Yawn…
The Facebook IPO (insider profit opportunity rather than Initial Public Offering) finally came and went. Much like its 900 million members, Facebook executives managed to garner enough fleeting “likes” from its Wall Street road show to ensure temporary short-term hype and big returns for key insiders. But, beneath the hyperbole lies a basic question that goes to the heart of its stratospheric valuation: Does Facebook have a long-term strategy beyond the rapidly deflating ad revenue model?
[div class=attrib]From Technology Review:[end-div]
Facebook is not only on course to go bust, but will take the rest of the ad-supported Web with it.
Given its vast cash reserves and the glacial pace of business reckonings, that will sound hyperbolic. But that doesn’t mean it isn’t true.
At the heart of the Internet business is one of the great business fallacies of our time: that the Web, with all its targeting abilities, can be a more efficient, and hence more profitable, advertising medium than traditional media. Facebook, with its 900 million users, valuation of around $100 billion, and the bulk of its business in traditional display advertising, is now at the heart of the heart of the fallacy.
The daily and stubborn reality for everybody building businesses on the strength of Web advertising is that the value of digital ads decreases every quarter, a consequence of their simultaneous ineffectiveness and efficiency. The nature of people’s behavior on the Web and of how they interact with advertising, as well as the character of those ads themselves and their inability to command real attention, has meant a marked decline in advertising’s impact.
At the same time, network technology allows advertisers to more precisely locate and assemble audiences outside of branded channels. Instead of having to go to CNN for your audience, a generic CNN-like audience can be assembled outside CNN’s walls and without the CNN-brand markup. This has resulted in the now famous and cruelly accurate formulation that $10 of offline advertising becomes $1 online.
I don’t know anyone in the ad-Web business who isn’t engaged in a relentless, demoralizing, no-exit operation to realign costs with falling per-user revenues, or who isn’t manically inflating traffic to compensate for ever-lower per-user value.
Facebook, however, has convinced large numbers of otherwise intelligent people that the magic of the medium will reinvent advertising in a heretofore unimaginably profitable way, or that the company will create something new that isn’t advertising, which will produce even more wonderful profits. But at a forward profit-to-earnings ratio of 56 (as of the close of trading on May 21), these innovations will have to be something like alchemy to make the company worth its sticker price. For comparison, Google trades at a forward P/E ratio of 12. (To gauge how much faith investors have that Google, Facebook, and other Web companies will extract value from their users, see our recent chart.)
Facebook currently derives 82 percent of its revenue from advertising. Most of that is the desultory ticky-tacky kind that litters the right side of people’s Facebook profiles. Some is the kind of sponsorship that promises users further social relationships with companies: a kind of marketing that General Motors just announced it would no longer buy.
Facebook’s answer to its critics is: pay no attention to the carping. Sure, grunt-like advertising produces the overwhelming portion of our $4 billion in revenues; and, yes, on a per-user basis, these revenues are in pretty constant decline, but this stuff is really not what we have in mind. Just wait.
It’s quite a juxtaposition of realities. On the one hand, Facebook is mired in the same relentless downward pressure of falling per-user revenues as the rest of Web-based media. The company makes a pitiful and shrinking $5 per customer per year, which puts it somewhat ahead of the Huffington Post and somewhat behind the New York Times’ digital business. (Here’s the heartbreaking truth about the difference between new media and old: even in the New York Times’ declining traditional business, a subscriber is still worth more than $1,000 a year.) Facebook’s business only grows on the unsustainable basis that it can add new customers at a faster rate than the value of individual customers declines. It is peddling as fast as it can. And the present scenario gets much worse as its users increasingly interact with the social service on mobile devices, because it is vastly harder, on a small screen, to sell ads and profitably monetize users.
On the other hand, Facebook is, everyone has come to agree, profoundly different from the Web. First of all, it exerts a new level of hegemonic control over users’ experiences. And it has its vast scale: 900 million, soon a billion, eventually two billion (one of the problems with the logic of constant growth at this scale and speed, of course, is that eventually it runs out of humans with computers or smart phones). And then it is social. Facebook has, in some yet-to-be-defined way, redefined something. Relationships? Media? Communications? Communities? Something big, anyway.
The subtext—an overt subtext—of the popular account of Facebook is that the network has a proprietary claim and special insight into social behavior. For enterprises and advertising agencies, it is therefore the bridge to new modes of human connection.
Expressed so baldly, this account is hardly different from what was claimed for the most aggressively boosted companies during the dot-com boom. But there is, in fact, one company that created and harnessed a transformation in behavior and business: Google. Facebook could be, or in many people’s eyes should be, something similar. Lost in such analysis is the failure to describe the application that will drive revenues.
[div class=attrib]Read the entire article after the jump.[end-div]