Three Issues That Hold Back Facebook's Profitability
John Paul is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
After Facebook’s (NASDAQ: FB) horrific IPO bomb, Mark Zuckerberg finally emerged from hiding to speak at a recent tech conference and to rally the troops. While his speech was partially successful, it also quietly distracted investors from bigger issues hindering short-term profitability. He did this by raising a hot topic that he knew would, momentarily, distract most stakeholders from FB’s mobile strategy shortcomings: He threw HTML 5 under the bus.
What was the result?
Investors and stakeholders alike ate it up and couldn’t get enough. It was like watching an old man feed seagulls at the beach. The fact that Zuckerberg openly admitted any sort of shortcoming seemed sufficient for everyone at the moment.
So what are the immediate issues that hold back FB’s current profitability? In my opinion they revolve around three key points:
- FB’s “Google Assumption” relative to profitability
- The true quality of FB’s user base
- Rumors of “fake” clicks
Even a Luddite today understands that Facebook’s long-term success depends on a strong, profitable mobile strategy but that’s not what investors should be concerned about at the moment. After all, no one will care about a promising future if it never resolves these issues. FB will continue to carry high expectations but if it cannot resolve these structural issues, the stock will likely go lower – even if the popularity for the social platform does not.
The Google Assumption:
Time and again we see that, especially in the tech industry, companies (startups or mature organizations) often make key decisions about new products or services based on the past results of other companies. If something worked well previously, they assume it must work well next time (aka: If A goes to B then B must go to A). But this is a fallacy. FB incorrectly assumed it could easily replicate Google’s monetization platform success because both generate enormous levels of traffic. The problem is that the type and quality of traffic these two sites generate is materially different. Today, even with FB’s lack of substantial improvement relative to profitability, FB continues to believe in the Google Assumption.
What Is the Google Assumption?
The assumption in Silicon Valley (and the broader tech world) revolves around the meteoric success of Google (NASDAQ: GOOG). Google made a highly disruptive, free technology that garnered not only intense popularity but also a high recurring interaction rate within its user base. Profitability should be easy, because the toughest part of any Internet-based business is often generating large, sustained, and recurring free traffic. Google figured this part out very quickly, but it also figured out how to build a very profitable ad platform relative to the specific type of traffic it generates. While many deny that they gloss over the second portion of Google’s success, in fact, they do because all they care about is the potential for a big payday.
This is where the disconnect occurs and this is often the Achilles heel for many popular yet unprofitable tech startups. They all assume they could be the next Google by default if they can just generate a lot of free traffic. Facebook has mimicked Part 1 of this strategy step for step – but it has failed to demonstrate its ability to execute Part 2, which involves monetizing they’re unique type of traffic.
FB’s Profitability Struggles Because of the Google Assumption:
Facebook believes if it continues to offer new, free, and innovative services like Google does, then profitability can be a second-tier concern because profitability should automatically improve over time . Simply put, FB proved that the fallacy of “if you build it and it’s popular, strong profitability will come” is false. Through its statements and actions, FB illustrates its belief that building a self-sustaining, highly profitable online platform isn’t difficult if you have an extremely popular and innovative platform. This may be a corporate culture issue, but the day when FB takes profitability seriously and no longer assumes it’s just a given will be the day when FB becomes substantially more profitable.
Are You A Real or Fake Person?
The day FB opened its doors to the world and became a non-exclusive social platform, fake profiles became a larger issue. No one in this industry is blind to this issue, but it seems FB did very little to prepare for this challenge. This neglect has created a significant problem that its grappling with today.
What is this problem?
According to documents filed by Facebook with the SEC in the summer of 2012, 83 million users (out of a total of 955 million) are hypothesized to be fake accounts. That’s almost 10 percent of the entire user base – and that’s a huge issue that can’t just be swept under the rug. To investors, the user base is where the bulk of the hidden value lies because of all the personal information it contains in the form of consumer data. After all, investors aren’t running to FB based on its current profitability they’re running to it because of the personal data they hold.
FB should have been prepared for this issue, but obviously they weren’t. Moving forward, this needs to be a top priority for FB. They cannot afford to overlook it for one simple reason: If FB fails to effectively and immediately deal with this and the quality their user base starts to materially resemble (or is perceived as) late-stage MySpace, advertisers will pull out. Even though FB has already disclosed this issue through the SEC, a brief public statement on how it’s handling the matter will only help increase its credibility and boost investor confidence.
Fake Clicks: The Bigger Danger Resides in Ideas Not Facts
In the summer of 2012, rumors began to swirl that FB’s advertising platform was being “gamed” by automated bots because of a music-platform startup called Limited Run. Limited Run even publicly disclosed its advertising campaigns to provide evidence of its claim and while FB is investigating the matter, it has not found anything yet.
Let’s face it, though: Would FB ever publicly admit something like this?
Not likely, because that would be the equivalent of the U.S. admitting it used to have aliens at Area 51. An admission of this magnitude could irreparably damage the credibility of not only the advertising platform but the entire FB platform as a whole.
Now, Facebook could have quickly squashed this rumor by stating that, while it has not found any weak points that could be exploited by malicious bots (aka: Fake Clicks), it will continue to aggressively review and monitor for such issues. Instead of taking a proactive PR approach, it sheepishly stated that it couldn’t replicate the results at this time.
What does a statement like that even mean? What if Mark Zuckerberg and his team can’t replicate the results? Does that somehow mean it just isn’t possible?
This goes far beyond bad PR for FB. What matters here isn’t so much whether it’s fact or fiction. History has proven that an idea or belief “among the people” holds much more power than any singular fact. If more issues like this keep getting tacked onto the list of platform credibility and quality-control issues, it will only increase the probability that FB devolves from the most popular social site in the world to just another unprofitable popular social site - because of spooked, untrusting advertisers. In the future, FB would be smart to handle rumors in a better fashion when they have the ability to inflict substantial damage to Facebook’s reputation, instead of leaving them largely unchecked.
The World of Tomorrow Isn’t Guaranteed If Today Isn’t Secured:
If Facebook fails to address these issues in some form, it won’t matter how promising the future looks. Issues like this cannot be overlooked and must be a top priority if the company wishes to be successful. Facebook must realize it is no longer in a venture capital beauty contest where vanity metrics such as rapid user base growth are the name of the game. In the world of publicly traded companies, popularity holds very little value if unaccompanied by profits. Everyone understands that mobile is the future of profitability for FB but if it can’t handle the issues listed today, then it’s unlikely any investor will remain confident that FB can handle mobile strategies, let alone mobile profitability, in the future.
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DragonBoss2012 has no positions in the stocks mentioned above. The Motley Fool owns shares of Facebook and Google and has the following options: long JAN 2014 $20.00 calls on Facebook. Motley Fool newsletter services recommend Facebook and Google. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.If you have questions about this post or the Fool’s blog network, click here for information.