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Wow, this New Economy stuff just gets more and more interesting.

First, Rupert Murdoch’s News Corp. bought out MySpace for a massive $580 million. In recent months, that’s been called a bargain. In fact, it has been, given that Google’s paid $900 million for advertising rights on the site, making Murdoch a 55% return in his first year as owner.

The MySpace deal set a precedent that saw YouTube acquired by Google for $1.65 billion this previous week. That immediately put the YouTube founders in the same ballpark wealth-wise as Michael Jordan. Now we’re hearing that Facebook has deemed Yahoo’s $1 billion offer an insult amid speculation Google’s preparing to make a bid and is holding out for $2.3 billion. Wow. Honestly, you look at those figures and wonder if we’re talking peanuts, not dollars. And then you look at their earnings, and you really wonder about wasting those peanuts so frivolously.

The Web 2.0 defence (”users trump all”) makes sense to a limited extent, but you have to wonder just how scalable and resilient this idea of valuing things by the volume of traffic is. Because let’s face it, Google would not have bought YouTube if it didn’t think it could turn a profit. And I’m sure they’ve done their maths.

Lies, damn lies, and statistics

That — the math — might be the first problem. There was another company not so long ago that employed seriously smart folks and built up a business around maths: LTCM. In case you’re not familiar with that name, LTCM was the hedge fund that collapsed in 1998, leaving $1.25 trillion in liabilities in its wake. Their employees — boasting PhDs from Harvard, MIT and the University of Chicago, and including one Nobel prize winner — bet big and bet risky, but were ultimately undone by unpredictable movements in the market.

By acquiring a company that has been in existence for merely 18 months and has never turned a profit, Google is doing the same thing, and that too in a notoriously unpredictable market. The mushrooming of competitors for YouTube hasn’t deterred them, the logic being that if Google Video — with Google’s great PR behind them — couldn’t challenge YouTube, smaller challengers can be brushed away with impunity. It’s hard to disagree without any hard data, but to play devil’s advocate, one could argue that the Web 2.0-friendly long tail concept could help competitors break away YouTube’s core audience a few members at a time. That core community, by the way, has already begun expressing doubts about the deal, wondering whether the ‘cool’ factor has been diluted with Google’s corporate (!) patronage and wondering why the community isn’t being rewarded more tangibly for their contribution to YouTube’s success. This fickleness is underlined, of course, by the fact that Google’s hip young image has apparently, overnight, gone corporate.

Vanity and hype

The defining characteristic of Web 2.0 success so far appears to be vanity. There are certainly other factors, particularly cheap bandwidth and hardware for consumers, but let’s be clear: the secret sauce to the social networking revolution is the ability of businesses to pander to the vanity of their consumers. It’s not like the ideas themselves are revolutionary: Friendster existed long before Orkut, Facebook or MySpace arrived; Yahoo! Photos existed before Flickr; Outlook/WebDAV-enabled iCal existed long before Google Calendar. No, the moment it clicked was when these repositories of personal data were put on display for the world to pass comment.

Vanity being the self-serving emotion it is, it’s probably not the best foundation for a business; loyalty would be a nice one, and straight-up technological superiority would be a great one. Unfortunately, virtually all the Web 2.0 successes we’ve seen are unsophisticated and easily replicable, albeit superbly executed. What that implies about their communities, and their creators, is another story.

The interesting observation to be made in all this, though, is the common link: Google, the company that made Rupert Murdoch look like a very smart man; that secured the future of YouTube before it ever turned a profit; and which is now being used by Facebook to secure a better deal. Equally interestingly, Google is pretty much the only company mentioned in this article showing stellar performance; could it be they’re on to something we haven’t figured out yet?

Maybe Google has figured out that its core business is hype as much as it is search. Rationally speaking, there isn’t much going to sustain the sanguinity that Web 2.0 has been coddled with, and you’d be hard-pressed to find anyone who doesn’t think these recent developments are taking us back into Bubble-era territory. The analysis that MySpace’s sale setting a precedent that makes ridiculous YouTube and Facebook acquisitions rational can be viewed another way: there is an atmosphere of optimism that must, nay will, be sustained. And that’s all Google is doing, sustaining and amplifying the hype, and absorbing companies that could only realistically survive if backed by its deep pockets. This sounds cynical, of course, but ask yourself why YouTube has been purchased, and consider the following reasons why it shouldn’t have been:

• Just about every analyst thinks YouTube is shortly going to find itself in the mother of all legal problems, being sued by all quarters. By buying it, Google inherits all of YouTube’s legal problems. Even if the legal problems are minor, Google would have been able to haggle a better deal if it had waited.
• YouTube content does overlap in places with the video content Google sells, so Google is effectively placing its existing revenue streams in jeopardy with this.
• YouTube has never made a profit, and isn’t likely to make one now. One of the big problems is covering the cost of bandwidth, which Google can sidestep by utilising all the dark fibre it’s been warehousing for ages. Nevertheless, there is a cost associated with this and Google really doesn’t stand to gain much monetarily, at least immediately.

Most significantly, the $1.65 billion paid out could have been invested in building a community for Google Video. Conventional Web 2.0 wisdom says this is almost impossible to do, but consider that $1,650,000,000 would buy enough Logitech webcams for every unique visitor who visited YouTube last year (72 million, at $21 dollars a pop, is $1.575 billion) and a fair number of broadband connections with the $75 million they’d have left over. You’re telling me that wouldn’t sway enough users to make Google Video work?

One final argument for the hype conspiracy: YouTube and Facebook were/are pretty much the last of the major Web 2.0 properties still available. Perhaps the thinking is to overpay for these two to keep the bubble of optimism intact, giving Google several years of strong revenues and happy shareholders before the next big thing comes along and it has to consider splurging again. Certainly, a collapse by either of these two most visible members of the Web 2.0 commodities would send investors scurrying for cover as they did once before, and raise questions about Google’s mediocre track record in anything other than search.

Where to now?

Yahoo! plays almost as interesting a part in the current situation as Google. Caught off-guard during Google’s ascendancy, Yahoo! quickly retooled, mirroring Google by opening its services up to developers and spending on research for products such as search to try and keep up. They also made several key acquisitions and alliances, including del.icio.us and Flickr. The current stall in talks with Facebook has opened them up to familiar accusations of not being in Google’s class in executing deals with aggression and panache, which essentially translates to calling them old-school plodders who don’t understand the new world. It’s difficult to agree, since by all accounts Facebook itself has done nothing to warrant a $2.3 billion dollar acquisition. In addition, it is questionable just how much benefit Facebook would bring to Yahoo!, since the latter is already the world’s most popular website and in that sense already the biggest social networking site of all. Indeed, one might argue a series of more appropriately priced deals to make it attractive to students would be the prudent course, particularly when paired with a continuing focus on strengthening their search product, which remains the key to breaking Google. It’s still quite possible that the pressure from Google and its shareholders might cloud their judgement and make them jump at Facebook, whatever the cost. It would be a massive shame if they do — they need think back only as far as their $5.7 billion acquisition of Broadcast.com from Mark Cuban, the same guy now saying the YouTube deal is crazy.

Regardless of whether there is anything to the hype conspiracy (facts and numbers can be mashed together to prove just about anything: witness Google’s conviction YouTube is worth $1.65 billion!), the fact is that after YouTube and Facebook, there are no major players to be acquired. Thus the period after these acquisitions would be an ideal time for the market to reflect on their investments and make strategy adjustments. In any case, it seems unlikely Web 2.0 properties will continue to enjoy such outlandish valuations. If they do, you better believe Michael Jordan will have something to say about it.

(It’s 3AM, I hope this isn’t completely incoherent.)