Is Facebook Really a Good Business?

Innovation, the Internet, gadgets, and more.
Feb. 2 2012 6:14 PM

Is Facebook Really a Good Business?

It’s nothing without its users, and we’re a fickle bunch.

Mark Zuckerberg
Mark Zuckerberg and Facebook are preparing for the social media giant's IPO

Justin Sullivan/Getty Images.

Facebook is the strangest Internet company ever to make it big. Compare Mark Zuckerberg’s site with Amazon, which just wants to sell you stuff—an old business in a new medium. By contrast, Facebook’s all-encompassing mission to “make the world more open and connected” seems positively zany. It’s not only that Facebook is ambitious; lots of Web companies, especially Google, strike the same revolutionary tone. What’s different about Facebook is its product: Facebook is us. You go to Google for Web pages, you go to Apple for computers, and you go to Amazon for stuff. What does Facebook give you? Me and you and everyone we know. Or, to quote another movie: It’s people! Facebook, is made out of people!

If this doesn’t strike you as a crazy platform on which to build a billion-dollar business, it’s only because you’ve used Facebook long enough to be seduced by its inevitability. But consider how novel the social network is, as a concept. Even though Facebook is named after a real-world object, the site has no analogue in the offline world—before social networks, the idea of a worldwide map of people and their relationships didn’t exist. Indeed, you don’t have to think back too far—probably to 2005 or so—to get to a point where it would have been insane to suggest that people of all ages in every country would voluntarily disclose everything about their lives to a single website. And, on top of that, that the company behind the site would make a grand profit by using this information as a way to serve up ads. And, finally, that we’d all have fun doing it.

Much of Facebook’s S-1—the document the company filed yesterday to kick off its initial public offering—functions as a detailed warning to investors on the risks the company faces on its path to becoming a world-changing business. Most of these risks seem unlikely—the death or resignation of Mark Zuckerberg, the mass infiltration of malware, a terrible undetected programming bug that brings Facebook crashing to the ground.

The warning that the document lists first, though, should not be so easily dismissed: If we fail to retain existing users or add new users, or if our users decrease their level of engagement with Facebook, our revenue, financial results, and business may be significantly harmed. What follows are several bullet points noting the various ways people could sour on Facebook. Together, they highlight a fact that gets lost in the giddiness over the company’s revenues. As successful as it’s been so far, Facebook is still something of a tenuous experiment. It’s an enormous business built on the theory that it is possible to collect, store, and mine information about everyone’s lives—and to delight both consumers and advertisers in the process. Facebook’s financial disclosures prove that the experiment has paid off handsomely.

But how do we know that this success will continue? Unlike Apple’s or Google’s raw materials—chips and touchscreens, Web pages and videos—Facebook’s main ingredient is ordinary people all over the world. And people are known to be a restive, fickle, crazy, unpredictable bunch. Is it really so wise to invest in us?

I’m not arguing that we’ll all leave Facebook for some other social network. As I’ve said before, that’s crazy talk. Instead I have a more general skepticism about the utility of the “social layer” that Facebook wants to build under the entire economy. In a letter to potential investors, Zuckerberg argues that most products and services can be improved by making them “social.” This has become received wisdom in the Silicon Valley; nowadays every site, app, game, and store plugs into some kind of social network, often Facebook.

In some instances, such social connections can lead to new products that make a lot of money. The clearest example is social gaming. The S-1 notes that Zynga, the company behind Facebook games like FarmVille, accounts for 12 percent of Facebook’s revenues. Most of the money comes from Facebook’s cut on the sale of virtual in-game items like “zebra unicorns.” The S-1 notes that there’s something dangerous in Facebook’s reliance on a single company for such a significant source of its revenue, but the real problem here isn’t Zynga. It’s the zebra unicorn. For how many years can we expect people to want to buy these silly things? Two? Five? And by the time the mania over zebra unicorns and carnival cows has died down, will some other equally successful social-network-infused app have come along to keep people spending?

This is the fundamental problem for social networks: You don’t know what will stick, and you don’t know whether the applications that do stick will make any money. Does inserting social information into a search engine make it better? As I wrote a few weeks ago, I’ve seen no evidence of that, either in Bing’s integration with Facebook or Google’s integration with Google+. It’s possible I’m wrong; perhaps Google and Facebook will find that social connections make search results more profitable. But I’m skeptical. Bing has been integrating results from Facebook for more than year. Raise your hand if that integration made Bing so awesome that you’ve set it as your default search engine.

What about music, movies, news, and shopping? We’ll certainly see social connections improve some of those things. For instance, if all your friends’ Netflix movies began flashing across your Facebook page, you may start watching more movies, and Netflix may benefit as a result. But I suspect that the gains from social networking depend on the specific product or service that’s being hawked. (Personally, I value my friends’ recommendations when it comes to choosing a movie, but I want a more authoritative source when it comes to choosing a cardiologist.) Facebook’s challenge isn’t just to attract enough products and services that are genuinely improved by social connections—it’s got to find enough such services that also help its own bottom line.

You could argue that finding new uses for social information isn’t such a big deal, because Facebook’s main service—getting a lot of people to goof off with their friends on the site and serving ads targeted to their profiles—will do well enough by itself. Facebook’s financials certainly suggest that advertisers are going nuts for the site. The company sold more than $3 billion in ads in 2011, accounting for about 85 percent of its revenue. Yet those impressive numbers don’t tell the full story about what advertisers think about Facebook. They say only that businesses want to have a presence on the largest social network in the world, which seems pretty logical. But what if Facebook’s growth slows down (which the S-1 predicts will happen as it sucks up everyone on the planet)? Will its advertising revenue growth slow down as well?

It’s hard to know, because while the S-1 shows that companies are spending lots of money on Facebook ads, it doesn’t give many details about how these ads work for businesses. Wal-Mart launched an ad to promote its Black Friday sales, and, according to the S-1, it reached 60 million Facebook users. But did that push more people to go to Wal-Mart stores? The S-1 doesn’t say. And I’d venture that Wal-Mart doesn’t even know. Last year, for a story in Fast Company, I spoke to many large advertisers about the effectiveness of their social-media ad campaigns. They all told me the same thing—they don’t have the tools to measure whether social ads are driving sales, and they don’t care, because these ads currently constitute a miniscule portion of their advertising budgets. To continue its rapid growth, though, Facebook is going to have to convince such firms to devote more of their money to social ads. It will only be successful in that mission if it can convince firms like Wal-Mart that when you see an ad about a Black Friday sale alongside a notice about your friend’s zebra unicorns, you’re prompted to ditch FarmVille and go shopping.

Don’t get me wrong. Facebook’s financials are marvelous, and they’re only going to get better as the site grows. If it were ethical for me to invest in tech companies, I’d buy up as many shares as I could afford. But that doesn’t mean Facebook isn’t risky. It is—audaciously so. It’s a company built on social trends, and social preferences are always changing, sometimes quickly and capriciously. There was a time not long ago in America when people attended book clubs and bowled together; now we bowl alone. Facebook’s future depends on successfully navigating such big changes. It’s one of the smartest companies of our times. But I don’t know if it’s smart enough.

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