In the Web 2.0 space, it would be extremely difficult to find a more-successful, faster-growing service than Twitter, who has carved out a significant niche for itself in the microupdates space, as people from around the world tell you what they're doing, right now, even if you didn't ask. The service has an estimated 6 million active users, and recently surpassed the 1 billion "Tweet" mark, if you count all updates. But the company hasn't yet made a buck in traditional revenues. (Although I can't claim to be privy to their books, and they just might have recognized something somewhere) Word comes this weekend, via TechCrunch and others, that Twitter is embarking on a new funding round that could see the company valued at $250 million. And while I already made the case that Twitter will get its funding, and could end up being worth a lot more than that number in short order, it is pretty easy to also poke holes in that analysis.Quite simply, now is a very difficult time to attain a high valuation. Venture funding is dropping dramatically, and positive exits for companies are rare. Practically nobody is talking about going public, so to make money, you would have to do it the old fashioned way, through profits. And Twitter has grown its user base rapidly, but has done so on the backs of users who are used to getting something for nothing. We've already seen users revolt when Magpie launched with the possibility of inserting ads in one's tweets, and you could expect to see the user base shudder when being asked to shoulder any of the revenue themselves - so you can practically forget about monthly fees. Given that scenario, site ads and ads inserted in third party applications, like TweetDeck, would have to be one option, but an unattractive one, as the ad market itself is tailing downward.
Additionally, what Twitter does is incredibly basic. It's sole functionality is one that it is easily replicated. You can provide status updates on Facebook, on GMail, on FriendFeed, and the whole process rolls back to AOL instant Messenger, when you would set an "Away" status to say you were "At Lunch" or "In a Meeting". So that's not hard.
A recent post by Paul Buchheit of FriendFeed, called Communicating with Code, showcased a prototype offering of FriendFeed that borrowed heavily from the look and feel of Twitter. Given FriendFeed updates include those from Twitter, and then build on with additional services, it can be considered a superset, while Twitter is simply one service of many. So the barrier to entry to compete with Twitter is not that hard, leaving the company's major assets as the community and its developers.
But communities are incredibly fickle. None of Twitter's six million users were using the service five years ago, and maybe, five years from now, they will be doing something else. If people use Twitter for conversation, they can replace that with e-mail, with IM, with FriendFeed, Facebook or other social destinations. I've talked about the five stages of being an early adopter before. One of the final stages is when you grow tired of an environment, and leave, begging your followers to come along. It happens with news groups. It happens with e-mail lists, and it just might happen with social networking tools, including Facebook, FriendFeed, Twitter and others.
Today, Twitter is among the hottest, fastest-growing brands out there. But no matter how you multiply its current revenue to try and guess at a market capitalization, the answer is still zero. At a time when real brick and mortar businesses are seeing their own valuations decimated, how can a virtual company with a free user base and a low barrier to competition expect to be valued so richly? Whoever does invest should exercise extreme caution.