Shares of Facebook started trading Friday, at a price that valued the company at $100 billion give or take a billion, the most valuable technology-related initial public offering in history. Not bad for a company that generated only $3.7 billion in revenue last year. Even more so for a company that reported a 6 percent sequential decline in net income in the last full quarter before its IPO.
That seeming disconnect triggered a flood of speculation – even hand-wringing – over Facebook’s business model. The company currently generates 80 – 85 percent of its revenue from advertising (the rest comes from e-commerce using Facebook’s virtual currency, Facebook Credits). While some of that ad revenue came from various kinds of “social advertising,” such as SponsoredStories, most of it came from ordinary banners and display ads.
In the view of many on Madison Ave., however, Facebook — so far at least — is a less-than-compelling ad platform. In an embarrassing move for Facebook, General Motors pulled its $10 million in advertising off the social network a week before the IPO, declaring Facebook ads to be ineffective. The head of one interactive agency called Facebook ads ”fundamentally some of the worst performing ad units on the Web.” According to one study, click-through rates for Facebook ads come in at only about half the industry average and well below those of industry leader Google.
For all its scale and cultural influence, in other words, Facebook is not yet very good at making money, which raises obvious questions about whether and for how long it can continue to support its lofty valuation.
So what to do? Here’s one suggestion: Think Apple, not Google.
What Facebook has built is not advertising or media platform but an incredibly rich ecosystem into which users pour their own value, in the form of the content they create, the time they invest, the connections they make. The long-term upside for Facebook lies in figuring out ways to harvest a portion of that value for itself.
Here the best model is Apple, which has been a master at harvesting value from other parties in an ecosystem for its own benefit. In the original iPod/iTunes ecosystem, most of the value of using an iPod came from the content, provided either by users in the form of their own music collections, or by the record labels through the sale of new music tracks. But Apple managed to grab the lion’s share of that value by keeping content costs low while charging premium prices for iPods.
It did the same thing again in the mobile phone business. The carriers subsidized the cost of iPhones to consumers, while developers added value by creating popular apps. But Apple was able to harvest that value for itself by taking a hefty cut of developers’ app sales, and establishing its own billing relationship with iPhone users, thereby cutting the carriers out of the app sales loop.
Mark Zuckerberg has vowed repeatedly that Facebook will always remain free, so charging users as a way of extracting value from the ecosystem is obviously not an option. But free to users does not need to mean free to use by commercial enterprises.
A telling hint of the potential leverage Facebook has over brands that use its ecosystem came earlier this month when traffic to several social reader apps on the social network appeared to plunge, suggesting Facebook users were tiring of the social reading experience. But further investigation showed the apparent drop off in readership was due to changes Facebook made to how links from social reader apps appear in users’ news feeds. Several social video apps experienced a similar jolt when Facebook made changes to how content from those apps is shared.
As GigaOM’s Matthew Ingram has noted, those experiences carry a potentially painful lesson for brands about the Faustian bargain they make in building their presence on Facebook. Facebook controls the flow of traffic to a brand user’s content, and it can turn that faucet on and off at will. But they should also be a lesson to Facebook.
The real value of Facebook to brands is not its sheer number of users or even the demographic and behavioral data Facebook collects about them — the sort of metrics that drive advertising placements. Its real value is the networked architecture of the Facebook ecosystem itself, and all the ways it enables content to be shared, surfaced, discovered, linked and liked.
That value may be harder to quantify than the total number of Facebook users. But as Apple has shown repeatedly, you don’t necessarily need a lot of fancy metrics to harvest value from an ecosystem you control. What you need is the willingness to use the leverage you have.