Facebook’s Challenge: Post IPO Profit

Granted, my last post about Facebook Premium Accounts was an April fool, but the fact is that Facebook is going to be facing some interesting challenges over the next couple of years.   The stratospheric valuations over the past 12 months, which have seen the social network hit a valuation of close to $70 billion have attracted a lot of press, but the fact is, once Facebook finally goes public, there are going to be a lot more calls for the company to start delivering significant profits for share holders.

When Google went public, it was already churning out big numbers in terms of profit.  It also had a business model that was already mature, and made perfect sense for advertisers:  There is clear intent present when someone searches for a product, and provided the price to buy that user allowed for a profitable transaction on the website, the advertising model made perfect sense.

Groupon is the same.  Advertisers offer a limited number of products at a fixed discount – usually to clear stock – and provided the conditions for the sale are met, the products are sold.  It’s a good deal for everyone involved.

Facebook is a bit different.  The core user experience at Facebook is actually disrupted by the advertisements on the website.  A well constructed and targeted campaign can be successful, but it relies more on impulse and awareness than a PPC campaign.  Click through rates on adverts are pitiful, and often, businesses buy into the Facebook advertising as a low cost CPM opportunity for awareness, rather than being a dedicated CPC deal.

When an advertising model is being subverted by the advertisers using it, either the price is wrong, or the effectiveness is questionable.

Facebook has a better way of tying users into the service than Google does.  People use it as a contact manager, a photo sharing website, and a bookmarking service.  A lot of personal data is held on Facebook, and this is makes it difficult to leave.

With last year’s revenue said to be around $1.8 billion, on costs of about $500 million, Facebook is profitable, but probably not profitable enough to justify the $70 billion valuation.  That’s going to create some friction.

Google has managed to increase profits each quarter through a combination of adding new revenue streams via acquisition, and through optimising existing channels over time.  Facebook would argue that they have plenty of untapped opportunities to raise revenue, however the question of how they can recognise these will be a big one to answer.

They have some routes open to them:

A premium membership fee, or a subscription model for businesses to use the service.  This has precedence, and a lot of LinkedIn members (roughly 1 million) pay for their memberships, however the use case is different.  LinkedIn is a professional networking website and having a subscription means access to more business information and greater access to data.  It’s a recruiting tool and the relatively low cost of premium membership is actually less than the cost of external recruitment companies or lead generation services.  With a largely casual user base, Facebook probably couldn’t expose general users to a membership fee without removing features from their free membership, and there are plenty of alternatives available for users to migrate to.

Increased Advertising Space.  Right now, there are comparatively few adverts on Facebook – one per page, although they have been experimenting with in stream ads.  This is not too disruptive to user experience, and is probably a given.  The challenge that it doesn’t address is the question of intent.  If Facebook is just a highly targeted display network, then that’s fine, but there is an awful lot of competition for limited display spend, and unless results can be guaranteed, then Facebook will only be getting a share.

Adverts on Mobile Facebook.  With around a third of Facebook users accessing the service from mobile devices, and no advertising currently present on the app, this seems like a given too, however the questions of effectiveness and impact on user experience will need to be addressed.  The stripped down mobile Facebook is fast, dynamic and user friendly.  Increasing load times with the addition of adverts will reduce the quality of the service and if it has a significant effect on the amount of data that the app consumes on rate limited mobile devices, having adverts could have a detrimental impact on the amount of usage that the app gets.

Adverts on 3rd Party websites.  This would be a big change for Facebook, and require a lot of development work.  It would also put them on a direct collision course with Google.  Facebook Connect is already in place on millions of web pages and is served in an iFrame that Facebook control.  By adding a suggested sites link or adverts similar to Adsense, but tailored to a combination of content and demographic relevance, Facebook could generate huge potential revenues – Adsense is worth around 30% of Google’s revenue, but it costs them.  They pay out 68% of click cost to publishers, and also have associated costs for serving the adverts, providing the reporting interface, monitoring click fraud, and making the payments themselves.  Infrastructure costs a lot, and even though Facebook is cash rich, the kind of investment needed to develop a platform from scratch would be phenomenal.