If you want to measure how quickly fortunes rise and fall on the Internet, look no further than the decline of Digg.com.

From its founding in 2004, the company quickly became the poster child of the Web 2.0 revolution and a new breed of social media startups. Digg offered a pioneering service that let users post their favorite links and then the Digg audience could vote them up (or “digg” them). A link favored on Digg could send such a tidal wave of traffic to a website that the phenomenon earned its own nickname: the Digg effect.

As recently as 2008, there was speculation about a Digg public offering of stock. But quicker than you can say “crowdsourcing,” things went sideways. In the past few months the company booted its CEO, saw its traffic tumble, and recently launched a new version of the service that has angered longtime users.

As a result, Digg has lost its status as the company entrepreneurs want to emulate and instead moved into a less exalted category: the cautionary tale. As a business case study, I think it offers two lessons. The first has to do with the need to innovate continuously on the Web to keep growing and stay ahead of the competition. And the second has to do with how hard it is pull out of a downward spiral.

A Digg representative said company executives were not available to comment. But Digg co-founder Kevin Rose has been addressing the most recent troubles in a variety of podcasts and blog posts. Rose has acknowledged that the latest revisions to the site have had problems, while at the same time insisting that rivals like Facebook and Twitter are not leaving his company in the dust.

“It’s not like it’s one of these things where I believe that Twitter is the death of Digg,” Rose said recently on the This Week In Tech podcast. “I mean, we still are a very profitable healthy business, just sitting there, doing what we do best.”

It’s unclear what Rose meant by profitable in that context. Previous CEO Jay Adelson was quoted in February as saying that thanks to its new advertising platform, Digg had become “EBITDA profitable” in 2009, meaning the company made money if you don’t count lots of bad stuff like taxes, interest and depreciation.

Two months after Adelson said that, he left the company amid rumors that the new version of Digg was taking longer than expected to roll out. The company subsequently cut 10 percent of its staff to curtail costs. Meanwhile, the company’s traffic declined from 14.3 million unique visitors in January to 8.8 million in July, according to comScore.

What went wrong? The world changed, and Digg was too slow to recognize it. From its founding in 2004, Digg offered a service that ranked Web links based on the input of the large, anonymous crowd.

But more recently, people have turned to Facebook and Twitter as ways to discover interesting, fun and relevant content on the Web. It turns out that we care more about what our friends and our trusted networks of followers than we do about the great anonymous mass of humanity on the Web. Digg was slow to react to this fundamental shift in behavior and has paid the price by watching its audience trickle away and the buzz surrounding the company dissipate.

“I think Digg, in its time, was incredible in terms of the power it gave its audience,” said Charlene Li, founder of the Altimeter Group. “But we have a lot more choices now.”

We’ve seen Web companies respond too slowly to changes before. Onetime leaders like Yahoo and MySpace were slow to adjust and saw their early leads slip away.

Digg is now finding that performing radical surgery, especially when it’s overdue, can be difficult. Few companies manage to strike the right balance between keeping core users happy, even as they dwindle in numbers, against the need for big changes to reignite growth.

Last month, the company unveiled the new version of Digg, which focuses on links that are being shared by friends and sources that you follow on Digg rather than the links favored by the entire user base. Digg is embracing the more social model of discovery that Twitter and Facebook have made popular, which I think is absolutely the right way to go. But predictably, Digg’s longtime users have been furious.

“The people who Digg a lot like to do it because they have a tremendous amount of influence,” Li said. “If you can filter them out, they lose their power and influence.”

Rose has been trying to perform triage. On his personal blog, he acknowledged a long list of problems with the new version while arguing that despite the hue and cry, users have generally reacted positively.

“At Digg it’s our job to try new things, analyze the usage data, iterate and evolve,” Rose wrote.

Good luck. Given the need for a dramatic reboot to reignite growth, Digg, seems to have, well, dug itself a deeper hole. And so far, the signs aren’t promising that Digg will be the rare company that manages to climb out.

Contact Chris O’Brien at 415-298-0207 or cobrien@mercurynews.com. Follow him at Twitter.com/sjcobrien or at www.facebook.com/ChrisOBrienJournalist.