Let me tell you three stories today.
A bunch of bloggers (whom I won’t name) were selling textlinks, which are basically links that point to other websites (e.g. thisisalink). Before I explain why these bloggers were selling links, let me give you some background coverage.
Basically, Google assigns each website a PageRank, which is a 1-10 scale that gauges the “popularity” of your site. Google ranks it’s search results based upon your site’s PageRank: ggenerally, sites with higher PageRanks will rank higher on Google, and the way to get a high PageRank is to get other high PageRank sites to link to yours. Since everyone wants to rank higher on Google (more traffic for their websites), a lot of websites buy links. This is highly frowned upon by Google as it messes up their search results (a shitty website that buys a lot of links can rank highly on Google).
Now back to the story. So basically, these bloggers were making a ton of money each month selling links Now here’s where it gets ugly.
Google is the one who assigns a PageRank to each website (e.g. Pagerank 4, or Pagerank 2). Google can change any site’s PageRank anytime it wants. A few days ago (all of a sudden), Google swooped in and changed all of these blog’s PageRanks from 4′s and 2′s and 3′s to big, fat ZEROS. All of a sudden, these sites have no more links to sell (because no advertiser wants to buy a link from a site that has a PR 0).
In other words, the primary revenue source for these blogs was instantly destroyed by Google.
Zynga is the maker of popular social games such as FarmVille, Mafia Wars, and Cityville. Their entire business relies on Facebook; Zynga’s games can only be played by Facebook users on Facebook.com. Zynga used to make money by selling virtual goods on Facebook via Paypayl’s payment system. But last year, Facebook decided to take a bite at Zynga’s massive revenue by initiating it’s own payment system called Facebook Credits and declaring that all payments on Facebook must use Facebook Credits. So here are the before and aftermath.
Before: A user buys $10 worth of Zynga’s virtual goods. Paypal takes it’s 3% fee, so Zynga is left with $9.7.
After: A user buys $10 worth of Zynga’s virtual goods. Facebook forces the user to pay using Facebook Credits, Facebook takes a 30% cut, and Zynga is left with $7.
As you can imagine, Zynga’s revenue tanked, but they couldn’t even do anything about it because they’re entire business was (and still is) based on Facebook!
Recently, a hugely popular mobile app was almost shut down by Apple’s App Store. Path is an up-and-coming mobile social network (it already has millions of users) which is successfully competing against Facebook in the mobile space. Just a couple of days ago Path started storing user information on it’s own computer servers, which is against Apple’s Terms of Service for app creators. Apple threatened to delete Path’s app from the App Store.
Path immediately complied because if they hadn’t, their entire business would have been annihilated in seconds. This near death experience for Path comes to show that Apple can destroy app creators at any time it wishes, even if doing so is “unethical”.
So what do all of the three above stories have in common? In each case, a company was badly (or almost badly) damaged in some way because it was totally dependant on another company. The network of bloggers depended on Google’s PageRank metric to attract advertisers, so when Google changed their PageRanks, the advertising revenue for these blogs tanked. Zynga is totally dependant on Facebook, so when Facebook decided to take a 30% cut of Zynga’s revenues, Zynga could do nothing about it. Path was almost wiped out because of a policy that Apple set.
So what’s the lesson here?
You must diversify your business if the key factors to your business are not in your control. For example, if those bloggers found an alternative way to make money, they wouldn’t have been so badly hurt when Google destroyed their PageRanks. If Zynga had made its’ games available to Twitter and other web users, it would not have been so badly hurt by Facebook’s greedy jaws. If Path enables an online version of itself, Apple cannot destroy Path by deleting Path’s app because users can still go to Path’s online version..
To make a long story short, diversity when the key elements of your business are not in your control. The key elements include customer acquisition, revenue source, marketing. Don’t dwell on delusion thinking and believe that the company your business is totally dependant on won’t one day suddenly attack your business. Anything can happen in business. It’s a dog-eat-dog world. Diversification will make you forgo short term profits (because diversification prevents explosive growth), but in the long term diversification can save your ass.
So when shouldn’t you diversify?
When all the key elements of your business are under your control, there is no need to diversify as diversification prevents explosive growth. For example, as an investor all the key factors of my “business” are under my control. No external force can forcefully cause me to lose money. Sure, the markets can go sour, but I can always cut my losses instantly. But the key elements to a company like Zynga’s aren’t under it’s control: their under Facebook’s control.
So the key word is: CONTROL. Do you have control over your business?