In my view, the Dot-com bust was probably caused by bad metrics. In 2000, Erick Schonfeld, then at Fortune Magazine, wrote, ”In Webspeak, you see, eyeballs mean customers.” In an effort to convice themselves of the hype, investors made a leap of faith that eyeballs meant customers and the economy paid for it.
Today, the tech community has made improvements beyond the “eyeballs” of Web 1.0 and vanity metrics. Entrepreneurs and investors highlight engagement and actionable metrics like funnels, conversions, and cohorts. Vanity metrics from the Dot-com era are typically washed to the side with insightful due diligence. Despite the improvement, the tech community still relies upon eyeballs for what I call “engagement” valuations.
Early stage startup success is typically based upon adoption and engagement success. Investors write checks if they believe a startup will become a significant business based off this initial data. This initial “engagement” valuation is grounded on the heuristic ”there might be something to this idea if people want to use it”. A successful business typically follows strong engagement. Once a business model is firmly established, startups shift from an “engagement valuation” to a traditional enterprise valuation and lose the “startup” label.
Sometimes this switch painfully fails to happen. Facebook is a prime example. Facebook has an astonishing 50% DAU/MAU and is the first platform to ever have a billion users (ok, only .955 billion). No tech company comes close with this level of engagement and adoption; however, the market is not buying the hype. Facebook’s new aggressive ad efforts have fallen flat. This bearish outlook has hit all web 2.0 stocks. As Facebook and other Web 2.0 stocks continue to decline, bullish investors still point back to engagement as a reason to buy.
“Engagement” valuations have rocketed Quora, Twitter, Pinterest, and Instagram to the billion dollar club without much of a business model. Private investors hope that these startups will find a way to monetize on a base of millions of active users. I submit that investors have limited data points at which to value of an early stage company and often these are unreliable; however, public investors are still about the bottom line.
Sometimes the tech community gets wrapped up in its own Kool-Aid believing that others will also enjoy the drink of an “engagement” valuation. This addiction to ridiculous growth leads us to value silly metrics over developing a real business. So far, Wall Street hasn’t enjoyed the Web 2.0 Kool-Aid because they were burned in the past and history has a habit of repeating itself.
“The sad truth is that many, if not most, CEOs we talk to cannot pin down the value of a customer. Therefore they do not know how much they should be paying for a pair of eyeballs” - Erick Schonfeld, 2000