but you cannot fight the falling tide of interest, or rather the rising tide of disinterest and outright mutiny. The most rabid fanboys in this corner of the technology world will still hyperventilate about the “limitless” potential of social networking apps but they have never comprised the bulk of the marketplace.

This is by no means an unbalanced rant on Facebook and social networking in general. After all, I did make my livelihood here for a few hectic months. There is definitely great opportunity in social networking and media. I’m just voicing some skepticism based on a business perspective to balance out all the frothy excitement.

Here are a few posts from others who have slightly different takes and perspectives, who generally agree with me but are more eloquent:

Anita Hamilton – Suffering From Facebook Fatigue?

Phil Burns – Nine Things that Absolutely Suck about the Facebook Home Page

Jennifer Mattern – Top Ten Reasons Facebook Sucks

Om Malik – Why do we have Facebook Fatigue?

Dave Winer – Why Facebook Sucks

Chris Williams – ‘Facebook fatigue’ kicks in as people tire of social networks

Gopinath M – Advertising on Facebook Sucks!! – This is the one reason that will kill Facebook faster than any other reason. For that matter, advertisers and marketers are finding that their ROI on social network advertising in general has been less than acceptable. Only the smartest or luckiest entrepreneurs will be able to solve the ROI puzzle.

What would I do if I wore the big shiny shoes of a venture capitalist? I would ignore all the “secondary” application developers and “social app gurus” out there who dream about untold riches. There will almost never be an acquisition of a social networking app that would be sizable enough to move my needle. I would focus on funding social networks in emerging markets. “Primary platforms” will still earn rich valuations. Indeed the model works, but I don’t think that Myspace Mexico or Facebook Finland will find much traction. I would bet on the entrepreneurs in those countries building primary platforms from scratch who have an intimate feel for the cultures of their native countries.

Social networking has thus far been primarily about connecting with lost friends, playing simple games, and gawking at strangers. Aside from the amazing ability to reconnect with buddies from middle school, the rest of social networking mirrors normal human behavior in real life. Lots of people need an avenue for rest and relaxation. Dumb games like Pirates vs. Ninjas on Facebook replaces old time-wasters like watching TV. Who hasn’t been to the mall or the park watching people pass by? We’re all voyeurs to some degree but social networks like Myspace (NWS-A) make us Peeping Toms powered by technology.

It’s been great fun, but social networks have ambitions to be more than just a digital playground. They want to be super hubs of e-commerce where people go to buy stuff. Even on that front, current efforts have been less than inspiring. Facebook has had some success getting people to spend micro amounts of money sending small digital images as gifts for their friends. This is much like the candy grams I bought for all the pretty girls in middle school, juvenile and bound to lose its novelty. Of course, new generations of kids are always going to join social networks, so the “digital dollar” gifts will always be in demand. It is a valuable business, but one that could evolve into something greater if Facebook or competitors figure out more useful applications for micropayments or “digital dollars.”

I believe that it’s perfectly fine for social networks to remain as fun hangouts but if the Zuckerbergs and DeWolfes of the world want their networks to be much more, things will have to change. The future of social networking requires much more elegant thought leadership that will lead to much more robust applications made by much more skilled developers and managers.

A big change has already begun. Corporations are slowly dipping their toes into the waters. While they’ve been big advertisers on the networks, they are beginning to interact directly with the community. Some are leveraging existing networks. Others are building their own networks so they can customize that interaction.

Let’s take a quick survey of what some grown-ups are doing today in the social networking space. This is by no means an exhaustive study, think of it more as a sampling of some of the more interesting and unique approaches. It remains to be seen which of their differing approaches will succeed, but a careful watch of their efforts might give us clues as to what that elusive future of social networking might look like.

Struggling Starbucks (SBUX) has seen its stock price fall over 40% over the past year due to slowing growth, customer apathy, and fierce competition from the likes of McDonald’s (MCD) and Dunkin’ Donuts. It recently announced the launch of its own social networking website called My Starbucks Idea. In what looks like a valiant corporate effort in crowdsourcing or leveraging the wisdom of crowds, the website attempts to engage the audience to share ideas on how to make Starbucks better. Not sure if the company has ever used fancy pants MBAs and consultants who think in terms of profit margins, market share, and brand extension, but any attempt to get the average Joe to opine about his cup of Joe makes sense. These are presumably the people who feel the strongest about their daily java fix, an emotional connection that ought to lead to insightful ideas. Therein lies a natural problem; the most passionate fans of Starbucks who share ideas are not the bulk of customers who feel that Starbucks has lost its way but wouldn’t be motivated enough to tell anyone why. While I’m at it, here’s my suggestion: brand extension usually does not work – get rid of the tastefully compiled music compact discs.

Networking giant Cisco Systems (CSCO) has always excelled in growth through acquisition. By acquiring technologies developed by small startups or budding competitors, the company has been able to keep its technology edge and maintain market leadership. However, this strategy has always been a tad expensive; after all, the venture capitalists that backed the acquisitions need to be paid off for making good bets. Now Cisco has launched a competition called I-Prize that could help the company identify good ideas long before they become pricey startups. The I-Prize competition allows the company to reach out to its community or ecosystem and motivate submission of ideas for rewards. The best idea gets funded as a new business unit and the idea generators get a big signing bonus and employment. The social networking aspects of I-Prize include the ability for entrepreneurs to comment on each other’s ideas and network with each other to form collaborative teams. Recently, Cisco released a blog post describing the demographic details of the semi-finalists in the competition. It appears Cisco is having a successful experience with this program.

Overstock.com (OSTK) has seen its stock price follow the trajectory of a roller coaster over the past year. The online retailer suffers from negative margins and a supremely competitive online landscape. It recently launched a community portal on its website that allows users to blog about their interests, write product guides and reviews, discuss auction items in online forums, and read the latest articles written by CEO Patrick Byrne. Byrne has been pilloried by the vicious financial press for his unorthodox behavior, but I love his independent, contrarian, and defiant style. I think the attempt to engage its most loyal shoppers to contribute product guides and blog about favorite products makes sense, but I would implement the strategy differently. Instead of Overstock hosting the blogs and reviews on its own website, it should attempt to build a loose network of affiliate bloggers and guides similar to blog networks such as Know More Media, b5media, and Pajamas Media. The separate network approach would result in less control but better search engine rankings, increased traffic driven by external sources, and a more active affiliate program fueled by a rewarding incentive scheme.

Dell (DELL) operates a website called IdeaStorm that resembles My Starbucks Idea. The mammoth computer manufacturer wants its customers to post and discuss ideas. One large component of the interaction design on the website involves the ability to “promote” or “demote” ideas posted by others. In this way, the site imitates the crowdsourcing methodology pioneered by Digg, the news aggregator community. For corporate executives that have been tasked with the daunting responsibility of building web communities with the potential to feed the parent company with business intelligence and game-changing ideas, check out Salesforce.com’s (CRM) Ideas platform. Dell’s IdeaStorm is built on the Ideas platform and appears to be a good implementation. My Starbucks Idea is also powered by the same platform. The platform is definitely a more cost effective solution than building a platform from scratch, but care should be given to customization and integration with existing websites or properties.

Dell has also been experimenting with innovative forms of advertising on social networks. Instead of what I call “passive advertising” on the margins such as banner ads and margin text ads, Dell is putting its name directly on web applications that social network denizens interact with. In partnership with Federated Media, Dell conducted an art competition on the Graffiti application on Facebook centered around the question “what does green mean to you” which ultimately drove traffic to another one of Dell’s social networking sites, ReGeneration. The ReGeneration campaign is an early example of what I call “appvertising,” a more direct and intimate form of advertising made possible through social networks.

Our favorite whipping boys, the American auto industry, might well need to try anything and everything to stem its losses to the relentless Japanese auto companies. In other words, in times of desperation, throw everything at the problem including the kitchen sink. General Motors Corporation (GM) has decided that social networking might be one way to persuade American consumers to buy Cadillac Escalades, Buick Enclaves, and Chevrolet Corvettes instead of Honda (HMC) Accords and Toyota (TM) Corollas. GM Next, the company’s attempt at social networking, is a content rich site that includes blogs, podcasts, and a healthy serving of videos. Unfortunately, the site feels too promotional and not focused enough on carrying a genuine conversation with car enthusiasts.

We’re witnessing the early stages of corporate involvement in social networking, both on the mass consumer social networks and on specialized corporate social networks. The operators of popular social networks desire to be more than just massive collections of frivolous games and applications. They’d like to move beyond the amateur and simple coding exercises haphazardly thrown together by weekend programmers with illusions of getting rich off their tiny applications. I think that’s a dangerous change in direction and few social networks will succeed in growing up and surviving the coming shakeout. It would behoove some savvy social network executives to heed Geoffrey the Giraffe of Toys “R” Us fame and consider that “we don’t want to grow up.”

Macro

• More pain in the housing market anticipated as some homeowners find themselves “underwater” or owing more on their homes than what their homes are worth on the market. According to Mark Zandi at Economy.com (MCO), 10% of all homeowners currently face this negative equity situation. Zandi also sees home prices falling 20% as the economy worsens into a recession. Zandi could be underestimating the damage; homeowners abandon their homes and mortgages at a high rate when they enter negative territory on their equity. Foreclosures and abandoned mortgages exacerbate the problem by increasing unsold inventory and unwanted supply.

• More goodies from Economy.com – their data shows that core capital goods orders have been steadily declining since early 2007. One of the few bright spots in economy has been the computer servers market dominated by the big manufacturers such as Dell (DELL), Hewlett-Packard (HPQ), and IBM (IBM). In our increasingly virtual/digital economy, computer servers are as tangible a core capital good as we’re going to find. Server sales increased 3.8% from 2006 to 2007 according to Gartner, a market research firm. This data confirms what I’ve been noticing in my industry. All my peers in Internet or web technology startups are increasing their investments in technology infrastructure and talent. If there is a recession afoot, it has not reached the Web 2.0 space. We’ll see how long this lasts; venture capital, the lifeblood of many of these startups, ebbs and flows to the rhythm of the public markets and their reception to IPOs. If Facebook can pull off an IPO, which it will most likely have to do because there are few companies with the firepower to acquire it at current valuations, then the party might still continue.

• Economic Karma – It All Balances Out Eventually: India’s growth as a center of information technology accelerated as the forces of globalization caused U.S. and European companies to outsource much of their technology needs to the land of spices where the labor was relatively inexpensive and talent was comparatively competent. Now there are rumblings that India is beginning to lose some of that competitive advantage as labor costs rise and the best talent has already been snapped up with very little real scientific expertise left to bid for. I suspect that much of the offshoring budgets of the Fortune 2000 will now start allocating resources to other parts of Asia and Eastern Europe. My company, SocialOptimize is outsourcing some of our mundane coding tasks to Guatemala and the Philippines. Also, the dollar’s continued weakening might make most overseas outsourcing alternatives less attractive when compared to domestic software engineers.

Micro

• In times of recession, when unemployment is high, the unemployed go back to school to add marketable skills and increase future earnings power. The leading companies in for-profit education include Strayer Education (STRA), DeVry (DV), ITT Educational Services (ESI), Career Education Corporation (CECO), Capella Education (CPLA), Corinthian Colleges (COCO), and industry giant Apollo Group (APOL). Apollo operates the ubiquitous University of Phoenix campuses. This investment thesis has worked in past recessionary times, but the unique risk this time around is the possibility that the credit crisis will hamper students’ ability to repay or obtain school loans.

• Continuing with what may appear to be a Chicken Little theme of extreme pessimism, consumers tend to put off the purchase of brand name luxury apparel in favor of generic brands and off-quality goods sold in discount retailers such as TJX Companies (TJX) and Ross Stores (ROST). Collective Brands (PSS), the owner of generic shoes retailer Payless ShoeSource should hold up pretty well as more consumers look for alternatives to Nike (NKE). This isn’t Chicken Little, this is survival of the fittest portfolio.

• Obscure Small Company: Water is the next oil. Watts Water Technologies (WTS) makes industrial products that address the water safety, quality, flow control, and conservation needs of the market. It sells product in North America, Europe, and China. Many so-called experts have predicted that food prices will rise because of the increasing demand for nutrition from a growing world population. Few have pointed out that a lack of clean water will make food prices skyrocket even more by rendering agriculture less effective, resulting in a shrinking supply of crops.

Technology

• Adobe’s (ADBE) Flex 3.0 and AIR to launch today at Engage 2008. Adobe’s suite of software has become increasingly important for web developers. Much of my previous startup’s strategy included using Flex intelligently. My current business, which is more consulting and agency-based continues to rely on Adobe software. Simeon Simeonov, a VC at Polaris Ventures, has a very good post about how AIR can be a game-changer as a live bridge between the Web and users’ desktops. It’ll be interesting to see how creative some developers can get leveraging AIR with their social networking web apps

• The success of Guitar Hero by Activision (ATVI) and Dance Dance Revolution by Konami (KNM) validates new video game interaction models based not on hand-held controllers but on input models based on other parts of players’ bodies. Now San Francisco-based Emotiv Systems has announced the launch of a new device that detects electric signals from the users’ brains and interprets those signals to control in-game action. This new interaction model should be very interesting in virtual world environments like Second Life. Of course, the early adopter of this technology could very well be the porn industry; it is usually one of the first movers in experimenting with new technology to distribute content and products.

• LinkedIn, the social network for professionals, launched a mobile version of its website. At its current state, it is “underwhelming” but the company ought to be able to figure out new user interaction models for encouraging connections. Technically, there won’t be a dichotomy between online and offline since mobile means we can be persistently online. On the “regular” version of the website, it has always been just slightly annoying to receive requests to connect from total strangers who share no relevant interests and whose only desire is to expand their “networks.” That behavior is a slightly more grown up version of Myspace (NWS-A) users’ notorious friend collecting. The firm should ensure strong filters to prevent this annoyance on the mobile platform – mobile spam is far more intolerable than desktop email spam.

Advertising Age is reporting that U.S. media employment fell to a 15-year low in December 2007. The major driver behind this slump is the struggling newspaper industry. This is not surprising because nearly everyone is spending more time getting their news on the Internet and less with broadsheets. Exacerbating the losses is the disappearing classifieds business as online alternatives like craigslist, partially owned by eBay (EBAY) offer cheaper and more immediate classifieds solutions. The New York Times (NYT), also known as the Gray Lady to the cognoscenti, recently announced another 100 job cuts as a result of diminishing revenues and profits.

Suffering to a lesser degree are the broadcast and cable television companies. Still, recent studies show that consumers are spending far less time surfing the boob tube and much more time online for entertainment on websites like YouTube which is owned by Google (GOOG). Employment numbers are falling here too but to a lesser degree than in newspapers.

Rounding out the traditional big three in media is the similarly suffering radio industry. Blame Steve Jobs and his Apple (AAPL) iTunes-powered iPods for the vanishing radio listener. The Billboard Music Charts just don’t have the same clout and influence they used to as music fans take control of their own playlists by getting farther out on the long tail. Who needs a disc jockey to tell you what’s hot when you can discover that perfectly obscure independent band on the Internet?

All is not doom and gloom. While traditional U.S. media is quickly shrinking, the U.S. advertising/marketing services industry is growing at a healthy clip. Advertising agencies, marketing-consulting services, graphic design, public relations agencies, and media-buying agencies are all segments witnessing expanding payrolls. This flies a little in the face of the argument that content is king. At least with job counts, it seems that those who subsidize the creation of content is king. Or perhaps content is still king but influence is moving away from professionally produced content controlled by a handful of conglomerates and towards massive amounts of user-generated content by amateurs and independent bloggers. Top bloggers are making a great living and their “jobs” aren’t being counted.

The growth in advertising/marketing services jobs bodes well for the startup that I am just beginning to build. SocialOptimize, my social media development and consulting agency that I co-founded, was started to answer a huge need in the marketplace. My partner and I found that huge corporations, members of the Fortune 2000, were in dire need of help addressing the burgeoning social networking and social media space. Huge user-generated content sites like Myspace, owned by News Corporation (NWS-A), and Facebook, partially owned by Microsoft (MSFT) are capturing the majority of consumers’ time spent online. Advertising dollars will flow to these platforms as agencies like SocialOptimize steer corporate marketing dollars to where the eyeballs and wallets are congregating.

Going forward, it will be interesting to see how Advertising Age will count the jobs and advertising dollars associated with social networking web applications and widgets. Software developers are finding ways to serve advertising through their apps and widgets. At SocialOptimize, we have had big marketers propose advertising on our own proprietary widgets because our apps offer marketers much more value than traditional advertising channels like newspapers and radio. This value comes from the ability to target deeper audience segments while offering demographic data and evidence of return-on-investment (ROI) at a more granular level. Well-designed apps are also much more engaging than traditional media, causing consumers to spend enormous amounts of time interacting with the apps and the social networks attached to those web applications and widgets.

The big negative about this report is that I’ll have to compete even harder to attract top talent to SocialOptimize. Good talent is so difficult to find!