A Skeptical Optimist’s Look at Facebook

We’re soon going to see how much the equity markets think Facebook is worth.

Optimists see Facebook’s prospects as almost unbounded. After all, it has almost a billion users and its users spend an astounding amount of time on the site.  Even if you replaced Zuckerberg with a dolt, the company ought to be able to figure out how to make gobs of money from having a community that is larger than the population of all but two countries.

Skeptics, though, remember how indomitable social-network-rival MySpace looked not that long ago. Then MySpace went into a death spiral as users flocked to Facebook. Skeptics have a more immediate cause for concern.  Facebook admits that it doesn’t have very good ways of making money when people use Facebook on mobile devices. That’s a big problem as mobile use skyrockets.

Me, I’m a skeptical optimist.  My optimism is based on understanding that Facebook isn’t just a platform—it’s a lot of interdependent platforms each of which could be valuable alone, but incredibly valuable together.  Read on to find out why I’m nevertheless a bit skeptical.

Unpacking the Facebook Platform

To the casual observer Facebook is mainly a social network where people link up with their friends. The movie didn’t exactly help elucidate what the platform is really about.  So here’s a really boring description and further evidence that I have no future in Hollywood.

Facebook’s user accounts are its core asset.  For every individual who joins, Facebook has a unique identifier, relatively rich self-reported data on the person including location, sex, relationship status, where they went to school, and more.  It also knows the other individuals, merchants, celebrities, and organizations that person is connected to. This has just started, but some users also have a wallet that is connected to one or more payment instruments.  Facebook has these accounts for almost 900 million people around the world. That’s one amazing database.

These accounts support seven interrelated platforms as shown in the Figure 1.

• Communications platform.  Facebook started out as a way for friends to communicate with each other.  Enriching this has been a major focus of the company as it has worked hard at growing and keeping the user base engaged.  But today, Facebook is the largest communications company in the world.  Most people use it for multi-casted messages between friends rather than for bilateral communications using voice or video calling.  But since Facebook has aliases (urls not to mention email addresses) for all of its users it can provide many different forms of communication.  Increasingly, Facebook is also a communications platform that connects individuals and merchants.

• Advertising platform.  Facebook has made its money so far by operating a fairly traditional online advertising platform that connects advertisers and users. The ads appear on the right-hand side of the page (with new methods just rolled out to include paid spots in the news feed).  Ads accounted for about 82 percent of its revenue in the first quarter of 2012.

• Application platform. Facebook provides APIs, SDKs, tools, and a sandbox to developers who it has courted assiduously for some time.  There are more than 500,000 applications on its platform. Social games are the “killer app” of the moment propelled by Zynga’s games such as Farmville.  Facebook is making money from applications by requiring them to use Facebook Credits for selling virtual goods (the main source of revenue for social games) and taking 30 percent of the value of credits when they are turned into cash.  That was a major contributor to the 18 percent of revenue in the first quarter of 2012 than came from “payments and other fees revenue”.

• Customer-relationship-management platform.  Facebook has almost 40 million “pages” with 10 or more fans. These pages are operated by merchants, celebrities and organizations who use them to organize and communicate with their fans.  This is a massive CRM system.

• Commerce platform.  Although this is happening in low volumes at the moment Facebook is being used to sell digital and physical goods to merchants.  A number of merchants have set up their fan pages so that they can sell things, malls have been established, and Facebook has developed an offers program to help drive consumers to merchants’ physical locations.

• Payments platform.  Facebook enables people to pay merchants on Facebook using Facebook Credits.  The company has a wallet which enables consumers to link several different method, including their mobile phone account as well as credit and debit cards, and purchase Facebook Credits.  At the moment, Facebook Credits are primarily used to purchase virtual goods but over time they will likely to be the main currency used on Facebook.

• Mobile platform. To an extent mobile devices are simply another browser-based device that can access Facebook directly through its url or indirectly through a mobile phone app.  But already Facebook’s mobile applications enable people to check-in at physical locations. Over time this mobile platform is likely to allow significant interaction amount Facebook’s consumers and merchants in physical space.

Facebook Optimism

The numbers shown in Figure 2 show how successful Facebook’s platforms are after just a few years of development. Remember, this company only opened up to the general public in September 2006.  My optimism for Facebook’s future isn’t based, though, on how good it is today but on how much runway it has.  The truth of the matter is that none of its platforms are anywhere near their full-on potential.

The most well developed platform—communications—provides mainly for fairly limited multi-casting of messages.  It isn’t a sophisticated platform for bilateral communication or for broadcasting in the way Twitter is.  And even for multicasting the communications are straightjacketed within a fairly limiting user page.

Some observers might think that the Facebook advertising platform is well developed. And it is relative to other online advertising networks.  But it takes little imagination to realize that with the social graph to use, and rich data on people, one can do a lot better than tiny clickable display ads. Facebook, like all online advertising, is still using 20^th century approaches to advertising and hasn’t yet developed innovations that really make use of the new technologies.  It’s starting with things like Sponsored Stories and the newly launched Highlight feature (where people can pay to have their posts bumped to the top of a news feed) but these are early experiments. But no one else has the social graph and data available to do what Facebook can do.

Skeptics point out that Facebook is nowhere in commerce and is getting killed in mobile.  But those are problems that talent, focus, and money can crack. None of those ingredients are in short supply at Facebook.  I put all of those in the opportunity column.

In applications, Facebook has essentially one killer app (games) putting it, at about the same point in its history, as the personal computer with spreadsheet software like Lotus 123.  With application developers around the world writing for Facebook in many different areas it is only a matter of time before there are more.

In the end, though, the reason why I’m optimistic about the economic future of Facebook is that it has almost a billion, and growing, accounts with rich information.  If Facebook succeeds in most countries in obtaining the penetration of Internet users it has achieved already in some countries, it will essentially have a incredibly rich database of the global population. It won’t have everyone. But it is likely to have account information in not too long for the people that account for most of the income (and spending power) in the entire world.

Facebook Skepticism

There are reasons to be skeptical that Facebook will be able to capitalize on the tremendous assets it has developed. But as I’ve just noted that’s not because it doesn’t have its game together in mobile or because there isn’t a lot of commerce occurring in Facebook-land.  To the extent I am skeptical that Facebook is worth $100 billion valuation it is that I see several sources of peril.

MySpace went into a death spiral because people stopped wanting to go there (it was getting pretty nasty) and because there was a nicer place to go – Facebook.  Facebook isn’t immune from positive feedback effects working in reverse. Some people may decide they’d rather go hang out some other place, and then more follow them, and then sooner than you know it a slow trickle of departures turns into a stampede.  Facebook is particularly vulnerable to younger people deciding that Facebook isn’t hip anymore. Those younger users could give a competing social network a critical mass (just like Facebook’s college crowd gave it a critical mass) and then that critical mass sucks in more people as they all grow up and enter the mainstream.  So far Facebook hasn’t had significant defections despite various actions that have led to significant complaints from their users.  But a significant misstep by Facebook, or a just a collective view from users that they’d rather be somewhere else, could sink Facebook – and it fast.

Facebook has done a much better job than MySpace at making people sticky.  People are attracted by all the applications and the fact that almost all their friends and merchants they’d want to be fans of are there.  That makes Facebook formidable, but hardly impregnable.

The other reason for skepticism is that Facebook hasn’t proved that it is adept at anything beyond the communications platform.  Its advertising platform isn’t particularly innovative.  Its software platform is well executed but Apple has developed a far richer and stickier applications layer.  It is way too early to tell whether Facebook can pull together social commerce, payments, or mobile.

The final reason to worry is that there is a significant risk that Facebook, and Zuckerberg, will get drawn into government investigations and lawsuits around the world over antitrust and privacy issues. Not because they’ve done anything, mind you, but just because that’s the way it is these days for successful companies with complicated business models. Facebook is by far the leading social network, immensely wealthy, and widely known.  That makes it a natural target for competition authorities and consumer advocates throughout the world.  In the not too distant future,  these investigators will have either gotten tired of beating up on Google or have extracted enough concessions from the search-engine giant that they feel like they can move on to fresher meat.  Facebook will be the next one up.  As the top executives at Microsoft found, these battles can take a lot of time and psychic energy.

In the end I’m more of an optimist than a skeptic.  If I were a betting man I’d probably take a flier on Facebook.  Since I’m not I’ll calmly watch my optimist friends sweat bullets if Facebook goes Groupon, and my skeptical friends turn green with envy as investors buy beach houses.