Facebook’s business model

Startups usually succeed because of a single major product or business innovation. Google is unusual in that they succeeded because of two major innovations: their core search product, and their keyword advertising business model. Back in 2000, when Google was wildly popular but generating no revenue, the conventional wisdom was that their business model was uncertain. Then Overture invented keyword advertising and Google adopted the same model. This turned out to be both wildly profitable and also, remarkably, created a better experience for both advertisers and users.

Facebook relies on an old internet business model: display ads. Display ads generally hurt the user experience, and are also not very efficient at producing revenues. Facebook makes about 1/10th of Google’s revenues even though they have 2x the pageviews. Some estimates put Google’s search revenues per pageviews at 100-200x Facebook’s.

The good news for Facebook is there is a lot of room to target ads more effectively and put ads in more places. The bad news is that, if there is one consistent theme in both online and offline advertising, it’s that ads work dramatically better when consumers have purchasing intent. Google makes the vast majority of their revenues when people search for something to buy or hire. They don’t have to stoke demand – they simply harvest it. When people use Facebook, they are generally socializing with friends. You can put billboards all over a park, and maybe sometimes you’ll happen to convert people from non-purchasing to purchasing intents. But you end up with a cluttered park, and not very effective advertising.

The key question when trying to value Facebook’s stock is: can they find another business model that generates significantly more revenue per user without hurting the user experience? (And can they do that in an increasingly mobile world where display ads have been even less effective.) Perhaps that business model is sponsored feed entries, as Facebook seems to be hoping (along with Twitter and perhaps Tumblr). The jury is still out on that model. Personally, I have trouble seeing how insertions into the feeds aren’t just more prominent display ads. You still have to stoke demand and convert people from non-purchasing to purchasing intents. A more likely outcome is that Facebook uses their assets – a vast number of extremely engaged users, it’s social graph, Facebook Connect – to monetize through another business model. If they do that, the company is probably worth a lot more than the expected $100B IPO valuation. If they don’t, it’s probably worth a lot less.

Anonymous

YES EXACTLY, THANK YOU. Finally someone understands that Facebook Ads are getting less relavant and they can’t survive with their current business model. And I’m also disappointed with FB new Ads strategy, making Ads more relavant. It seems that Zuckerberg didn’t get it yet, just let me have a peaceful walk with my friends in your damn park.
Anonymous

Given the volume of data that flows through Facebook, which will arguably increase a hundred-fold over the next few years, surely deciphering intent will become easier over time? If I’m liking cars, talking about cars, reading about cars, sharing photos of cars, and commenting on car blogs then I’m probably a car buyer. As much as I would be if I searched for ‘cars’ on Google. Layer a personal profile on top of those signals and you’ve got a pretty well-targeted prospect. Then just serve ads in whatever format works best – text, video, in-feed etc. Facebook just needs to infiltrate every corner of the web with its social graph which is exactly what it’s doing. Isn’t that worth $100bn?
http://twitter.com/jqquah Wilson J Q Quah

Good point, personally I agree that Facebook’s attraction is its largely untapped potential to generate alternative revenues elsewhere with the gigantic data they have. Who knows if they could create a whole new ecosystem of commerce within facebook itself?
http://michaelsinanian.com/ Michael Sinan

What about paid photo storage?
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http://avc.com fredwilson

the partnership with zynga over social gaming and social gaming monetization was one area that it seemed they were harvesting demand. but the zynga partnership is not growing much these days

http://twitter.com/b1lynch Bill Lynch

I think it will be something in the vein of social gaming that leverages their audience in a contextually relevant way – perhaps an American Idol type contest where users share and ultimately pay a nominal voting fee to support their favorites?

https://plus.google.com/112879998616209951634/posts David Barnes

Facebook used to offer virtual gifts. I don’t know why they can’t also offer physical gifts and become a sort of social commerce platform.

Usually when I visit Google I have no purchase intent but sometimes I do, and it’s those sometimes where Google can make its money. Facebook can engineer a similar situation: I might have purchasing intent on a close friend’s birthday; I might ask my Facebook friends to recommend a local plumber. Facebook should be able to react to that in some way (“300 people in your local area liked Drains R us… why not give them a call?”).

People use Facebook too:

- Arrange dates and days out — Facebook can suggest places
- Ask for movie recommendations — Facebook can suggest cinemas
- Ask for advice on buying houses, car seats, washing machines, laptops

A lot of the big purchases we used to ask Google about we now ask Facebook about. Facebook needs to develop an advertising platform that answers those questions.

http://twitter.com/DrDisrupt Dr.Disrupt

Totally agree. Facebook should make money by improving user experience. Advertising can be more than display ads.

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http://twitter.com/DrDisrupt Dr.Disrupt

Guys, I’m not sure you’ll easily find the solution for Facebook revenue model by looking at the current advertising industry.
I think Facebook should focus on the core of their users’ interests.

Why people entering Facebook? Without starting an endless argument, I’ll say in general: to stay tuned.

SO, Maybe I can use my Facebook to stay tuned about NEWS? and I’m not talking about Liking CNN page, I’m talking about a smart news feed that can easily flipped into a social news-reading experience.

What about MUSIC? maybe I can watch TV together with friends? Maybe I can create a professional mini-networking group for my small business? Maybe I’ll be able to open Facebook Email account for my business…

All these services CAN be monetized.

By redefining the entire social experience, Facebook can integrate new amazing revenue models (at least I believe!).
http://twitter.com/mekalav mekalav

How about charging for brand pages? How about Improving on the shopping front,once click buy? facebook instant offers? May be facebook should buy Pinterest?
http://twitter.com/Luca_Ascani Luca Ascani Populis

I disagree. Facebook Ads are disruptive for Display Brand Advertising. they are creating a direct link btw the brand and the user. you’re not just pushing your brand, but you’re targeting a user and create a community.
http://arnoldwaldstein.com/ awaldstein

What I’ve observed about Facebook and Twitter to some extent, is that these one-to-many, gesture-based models are great for advertising, poor for engagement and interestingly, in Facebook’s case, almost completely devoid of transactions.

I struggled with this topic but force out my thoughts on the connection between community and commerce here: http://awe.sm/5qhUT
http://www.c3metrics.com c3metrics

No need for a new biz model.

Viewable Impressions (being pushed thru via the 3MS initiative) combined with Attribution will demonstrate the value of brand awareness vs. purchase intent.

The big roadblock: Facebook’s unwillingness to open up their platform to third party measurement.
http://www.facebook.com/profile.php?id=578035478 Joe Ciarallo

Facebook’s ads aren’t “display,” though. And your “park” analogy could apply to almost any brand advertising. So, it seems many of the points being made this week are claiming “all brand advertising does not work,” not “Facebook advertising doesn’t work.” So if it’s all intent based, what do we do to generate intent and build brands?
http://www.seeingbothsides.com bussgang

Great post, Chris. Facebook likely will pursue multiple models rather than one simple one, as Google did. I’m guessing they indeed move strongly into search and creating a real-time bidding platform that replicates what is happening elsewhere in the Web with exchanges. They’ll also likely become a massive financial services firm, capturing credit cards, payments and loyalty. Finally, they’ll probably get into ecommerce and social shopping. In other words, flavors of Google, PayPal and Amazon. What’s really interesting to me is that all this attention on Facebook’s real model and value will soon be directed towards the next set of darlings – ie, Twitter, foursquare, tumblr and Pinterest. Despite conventional wisdom, public markets have a way of forcing rigor and scrutiny on long-term value opportunity, which is a good thing.
Ricardo Diz

Great article. When using Facebook, people not only are not in a “purchase intent” mode, but seeing ads gets annoying…
http://www.facebook.com/iamsimonsmith Simon Smith

Facebook should compete directly with ebay
both in terms of really challenging paypal and also the auction side of things. If I want to buy a car – I can then go to facebook and see which of my friends has a car for sale, or which of my friends friends has a car for sale. I can then ask my friend if their friends is a trust worthy person to buy a car from.

I buy lots of stuff from Amazon cos it is really easy. Facebook should throw money at making it easier to buy through Facebook than any other system.
http://twitter.com/TeaWithCarl Carl Levinson

Google did not innovate the keyword advertising business model.
They stole it from GOTO/Overture, and then eventually paid $1+ billion in legal costs to Yahoo/Overture.

http://www.cdixon.org/ chris dixon

I said Overture invented it.

http://www.facebook.com/iamsimonsmith Simon Smith

They could also buy Automattic – WordPress.com has a great network of blogs that Facebook could push ads through. If people are not looking to buy when they are using Facebook then go looking for the people when they are looking to buy.

There are millions of blogs with reviews, or about people interests etc where Facebook ads could be successfully used.

It would also allow for tight integration between Facebook pages and a WordPress blog with a brands own domain name.
Paul Park

The search business model is broken. Period. Whether google realizes it or not, it will not be sustainable in 5-10 years. Here’s why.

Search inherently is good at finding pages that contain “keywords”. Hence, the most benefit is derived from discovering various “keywords” across millions of disparate webpages, and displaying them in somewhat of a ranked fashion. What real value does a result list of 13 million pages provide me? Do we all not simply look at the top 10 results, and perhaps if we are desperate flip to page 2, only to discover there’s nothing relevant there?

Think about this. The Internet, can be likened to a giant hard drive. Whenever trying to obtain information from your personal hard drive, whether it be documents, photos or videos, do you always use the “search” function or do you only use it when doing a deep-dive into a particular “keyword”?

The fact is, search is good at finding webpages, not websites. I’ve developed a new model that will disrupt the entire paid keyword advertisement scheme and provide more benefit to the end user.
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http://www.asoftwarestartupguy.com David Miller

The NY Times decision is telling. Facebook is rapidly becoming the de facto authentication provider for consumers on the web.
At some point in time, I would think they’ll start charging developers to use the Open Graph: they’ll have no choice but to pay for it to engage those users in the way those users want to engage.

It’ll be the Web’s O/S just like Windows was on the desktop. Or something like that …

I’d rather have their user-base with a shitty model than neither. That’s what Google had, they were patient, and they pounced when the right model that fit their business came around. My guess is that the same things will likely happen with Facebook.

Eventually, someone will figure it out, and then they’ll be in position to out-execute and at scale.
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Anonymous

Facebook’s next business model: they are the platform for chillin’ with your peeps:

http://smoothspan.wordpress.com/2012/05/16/facebooks-next-business-model/

Cheers,

BW
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http://twitter.com/mikeyavo Michael Yavonditte

You nailed it. Facebook has a world-class team looking at this challenge, but the game will be won in the nuances, rules and policies as much as in the placement and format of ads. Get an important variable wrong and you lose. Yahoo’s ad system failed relative to Adwords because they got rules and policies wrong. They simply didn’t make the right decisions fast enough. One example to highlight what I mean: Google adopted a 25 character title and a 35 character description very early on. We (at Quigo) had empirical evidence to prove that their policy was optimal for driving CTR. It took Yahoo a few years to make this change. Of course, by then, it was too late as they did several other things that were sub-optimal.

Advertisers that are bidding on media like to spot repeatable patterns. This makes ad performance more predictable. This is IMHO key to the success of any ad system.
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http://twitter.com/b1lynch Bill Lynch

Great post. I think FB is a tremendous success and I have tremendous respect for Mark Zuckerberg but $100B? …Amazon market cap is $102B I think FB is a really big bet at $100B. I don’t believe the current revenue model will support $100B – however I do think Mark Zuckerberg can figure it out.
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David Anderson

The answer lies in stepping off the cliff: http://charleseisenstein.net/for-facebook-a-modest-proposal/ (not my link — this dude is really smart, think about it, at least as a devil’s advocate)
http://www.elieseidman.com Elie Seidman

Great post. I think all “media” companies should be divided into “purchasing intent” vs “no purchasing intent”. The profitability of the media businesses where the customer has purchasing intent – and what is being sold to advertisers is that intent – is totally totally different from the media companies where all that can be sold is a demographic.

http://www.cdixon.org/ chris dixon

Totally agree.

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http://www.facebook.com/people/Stone-Catcher/1169185993 Stone Catcher

they are actually looking at another customer base
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http://twitter.com/simon_baptist simon_baptist

Jed Williams from Kelsey wrote a pretty good analysis of if the stock is worth it or not and I’d recommend having a look at that.

One thing I’ve started to think of is FB as an infrastructure play, i.e. akin to AWS. FB has solved some pretty big scaling problems, e.g. picture uploading, and so like how they have solved the universal login they could also make those kind of features available.

You can see the work Josh Williams and co on the Location team and checkin aggregation and sharing as an example of the way it could play out.
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Chris Dixon