Sale Of Digg Reminder Of Potential Risks To Facebook And Other Social Media Investors

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In 2011, social media watchers may recall reading in Bloomberg that Myspace, which had been purchased by News Corporation (NASDAQ:NWS) for $580 million in 2005 had reportedly been sold for just $35 million to private investors, including Justin Timberlake. In 2006, some may have felt News Corporation made a great investment, as Mashable reported that Myspace was the most popular website in the United States. At the time of writing this article, Myspace ranks 102nd in the United States, according to Alexa traffic ranking estimates.

Late last week, Digg, another social media pioneer, made headlines for a reportedly low sales price, once again providing a reminder of what a difference a handful of years can make in the ever-changing social media world.

Differing Media Reports of the Value of Acquiring Digg's Assets

The Wall Street Journal reported on July 12, 2012, that the social news-sharing site Digg was sold to Betaworks for just $500,000, according to the WSJ's sources. To put this into perspective, the WSJ reported that in the fall of 2008, Digg raised $29 million in an investment valuing the entire company at about $164 million.

However, in a report released on the same day by TechCrunch, which seems to be receiving less attention from the media, the actual sale price of all of the parts of Digg was closer to $16 million. According to TechCrunch, Washington Post Co. (WPO) paid about $12 million for the Digg team; LinkedIn (NYSE:LNKD) paid $3.75-$4 million for patents; and Betaworks bought Digg's remaining assets for $500,000-$725,000.

Betaworks has confirmed on its site that it acquired the core assets of Digg; however, it did not confirm the price in its blog. We may never know the actual price. Certainly $500,000 is a more controversial headline number for those familiar with Digg, but a $16 million sum-of-the-parts valuation is still a dramatic fall for a company worth about 10 times less than four years ago.

Digg's Rise and Fall

For those of you unfamiliar with Digg, it is a social news-sharing site launched seven years ago. Think of your favorite traditional news website. Then imagine that instead of paid editors, audience members submit links to articles, and vote which articles become "popular" and make it to the main pages of various news sections you would find in a typical newspaper.

In October 2006, according to ReadWriteWeb, Digg ranked within the top 20 of websites by traffic rank in the United States, based on Alexa estimates. For comparative purposes, Alexa currently estimates Facebook (NASDAQ:FB) to rank 2nd; LinkedIn to rank 9th; and Huffington Post owner, AOL Inc. (NYSE:AOL) to rank 18th within the United States.

At the time of writing, Digg ranks 227th in terms of web traffic in the United States, according to Alexa, and 191st globally. If you click on the traffic rank, and "maximum" parts of Alexa's graph (can be viewed here), you can see that Digg's popularity has significantly declined over the past two years.

By contrast, Digg's competitor, Reddit, which provides a similar social-news sharing service, without the same aesthetic news page look of Digg, is ranked 60th in web traffic in the U.S. at the time of writing this article, according to Alexa.

Potential Explanations for Digg's Fall

There have been various explanations in the media as to the cause of the downfall of Digg, which include the rise of Twitter, Facebook, and Reddit. I disagree with these arguments. While Twitter and Facebook allow the sharing of some news stories with friends, neither site has multiple news sections that allow users to browse which section of the news they want.

If you look at Alexa's Digg or Reddit traffic rankings, you can run a comparison tool that does indicate that over the past two years, Digg's popularity has declined, while Reddit's has increased. But I believe this has nothing to do with the popularity of Reddit's format, but rather the massive unpopularity of a change to Digg's format in 2010, that caused Digg's users to switch to Reddit.

As reported by PC World, in an article offering explanations for Digg's demise, Digg dramatically redesigned its website in August 2010, resulting in a 24 percent drop in traffic in months. When Digg users like an article, they click a "thumbs up" button, indicating they "Digg" the article. Here is a link from Digg to an article from the Huffington Post in 2010, indicating that angry Digg users were Digging stories from Reddit. At the time of this article, over 3,000 people "dugg" the Huffington Post Digg rebellion article.

The Importance of Digg's Lesson To Other Social Media Sites

Digg faced a situation similar to when The Coca-Cola Company (NYSE:KO) introduced "New Coke" and received a massive backlash from its fans. Unlike Coca-Cola, rather than revert to the original, more popular format, Digg stuck to its guns. Digg needed to find a fine balance between retaining its users and making money, something it had trouble doing, as reported in the PC World article referred to above.

That said, Digg had an opportunity to listen to its extremely vocal core audience, and chose to ignore it.

Does this sound familiar? It may, because Facebook has found itself in similar circumstances. In the past, Facebook has managed to successfully deal with initial user dislike of major changes. For example, when Facebook introduced the news feed in 2006, Businessweek reported "hundreds of thousands of Facebook's most avid users turned on the site..." Facebook dealt with this by tightening up privacy protections, and communicating via its blog with its concerned users. Although interestingly, it was also reported at the time that "at no stage has the company considered pulling the features altogether."

Facebook introduced its Timeline feature to its users (after allowing developers earlier access to it) in December 2011. In February of this year, a non-scientific poll conducted by SodaHead, and quoted by various media outlets, indicated 70% of Sodahead users thought Facebook should "lose" the new Timeline feature.

It is still unclear when, if ever, Facebook will require individual user accounts to switch to Timeline. As an example, at the time of writing, in Canada, Facebook still offers instructions how to switch to Timeline on its help page. Perhaps this is because Facebook is either exercising caution before forcing everyone to switch to a new feature that may be unpopular, or perhaps Facebook is trying to improve the feature before making it mandatory.

Further, last month, Facebook risked potential backlash by switching its users' primary email addresses on their profiles to Facebook.com addresses, without first asking for permission. As I suggested in this article, perhaps this is because Facebook is concerned that with further Apple Inc. (NASDAQ:AAPL) iPhone integration when the iOS 6 operating system comes out in the fall, that the need for logging into Facebook will decrease as people's non-Facebook email addresses get added to their friends' iPhone contact lists.

Alexa estimates indicate that the average time spent on Facebook using computers has declined per user from over 30 minutes per user in 2011 to just under 20 minutes per day over the past week. This is not surprising as the ability to access Facebook via smartphones becomes more common, and as Facebook has acknowledged that it needs to find ways to successfully monetize its growth in mobile use.

The problem that Facebook, or any social network searching for new ways to monetize the use of its services, is that if the changes made to the platform prove to be unpopular, the company risks facing a massive backlash that can very rapidly lose users, as evidenced by Digg.

The one disadvantage that Digg had compared to Facebook is that competitor Reddit was available and all too happy to take Digg's business, much like Facebook took much of Myspace's business. Facebook may have some leeway to make potentially unpopular changes to its web-based or mobile formats if there is no competitor that its core users will jump ship to. Investors in any social networking company will want to keep a close eye on potential alternatives its users may choose to share information and evaluate the probability of the users making the switch.

Even if Facebook proceeds with caution and manages to avoid upsetting its users with any changes, investors may want to consider how many interactions that currently take place on Facebook may be done without using Facebook on smartphones in the future, especially when iOS 6 is introduced in the fall. If Facebook users begin sharing information previously shared using Facebook with new mobile phone operating systems or applications instead, Facebook may be forced to make web or mobile platform changes to try to stay competitive. Digg serves as a reminder of the potential challenge of walking the fine line of doing what is necessary for earnings, while trying to retain user popularity.

Disclosure: I am long AAPL.

Additional disclosure: Conrad Schickedanz has written numerous articles for another web site voted to be popular on the main page of Digg, including the second most popular article on the Digg main page on a day during July 2007.Disclaimer: The commentary expressed in this article is not legal advice, nor investment advice, and is subject to Seeking Alpha's Terms of Use, which are available here: seekingalpha.com/page/terms-of-use