fictive facebook, part 1

“Fictive Facebook” is a series of blog posts, where I will try to conceptualize the overarching social network of our time, simply by envisaging the different ways in which it could all have been so different…

This is the first part, in which I focus on the burning question that has nagged everyone, since the company’s IPO on May 17th, 2012: How will Facebook make money to justify such a high valuation?

The initial $38 share price was insanely high – it meant that Facebook would have been valued at $104 billion and its price-to-earnings ratio (P/E) would have been 107. (For comparison, Apple’s is around 13.) To get a feeling of how insanely over-valued the company is, the IPO price meant that each Facebook user would have been valued at $115, while the company’s current turnover is around $4.70 per user and year. Since the original IPO, the initial share price of $38 has however slumped by more than a quarter.

How will Facebook make money?

Advertising.

While the desktop version of Facebook has been ad-financed from the start, the mobile version of Facebook has so far been ad-free. However, there are plans to feature sponsored posts on the mobile platforms. What is noteworthy with Facebook advertising is its reliance on the idea of Social Ads; ads that are thought to be relevant to the user’s preferences, based on his/her social ties. One should expect that Facebook is continually trying to develop the Social Ad even further – targeting users with personalized ads, based on personal data.

Yet, this is only part of the story. As The Economist wrote, right before the IPO:

The obvious way for Facebook to boost revenue is to keep inventing clever ways to advertise on its network. But it also intends to explore a host of other areas, from payments to “social commerce” (eg, online stores to turn Facebookers’ “likes” into purchases), either by itself or through applications run on Facebook’s platform by other firms which pay to reach its audience. Such initiatives may in theory bring in billions of dollars of extra revenue. But until there are clearer signs that they will, a valuation towards the lower end of Facebook’s own pricing range seems reasonable.

Peter Miles, commenting on the Economist article, notes that a P/E of 20 is reasonable. “They made $1B profits last year. How are they going to quintuple profit?”

If the revenue per user remains the same or less (and arguably it can only go down) they have to add nearly every man, woman and child on the planet to get to $5B profit and a P/E of 20.

In fact, they are going to have a hard time doubling profit. Signing the first billion users was relatively easy. These users are a wealthy, techno-savvy crowd from prosperous countries. The next billion will be much harder. They will be poorer with less access to technology and therefore less valuable to advertisers. FB will have to spend more to gain these users – they will have to advertise and there will be competition for the next wave of users.

If one looks at the growth in number of Facebook users so far, this appears to be a straight line, but such expansion is never likely to follow a pure exponential behavior (a paradigm for unlimited growth) but has a logistic function with asymptotic plateau (a paradigm for growth in competition) or, plainly speaking, an S-curve (growth becoming saturated).

  

Funnily enough, the data showing userbase growth is often used to justify the high valuation of Facebook, alongside its seemingly similar growth in turnover. But all that this data shows is that revenue per user has remained roughly the same, while user growth has been rapid. As continued userbase growth on the same scale is unlikely, revenue per user has to increase – dramatically – in order to justify the high valuation.

In order to justify the initial IPO valuation of $104 billion, the revenues would have had to increase four- or even five-fold.

Even on today’s numbers, Facebook’s revenues imply that each monthly active user generated just $4.11 last year; each daily active user $7.68. Compare that to ITV, to which about two-thirds of British people tune in every week; they are worth £43 a year to advertisers.

If revenue were to come from advertising alone, this simply means four times as many (or four times as invasive, alternatively four times as effective; pick your option here) ads. Arguments have been made that tailored advertising according to the social graph” is more relevant to users. But this argument is challenged by the findings in recent surveys which indicate that 83 percent of Facebook users “rarely or never clicked on Facebook ads or sponsored content”.

However, it is vital to see how Facebook has become less reliant on advertising in the last years. In the fourth quarter of 2011, advertising constituted 83 percent of revenues, down from 90 percent the previous year (and even 99 percent earlier in 2009). Facebook is increasingly reliant on affiliates like Zynga to make up for this decreased reliance on advertising (Zynga stands for 12 percent of Facebook’s revenue).

While advertising comprised $3.15 billion of Facebook’s revenues last year, the company earned $557 million from Facebook Payments – the virtual currency it began requiring game developers on the platform to use as of July 1, 2011 – and other fees. Payments are making up an increasingly hefty chunk of Facebook’s revenue.

It should be clear that Facebook would struggle to extend revenue simply by increasing advertising alone. What is more significant is how the company has diversified its revenue model!


A “freemium” version?

Early on, Facebook made a promise to its users: You will never have to pay for Facebook.

But – noting the example of equally “free” and “open” music streaming service Spotify – such a promise needn’t rule out a “premium,” ad-free user experience that is available to those users who want to pay, while the rest of the users would have to stick with an increasingly ad-littered, “free” version.

The recent invention of “Facebook Highlight” is a step in this direction. It is a service that is currently being tested in New Zealand (apparently a favorite roll-out spot for Facebook updates). Put simply, Facebook is considering charging its members a small fee to “highlight” important posts so they are more visible to the user’s personal network. This is also featured for administrators of Facebook Pages, who can pay to let their message be extra visible on both desktop and mobile clients.  (The early Swedish social networking site Lunarstorm actually featured a somewhat similar feature, where one could pay in order to get one’s message to turn up in a featured “Live Stream”.)

Similarly, there are companies selling cover photos for Facebook Timeline. It would not be far-fetched to think that Facebook might start selling more appealing or embellished graphics for users to adorn their Timeline pages.

What about small, purpose-driven social groupings, like for example exclusive groups that people join – paying a fee – in order to let the group help them work out or follow a diet. Perhaps Facebook could offer specialized functionality here, simply asking or even requiring users to pay for particular features if they are intending to run Facebook groups commercially. If you’ve joined a group for physical workout, perhaps you would appreciate a reminder function that reminds you to do those miles on the treadmill and eat that special diet, and so on.

All of these examples are ways of diversifying the Facebook experience, and in effect creating custom updates to the service that users would have to pay for.

What is more, Glancee – “a nice-guy ambient social location app for normal people” – was recently bought by Facebook. They have developed an app which makes it possible to find people in social networks who share similar interests and friends with the user. It is not entirely implausible that, in the future, Facebook could launch a service which helped users to find people with similar interests among strangers, perhaps for a fee.

Extending the userbase?

Currently, Facebook bans users under 13. This requirement is regularly flaunted, however, by millions of minors typing in fake birthdates. Hence, Facebook is exploring the possibility of allowing children younger than 13 years old to use the social-networking site under parental supervision; a step that could help the company tap a new pool of users for revenue, but also inflame privacy concerns.

This would, in effect, require a diversification of the service. Will we se “gated communities,” sponsored by Disney and McDonalds, offering a “child-safe” Facebook experience, and will advertising be more integral or less invasive on such a network? If the under-13 option comes with less invasive advertising, perhaps also adults would choose to use this version. (Hang on, how would they be able to verify the age requirement in those cases? Withstanding a Justin Bieber song in its entirety could be one prerequisite.)

Anyway, extending the userbase would also be something that is further consolidated by the recent news that Facebook would be natively integrated in Apple’s forthcoming mobile operative system iOS 6, much like Twitter was integrated in iOS 5:
The baking of the world’s biggest social network deep into one of the world’s biggest smartphone operating systems is a move that, while incredibly delayed, will present important advantages to both companies. Equally, it will be annoying for some, and even frightening to others.

But more frightening, and a chilling reminder of existing global gaps in media literacy and corporate responsibilities, would be the rather likely scenario that the Facebook experience would be forked according to national preferences and willingness to be exposed to ads.

Within conventional marketing, a notable megatrend is that advertising tends to be more invasive and aggressive in developing countries; think of the marketing of cigarettes in China, or commercial radio in Nigeria. The ad-free version of Public Service – so dear to people Northern Europe – is in fact an exception from the global norm: It is mainly in the UK, France, and Scandinavia where this ad-free version of PSB has been the guideline model.

Could this apply to the emerging social networking sites as well? Well, for those having grown accustomed to a rather ad-free experience, increasing penetration might be an eyesore – but to those who haven’t yet been exposed to the current format, a more ad-heavy version might be likely to be championed. According to recent data from TNS, openness to commercial brands in the social media ecology is much higher in the developing world than in the rich global North:


Partners who pay to play?

Facebook doesn’t have an operating system like Apple, but increasingly the company has figured out how to take advantage of the app-store model. By launching their own Facebook “App Center” platform, Facebook has begun monetizing the mobile market in a new way.

Developers will get the usual 70 percent of purchase price for paid apps – this is the “crystal prison” infrastructure model that Apple has championed for half a decade, now applied to Facebook. (Microsoft charges less, by the way.) CNet’s Rafe Needleman argues that “Facebook doesn’t need to make money selling apps. It knows how to make money from users and their activity within the apps” and that “third-party Web site companies can get a big boost from being promoted on the Facebook network – if they use Facebook for login”. The plan appears to be this:

Facebook benefits as it becomes the de facto standard for “universal login” in the online ecosystem; it will make it even more integral to the operative setup for users, harder to switch from, and it will provide new opportunities for monetizing this de facto monopoly position.

Zynga has had to pay rent in order to hire property inside the Facebook infrastructure for a rather long while now: Facebook takes a cut of all money exchanged through the use of “Facebook Payments,” and in the case of virtual goods purchased on Zynga, that cut is up to 30 percent.

I can only once more recommend one of the best articles on the current structural problems for the internet in the recent year: Mat Honan’s critical insight that what Google is desperately lacking is socially relevant data – this while Facebook has troves of it. Between 2009 and 2011, Google had a deal with Twitter where tweets were made searchable in real time, but that deal fell through, for reasons neither party will fully disclose. Google+ was obviously a way for Google to try to tap the glut of “socially relevant data,” but G+ remains so many times smaller, and less ubiquitous than Facebook. Will Google be interested in striking a deal with Facebook, and eventually having to pay in order to get access to more socially relevant data?

Dealing in micropayments?

Facebook Credits is a Facebook-only currency that it sells to consumers to let them buy virtual goods in games like Zynga’s FarmVille and Crowdstar’s Happy Island. Facebook splits revenue from Facebook Credits with app developers, meaning it has to disburse funds as well as collect them.

Currently Facebook’s only source of non-ad revenue is its digital currency, Facebook Credits, which people use to buy virtual goods, such as tractors in Farmville. During the first quarter of 2012, payments grew to make up almost 18 percent of Facebook’s revenue—close to $200 million in total. Overall, though, fewer than 2 percent of Facebook’s users have bought virtual goods with their payments option. There’s a lot of potential growth, in other words, along with hints that a big online operator such as Spotify may begin accepting Facebook Credits in the future.

There is a rumor that Facebook could start its own ad network – directly competing with Google’s AdSense, which places ads on third-party websites and shares revenues with their publishers.

Facebook already has planted a presence across hundreds of thousands of websites with its “Like” and “Share” buttons, comment functions, and other social plugins. It would be easy for Facebook to sign those publishers up for an advertising network powered by Facebook’s detailed demographic information. But then it would have to start cutting checks on a massive scale — something that would be eased by a dedicated payments-processing operation [Facebook Payments].

To be a facilitator of micropayments would make Facebook a competitor to PayPal, Amazon, VISA, and indeed the entire banking industry. It would even further consolidate Facebook’s role as facilitator of a shopping mall internet where clean, anodyne interactions take place vetted, real identities within a corporate megastructure. (More on this in my forthcoming blog posts…)

However, once again actual empirical data speaks against such nefarious, grand plans. In a recent poll, more than half of respondents however said they felt “not safe at all” using Facebook to purchases goods and services.

Becoming more of an image sharing platform?

Another trend at the moment is that of more image- and video-driven realtime status updates among users. Today, a status update on Facebook is very likely to be a camera-phone snap rather than an enthusiastic sentence. It’s of course against this background that we should read Facebooks spectacular purchase of Instagram in April 2012.

Note, however, that Instagram didn’t even exist on Android until April 3rd this year – a week before being purchased by Facebook! Back then, Dan Frommer argued that the deceivingly simple service of Instagram (only showing those photostreams that you’ve personally opted to see) could be ruined by merging it with a bigger userbase, making users see photostreams also from people they didn’t wish to follow in the first place. Now, with the Android launch, this didn’t happen – the Instagram user experience remained rather intact, compared to the hipster/iPhone-only original – but with Instagram-type clones directly embedded in the Facebook infrastructure, sharing risks becoming more of a requirement han a choice. The newly launched Facebook Camera is a case in point.

Facebook Camera was only recently launched, in late May 2012, offering a very Instagram-like experience. Yet, the difference is that the Facebook Camera app of course comes bundled with some rather malicious bells & whistles that go against the beautiful simplicity of Instagram. When you install Facebook for Android, it apparently installs Camera and Messenger apps that are somewhat mislabeled and disguised as default apps. “People love Instagram, but almost nobody loves Facebook.”

A Camera app, why not a Facebook Phone?

Currently, Facebook has no real control over mobile platforms. It relies on updates such as that to the iOS 6, where its competitors allow more seamless Facebook integration on their own platforms. This is very much like the way Tim Wu describes Google in The Master Switch, by the way – he notes that Google did not control the infrastructure (servers, cables) nor the content, but that it was their role as facilitators that garnered them the leading edge in the emerging digital ecosystem in the last decade. Similarly, one could regard Facebook as providing a similar facilitating role, with the difference that Facebook provides social/real-time relevance while Google provides statistical/archival relevance. Nevertheless, Facebook as a business rests on technologies that other companies control. There is no guarantee that mobile devices will continue to feature Facebook.

What Google did was to increasingly dominate the market of operating systems for smartphones and tablets (Android) and to increasingly take control of cables (dark fiber) and servers (data centers). Facebook is establishing data centers too, but according to my interpretation mainly to continue a business model that remains, principally, the same.

Recently, rumors began spreading of a possible new product: a “Facebook Phone”. This still remains an unverified rumor, but if Facebook were to make this move, the above scenario could all change, moving Facebook more in the direction of Apple, Microsoft and Google.

More news on this to follow. Stay tuned.

Do you see more ways in which Facebook will make money in the future? Please share your thoughts and opinions in the comments section!

Trackbacks/Pingbacks

  1. fictive facebook, pt. 2 | mediark - July 3, 2012

    [...] first post was about how Facebook could be expected to make money. This second post is about the [...]

  2. Jättestor artikel om Facebooks framtid… » Jonas Andersson - October 29, 2012

    [...] bli som underhållningsbranschen, de kommer att behöva jobba på flera fronter samtidigt. Jag har bloggat om detta: Facebook har redan blivit allt mindre beroende av reklam, och i stället börjat få [...]

  3. what facebook should do | mediark - April 4, 2013

    [...] 1 here, pt. 2 [...]

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