The Eternal Search for the Right Facebook Ad

Peter is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

Facebook (NASDAQ: FB) is by far the biggest social network in the world in terms of active users. However, is an enormous user base a guarantee of a rising stock price and satisfied stakeholders? Ultimately, as a public company it has to be.

Unfortunately the IPO of the Century is infamous for all the wrong reasons -- highlighting the difference between potential and reality. Facebook has made repeated attempts to transform its billion users into billions of advertising dollars to justify its very rich premium while at the same time not chasing users away. I still don’ think they have succeeded and may never do so.

This was the biggest issue plaguing Facebook pre-IPO – could they make the transition from internet darling to public company? Google faced a similar problem when it went public.  Would it be able to make the transition in culture a public company required?  The better question was could they monetize a search engine?   Many thought no; history tells us otherwise.

Has Facebook found it yet?  I don’t think so.

2012 has been the year of the most rapid and frequent changes in all aspects of the platform, for example interface, ads strategy, EdgeRank algorithm, etc. But the most aggressive transformations with most impact were concentrated in its attempt to create advertising strategies so tempting that no brand could resist them. So, with little consideration of users’ complaints about privacy and data infringement, Facebook ploughed ahead to collect more and better data.   

What once was a private network for people to connect socially slowly began resembling the online platform for advertisers to monitor, analyze and reach their target audiences. If you want to review all the specific attempts that Facebook made to turn its users into dollars read The Atlantic Wire’s excellent chronological overview of 2012.

In the middle of December, Instagram announced an additional term of use which will become valid from January 2013, bolting advertising onto the application.  According to Sterne Agee analysts Arvind Bhatia and Brett Strauser, if Facebook fills up Instagram with ads, it could generate $500 million to $700 million in advertising revenue over the next three years. If this does not antagonize a huge swath of users then the Instagram purchase was a shrewd one in the short term; converting stock to instant revenue. It is, ultimately, $200- $300 million in direct revenue annually and still does not justify a $64 billion market cap.

Mobile Innovations

In mid-December, the platform introduced a new local search and discovery feature called “Nearby.” It enables users to discover specific places and “Like” them, leading to the business’s Timeline. It is a social feature, so the displayed information will be influenced by users’ friend’s recommendations, check-ins and other social cues.

This is one of the better examples of Facebook creating value for their business clients while not making their users feel like they are being "sold," and the kind of tightrope it has to walk to be more successful.  The value for investors will be the rates at which Facebook can sell that data back to its clients, which is what needs to be watched carefully.

Video Ads - The TurnItOff! Factor

I know people whose entire life is built around Facebook. They use the platform to connect with colleagues, classmates and friends, look for jobs, read the news, and so on.  Most of these people won’t mind advertising as long as delicate means of grabbing their attention are employed.   But there is a large segment of its user base that is hostile to being overtly sold and would prefer to never see an ad.  Linkedin neatly avoids this as it was built as an environment for the professional side of your life, not the personal one.

And since Facebook is more living room than cubicle, the intrusion of someone walking in and shouting at you to buy their stuff is just rude.

So how well do you think video ads are going to go over?  

Despite the huge growth path that video advertising is on I see Facebook as the wrong vehicle for them.  And with the growth rate at which users are flocking to the Facebook’s mobile platform – 15.1% CAGR over the past 8 quarters and more than 600 million active users—video advertising there is not a rational option with people paying directly for their bandwidth usage. 

We know how powerful the inertia of time invested in a platform is by looking at Activision Blizzard’s World of Warcraft.  Switching and starting again in a different game is a major life change.  Since WoW is also its own social network it mirrors Facebook’s hold on its users nicely.  The MMORPG industry has had to shift to different models to cope with WoW’s dominance and yet WoW still has 10+ million players.  

For proof of Facebook’s power over its users look no further than the relative ‘stickiness’ of its users compared to rival networks.   

<table> <tbody> <tr> <td> <p><strong>Network</strong></p> </td> <td> <p><strong>Facebook</strong></p> </td> <td> <p><strong>Tumblr</strong></p> </td> <td> <p><strong>Pinterest</strong></p> </td> <td> <p><strong>Twitter</strong></p> </td> <td> <p><strong>Linkedin</strong></p> </td> <td> <p><strong>Google+</strong></p> </td> </tr> <tr> <td> <p><strong>Avg. Monthly Time per user</strong></p> </td> <td> <p><strong><em>6.75 Hrs</em></strong>.</p> </td> <td> <p>1.5 Hrs.</p> </td> <td> <p>1.5 Hrs</p> </td> <td> <p>21 Mins.</p> </td> <td> <p>17 Mins</p> </td> <td> <p>3 Mins</p> </td> </tr> </tbody> </table>

The problems with Facebook as an advertising platform may ultimately be a poor interface. Facebook has to bolt the advertising onto the interface like Frankenstein’s monster – or Yahoo! – or embed it so deeply that it’s unrecognizable. 

Tumblr and Pinterest let the content itself be the advertising.  Even Microsoft’s new network So.Cl recognizes this shift in design.  The rise of both Tumblr and Pinterest -- now the 3rd most popular social network in US in terms of traffic – are more interesting than the failure of Google+. Tumblr, Pinterest and So.Cl are visually based and there’s no changing that without changing Facebook.  

At this point I still have to think that Facebook’s stock price is over-estimating its leadership’s ability to see these issues for what they are and make use of the high quality data they are collecting.  I keep seeing them trying new ways to re-invent Google’s and Yahoo’s revenues streams in the same way that Google and Yahoo! tried to tie Facebook’s platform to their revenue streams and it hasn’t worked either. 

PeterPham8 has no positions in the stocks mentioned above. The Motley Fool owns shares of Activision Blizzard, Facebook, and Google and has the following options: long JAN 2014 $20.00 calls on Facebook. Motley Fool newsletter services recommend Activision Blizzard, 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. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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