The perceived value of the most popular Web 2.0 startups lies in their large ‘communities’ and the content that those large communities contribute.

Without their communities, services such as Facebook and Digg would be of little value to advertisers, investors and potential acquirers.

This has created an interesting dynamic. Many Web 2.0 startups are controlled by their communities more than they control their communities. This means that, in essence, their most valuable assets are not really in their possession.

The importance of communities, which can be fickle and potentially volatile, to Web 2.0 startups has significant implications for all parties involved:

  • Startups really have limited control over the asset that creates perceived value in their companies. In many cases, the asset of community can quickly turn into a liability when the community isn’t happy and therefore startups may have a limited ability to execute their plans and implement new initiatives as freely as they would like or as is necessary.
  • Investors risk losing money when investments in community-driven services are hampered by user revolts or wrenches users throw into potential exit scenarios.
  • Acquirers risk finding themselves holding the keys to community-driven services with no communities if users migrate away from the services they buy.

Digg may be the most visible case study. The victim of user revolts in the past, Digg is apparently finding that its desperate search for a buyer is being complicated by a vocal community whose most powerful members seem vehemently opposed to the idea that Digg could be bought by Google or, god forbid, Microsoft.

Digg’s plight is exaggerated by Digg’s demographic makeup – its most powerful users are predominantly male geeks who think that “use protection” means browsing the internet with an ad blocker, who are apt to list Microsoft as a member of the Axis of Evil and who believe the use of closed source software should be punishable by death.

Given this, it’s no surprise that the Digg community is not excited by the prospect that two of the largest technology companies could very well be running the show instead of Web 2.0 party-hopper Kevin Rose.

The situation must be especially frustrating to investors who have poured over $11 million into Digg at a hefty valuation. As it stands now, the company, like so many other Web 2.0 startups, seems woefully incapable of generating enough revenue to turn into a self-sustaining business that can reasonably be valued at what investors have bought in at.

Like other Web 2.0 favorites such as Facebook, Digg’s primary source of revenue is reportedly an advertising deal with Microsoft that guarantees it payments. Unfortunately but not at all surprisingly, Digg users apparently don’t click on ads.

In my opinion, Digg is bascially a startup that has nowhere better to go than Mountain View or Redmond if a free ride is being offered. Its users are simply hell-bent on blocking it.

Should every community-driven online service fear a fate like Digg’s? Not necessarily. The user reaction to MySpace’s acquisition by News Corp. was entirely uneventful and MySpace has done incredibly well under News Corp’s control from a growth and revenue standpoint. But MySpace has a markedly different demographic makeup than Digg and to News Corp’s credit, it did not make drastic changes to MySpace after it bought it.

I would argue that all of the Web 2.0 hoopla blinded people, especially investors, to the complexities and risks inherent in running community-driven services. Not only was the ease with which these services could be turned into killer marketing platforms overestimated, so too was the ease with which these services could be turned into potent businesses that could be sold off for large sums of money.

The investors who poured more than $13m into Friendster probably never anticipated that the vibrant community at the world’s most popular social network would essentially disappear, just as Friendster founder Jonathan Abrams probably never anticipated that turning down a $30m acquisition offer from Google would be his last shot at making an easy fortune.

And the investors who have provided funding for Digg probably didn’t plan on the company’s greatest asset – its community – becoming an impediment to an exit.

Of course, I am not surprised. In late 2006 I noted:

“It’s becoming readily apparent that users are really in control and they’re not as loyal to the popular Web 2.0 services as one might expect. The fact that Facebook, which is considered by many to have the most loyal following of any social network, has faced a backlash from hundreds of thousands of users and growing, many of whom are threatening to boycott the service or leave altogether, highlights the fact that these services, which are all free, are highly vulnerable to mishaps, changing tastes, etc.”

I suggested that people recognize the following:

“The value in all these communities is created by the users and once these companies start doing things that users perceive to be against THEIR interests, users become a lot more vocal about the fact that they’re building all the value for these services. They seem to be very cognizant of the fact that they’re creating these paper millionaires and aren’t likely to continue supporting this creation of (paper) wealth if they don’t get what they want. And who can blame them? The hubris and arrogance displayed by Facebook management in its response to their mistakes has proven that money is now driving management, not the original principles that made them so successful in the first place.”

“These Web 2.0 services and technologies are commodities. People are invested in services like Digg and Facebook, but they’re not customers and there’s no real massive barrier stopping them from jumping ship.”

“Digg, Facebook, etc. have some of the characteristics of brands, but they’re not Coca-Cola or Budweiser by any stretch of the imagination. At the end of the day, they’re tools for people to communicate and share. Maybe they should think of themselves as providers of tools as opposed to $200 million or $2 billion companies.”

“Web 2.0 bloggers, VCs and the like are not the people who matter in Web 2.0. It’s the users.”

If there’s a lesson to be learned in all this, it’s that all bets are off when you’re dealing with people and given that Web 2.0 is peopledriven, startups, investors and acquirers should be cognizant of the fact that there’s no such thing as a sure bet in Web 2.0.

In the case of Digg, it may very well get its exit, but the buyer may just get more than it bargained for. Caveat emptor.