After a pro-longed absence caused by intense work and then an intense vacation I am back at it. I left promising to write about Facebook’s business model, and now that the company’s IPO is on the horizon the topic is even more fitting.
How does Facebook make money? One way that Facebook makes money is through a revenue-share model it maintains with application developers like Farmville. Buy some currency through a Facebook game and Facebook gets a cut. While this represents a lot of potential, I’m more interested in the advertising model which could either be a massive dud or a game changer. Allow me to explain.
As I mentioned in my last post, Google’s advertising model works so well because it catches potential customers at exactly the moment they’re looking to make a purchase. Simply put, Facebook can’t compete with that. Instead, Facebook sells ads to advertisers based on who you are. For example, if an advertiser on Google is bidding on the keywords “golden rings” and “golden watches”, the advertiser on Facebook is bidding on “men” “24-30 years old” in “Southern California”. Whereas Google is more direct response, Google functions better for advertisers interested in branding by getting their name in front of their target audience.
Or at least that is how it’s supposed to work, right? The blessing/curse of Facebook is that it has really high engagement: people are constantly posting photos, tagging each other, writing on each other’s walls, etc. In fact, the engagement is what makes Facebook one of the largest time consumers on the internet. The down-side of this engagement is that hardly anyone notices the ads, and even fewer click on them. Why would you?
Facebook thus solves one problem while creating another: on the one hand, branding advertisers are prone to statements such as “you’re always wasting half your marketing budget, you just don’t know which half.” After all, if you pay for a billboard seen by everyone but your only really interested in women, you’re clearly not getting the best ROI. Facebook allows branding advertisers to go after exactly who they’re looking for: even better, advertisers can gain insights into their customer base they never considered before. Say for example that a Gillette Campaign really clicked with men between the ages of 24-30 who listen to Nirvana, are vegetarians and have tried skydiving. In the past if Gillette were able to recover this information they’d have a difficult time finding the right audience (Certain TV shoes are seen as a proxy for these types of behaviour, which is one of the things that makes television so valuable for advertisers). With Facebook, however, they can optimize their budget to target exactly that demographic.
On the other hand, what does it matter if you find your audience but your audience doesn’t notice you? While Facebook, like Google, has a great self-service offering that makes it easy for even small advertisers to setup and run campaigns, if they can’t get people to click on the ads none of it really matters.
But it does matter. The reason I say it does matter is because the old fashioned “Here’s my ad, come click on it” strategy will never bring Facebook the growth it needs to become a titan of the internet. Instead, what will drive Facebook are the new types of advertising that are only beginning to come to light. Brands need to get you thinking about and interacting with their products in a way that is interesting and not annoying. Slowly but surely, they’re doing it.
Let me give you an example of what I mean. LAN, an Airline I fly frequently due to my excursions in South America, recently ran a campaign where it asked people to submit their favourite love/travel story. I submitted a story in the hopes of winning some free airfare. LAN then spammed my wall and put their ad in front of my 1000+ friends. Some of my friends also wrote stories. None of us won anything but the time we spent thinking about, talking about, and interacting with LAN is far more valuable then a momentary glance earned by a billboard.
With the advent of Facebook then two things are happening: one is that brand advertising is becoming a lot more like direct response in that it is becoming analytics based and insightful. No longer will people have to waste half of their budget: instead, they’ll want to see real performance from the money they spend. Second, the division between advertising and content is fading. Like my LAN example, advertising becomes fun, engaging, and something people want to share (think Dos XX or Old Spice Guy). People share advertising because they want to, not because they have to. This, in my mind, is where Facebook’s true potential lies.
While potential is great, when you become a public company investors want to see results. Jeff Jarvis recently pointed out that Facebook’s total revenue is equal to what Google makes on Mobile alone (9% of Google’s total revenues). In other words, Facebook has a long way to go before it reaches Google’s league. Furthermore, as anyone who has worked in online advertising will tell you, a lot of marketers are still very nervous about advertising with Facebook since they can’t control what content their ad will be displayed next to. Marketers shrill at the idea of their ad being shown next to someone’s racist slurs or party shots (unless you’re Sambuca), and this is type of behaviour is difficult to control on a web application that relies on its users to create the content.
While not one to make stock predictions my thoughts are this: Facebook’s IPO will definitely be over-prescribed. Nevertheless, if you believe in its potential and are willing to hold on for the long haul, it might prove itself worthy over time. Just don’t forget that in as short a time as it took for Facebook to amass almost a billion users, the next Facebook might be able to do so even faster. As Eric Schmidt is fond of saying, competition on the internet is only a click away.