LinkedIn and the 80/20 rule

Social networking started its meteoric rise more than a half a decade ago, but some of the biggest names in the space are just getting set to really cash in.

One of those names: LinkedIn, the social network that has carved out a lucrative niche as the social network for professionals. It's going public soon, and could pave a golden path for social networking brethren like Facebook when they go public.

On the surface, LinkedIn looks impressive. In the first three quarters of 2010, it generated upwards of $160m, double what it produced in 2009. Perhaps more importantly, 2010 also marked the company's first year as a profitable enterprise.

But does LinkedIn look more impressive a company than it really is? At least one observer thinks that might be the case.

Last week, Jim Edwards, a former managing editor at Adweek, noted that LinkedIn's usage is driven by a relatively small number of users. In the "risks" section of its IPO prospectus, the company reveals that "a substantial majority of our members do not visit our website on a monthly basis, and a substantial majority of our page views are generated by a minority of our members" and "the number of the registered members is higher than the number of actual members".

According to Edwards, "This smells bad for advertisers. Consumers need to see messages more than once a month in order for ads to work." But is that really the case?

It's worth pointing out that advertising is just one of LinkedIn's revenue streams; the company also makes money from paid memberships and recruiting solutions. As early as 2008, its other sources of revenue accounted for three-quarters of the company's revenue.

But revenue breakdowns notwithstanding, LinkedIn's usage is likely just another confirmation of the Pareto principle, more commonly referred to as the 80/20 rule, which basically states that 80% of Y will be produced by 20% of X.

In other words, 80% of a company's revenue will be generated by 20% of its customers, or 80% of its pageviews will be generated by 20% of its customers.

While the numbers 80 and 20 may not be precise, many businesses find that the general rule holds true. Which is important, because acknowledging this, it's probably to be expected that LinkedIn -- and even Facebook -- sees much of its activity from a relatively small number of users.

It would actually be more surprising to see usage distributed evenly, and such a pattern might even pose risks of its own. The nice thing about the 80/20 rule is that, when it's observed, it gives a business the opportunity to segment and focus most on serving those customers or users who drive the majority of the value creation, as opposed to being stuck trying to be everything to everybody.

At the end of the day, there may very well be an argument to be made that social networking companies like LinkedIn will be overvalued when they go public, but the mere fact that a minority of users creates the majority of the value isn't one of them.

Photo credit: ifindkarma via Flickr.