What Is The Facebook Formula (Part I)?

From Thinking Outside The Boxe’s Sydney Correspondent

This extensive two part article will attempt to discover the ‘Facebook Formula’, the way in which Facebook can reach its potential by generating solid and sustained revenue growth. The first part of this article will discuss the IPO and examine what went wrong. The second part of the article will look for some creative, yet realistic, solutions.

In early May 2012 Facebook announced an Initial Public Offering (IPO) valuing the company at around $75 billion. If the expected shareholders exercised their options (sold shares) the company value would have been expected to rise to around $98 billion. With much fanfare the IPO occurred on May 18. In the four months since then the company’s share price has halved and now sits at around $18. Unfortunately for Facebook 1.2 billion shares, currently locked up, will be up for sale by the end of 2012. This will place further downward pressure on the sale price. On September 5 Facebook founder Mark Zuckerberg announced that he will not sell any of his 500 million shares for at least 12 months. Cynical commentators have viewed this as an attempt to help stop the slide in the share price.

So what went wrong. How was Facebook so incredibly overvalued by the owners when a number of experts strongly believed this was the case? In fact ABC news reported on a survey (on May 16) which found that only 8% of 124 portfolio managers and buy-side analysts expected that Facebook would be trading above its initial price six months after the IPO. The main reason that Facebook was overvalued seems to be that it is unable to generate enough revenue. One expert quoted in the ABC report compared Facebook to Google saying that Google has many formats to offer potential advertisers whereas Facebook has only two. The same expert questioned whether Mark Zuckerberg even had the will to improve advertising revenue. Putting aside the question of Zuckerberg’s desire (surely someone at Facebook sees the need for ad revenue) this seems incredible for a company with the leverage of 900 million users.

As mentioned, the core of Facebook’s problem seems to be an inability to leverage its revenue model beyond its current point. Adding to this problem is the fact that in 2011 a massive 85% of Facebook’s revenue was generated through advertizing. This is essentially through the sale of users’ personal information to advertisers. However, as Facebook has already discovered people will only put up with this if they don’t believe it is a breach of their privacy. In May 2010 PCWorld reported on a backlash urging aggravated Facebook users to leave Facebook entirely. Another substantial problem is the fact that membership is stalling, or at least not growing at the rate it once was. However this is not a major concern as 900 million users is still a huge amount of people. The problem would be if large numbers of users decided to leave Facebook.

Of course the main reason for the huge number of Facebook users is the fact that it is free . If he had been a smarter businessman, or a businessman at all – and given his apparent lack of interest in growing advertising revenue he hasn’t changed – the young Mark Zuckerberg would have built a revenue stream into Facebook that would have provided another source of revenue. For example, if users were charged a one time 99 cent joining fee (the cost of an itunes song) Facebook would have generated almost a billion dollars in revenue already from this strategy alone. However it is also possible that less people would have joined Facebook if it wasn’t free. We can be sure that if Mark Zuckerberg had his time over he would have built at least one revenue stream into Facebook from the outset. But we cannot assign too much blame to him. Hindsight is always 20/20 and there is no way Zuckerberg, or anyone else, could have anticipated the success of Facebook, and the speed at which membership grew. After all it is easy to forget that Facebook is only 8 years old. So in a sense Zuckerberg, and other executives have always been playing catch up.

As we have seen Facebook has been hamstrung by the fact that it is free (“and always will be” according to the Facebook landing page) despite rumors to the contrary that ironically periodically circulate throughout Facebook itself. It is too late for the company to start charging new users as the already sluggish growth rate of the business would likely fall to near zero. This shows the importance of planning in business. Something that Mark Zuckerberg never did because he never saw Facebook as a business.

Despite the fact that rivers of gold are promised to, and expected by, countless internet entrepreneurs this is rarely the case for most. The core problem facing these individuals is that the internet, while extremely low in overheads, is for the most part free. Internet searches are free, email is free, and so on. Nowhere is the problem of getting internet users to pay illustrated more clearly than in the media. Newspapers in particular are trying to generate revenue from the increasing number of people who access their websites online. So far the most popular method used to achieve this is a ‘pay wall’. This means that readers can browse a certain number of stories for free but have to pay for premium content. Media Life reported in August 2012 that 300 American newspapers (including the New York Times) use paywalls. Time will reveal how successful this strategy is. The fact that the internet is largely free is probably a large reason why Mark Zuckerberg never thought of building a revenue stream or streams into his website.

It is very easy for commentators to sit back and dissect the problems facing companies like Facebook. It is far more difficult to run a business with membership numbers rivaling the population of some of the largest nations on the planet. However it is important to remember that success and failure are both relative terms. Facebook is still a company worth $50 billion dollars. There are many people who would love to have the problems Mark Zuckerberg has. In the second part of this article we will attempt to discover and examine some ways in which Facebook might sustainably increase its revenue in the future and uncover the Facebook formula.

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