Something must be there in their product that everyone is willing to pay top dollar. And these are all smart people who are ready to pay btw, not any average joe investor
There are always 3 things: idea, team and execution.
Color had a genuinely interesting idea: make a social network via implicit information rather than deciding whether or not the a person is a "friend".
I can see this being of particular interest to Google as they built themselves on a similar premise: ranking web searches via implicit data (links, etc.) rather than a hand built index.
So, with an interesting idea and a strong team they secured both acquisition interest and a huge funding round. The idea being that they would release a series of applications and products that would deliver on the promise of implicit social network creation.
Then their PR got ahead of them (no doubt purchased with a chunk of the $41 mil) and expectations got built to a level that could never be delivered on with the first iteration of their first product - an iPhone photo app.
So, now there is a big backlash as people feel "duped" by the gap between the hype and the product and it is crushing the company.
Investors act irrationally all the time and it doesn't help when their coffers are so overfull with other people's money that $40 million becomes chump change and not even noticeable in the ledger.
I suspect there might be some pretty heavy use of computer vision as related to those images -- perhaps to pick out brand preference or otherwise personal/private information that could be rolled up/anonymized such that marketers would buy in aggregate.
If the product was released differently, it very likely could have been successful. It seems to me that once they got all that VC funding, they were desperate to release something to prove their worth. But, since their product depends on tons of people all using it in a geographically tight area, it crashed and burned. I think had they started releasing at events (ala twitter @ sxsw), they could have had some success.
That sounds like a great co-branding opportunity. Color could also sell/host conference services such as preloading conference-related photos/ads or providing additional Color photographers to "augment" the conference's Color photos when the app's adoption is still low.
I feel like their target market should not have been the US but rather Europe or Japan. Both much higher population densities where location/presence based technology does much better (see 3DS Street pass feature).
I too feel like there something there people think has value but the average person doesn't see. But maybe there is nothing and this is really as irrational as it looks.
