June 12, 2012

Why will Facebook always be free? Here’s why...

On its homepage, Facebook prominently advertises that its service is "free and always will be."  Yet it hasn't stopped false rumors of a pay scheme from going viral on numerous occasions.

Why will Facebook always be free?
Here’s why:  It doesn’t need the money.

In 2011 Facebook pulled in approximately $4.27 billion in revenue -- double what the company made in 2010.  Projections for 2012 near $5 billion and last month we saw the social media giant go public -- bringing in significantly more capital.  Impressive numbers, but the bottom line is not necessarily the bottom line.

The company’s business model revolves around having as many users as possible. Remaining free is paramount to doing that.

Facebook makes money through three sources while allowing users on its site for free:

1) Advertising
2) Virtual Goods
3) Applications

Restricting users’ ability to use the site would actually be detrimental to that model.

By the end of Q1, 2012, 82% of Facebook’s revenue came exclusively from advertising.    Highly targeted, affordable advertising based on the plethora of data that its members share on the site is extremely valuable to brand’s looking to engage with their target audience.  Facebook didn’t even introduce its ad platform until 2007 — because the company wanted to focus on adding users as quickly as possible – their most valuable money-making commodity.

When you see “Sponsored” on the right-hand side of Facebook, someone has paid for those links. Advertisers have the option of paying per 1,000 impressions (every time it shows up on somebody’s screen it’s an impression) or per click. Therefore, depending on how the advertisers set up their ads, Facebook gets paid every time someone clicks on or views an ad. A huge part of the Internet works this way, with ads generating many thousands of sites’ revenue.
By the end of Q1 2012, the network has generated 82% of their revenue through advertising.
However, the difference between it's division of revenue among advertising and other sources continues to increase. 

The way Facebook earns even more money with ads goes beyond offering advertisers good targeting data.  Facebook thrives monetarily from being useful to visitors. When Facebook makes a change, you can bet it’s either to:

  • Generate attention to their services so that people will use Facebook more and click/view more ads (note that even the “I HATE THE NEW FACEBOOK!” comments keep the attention on Facebook itself)
  • Generate more revenue from the ads (It’s rumored that Facebook will soon stop delivering business updates into your feed unless you interact with them a lot, meaning that they will have to buy advertising on Facebook)
  • Respond to features of another service (Facebook is changing a LOT in response to Google+),
  • Improve their performance (meaning their servers don’t have to do as much work)

All of these things are driven by money.

If you Book Them, Will They Come?
In a recent poll by Reuters/Ipsos, four out of five Facebook users said neither advertisements nor comments on the social network have ever led them to buy a product or service.  The vast majority of Facebook users say they ignore ads on the social network.  Google appears to be more effective at attracting clicks, as The Wall Street Journal cites a click-rate that is seven times that of Facebook.

Facebook has also proven ineffective in a B2B environment. Like all other Internet ads, Facebook ads also have a very low conversion ratio. However, if you follow my blog regularly, you know the importance I place on integrated strategy, so for my recommendation would always be for B2B’s using Facebook to use it as a supplemental marketing strategy rather than a sole marketing strategy.  (As with any marketing, the key to success is to understand the benefits and limitations of different advertising tools and to identify what fits the company and the product.)

In the face of scrutiny regarding the effectiveness of their ads, Facebook is now rebuffing claims that their advertisements are ineffective.  They’ve come out with their own research results, which show that most ad campaigns get companies $3 for every $1 they spend.  The Los Angeles Times reports that the data released by Facebook, together with comScore, shows that 70% of ad campaigns will get advertisers a return three times what they put in and, in nearly half of all campaigns, Facebook ads get companies $5 for every $1.

“This provides some strong evidence that Facebook can be an effective marketing channel,” said Andrew Lipsman, vice president of industry analysis at ComScore, to Bloomberg. “These are strong results.”

Virtual Goods
Zynga is an innovative company that brought casual gaming to the masses, there most popular game being FarmVille that users can play via Facebook -- and of course share socially their journey through the game.  As far as their business model, Zynga gives their games away for free, but charges gamers for “virtual goods” that can be purchased inside of a game.  These “virtual goods” allow gamers to experience new capabilities and access new features that were previously locked down.   While this may sound like somewhat of a gimmick, the “virtual goods” business model has been extremely lucrative for the company.

Facebook takes a cut when users buy virtual goods on games played through the network.  In the FarmVille example – simply put, each time a user buys a cow, they put in their credit card information and Facebook takes a 30% cut of Zynga's revenue on that cow.  And a roughly similar cut from other companies.

How big a business is this?  According to PC Magazine, Zynga contributed about $445 million to Facebook's profits last year.  The worldwide revenue from sales of virtual goods is expected to hit $15 billion in 2014, and Facebook plans to continue to get a growing percentage of that market.

And “virtual,” is not necessarily a literal interpretation of a cow you neither have to house nor feed.  Retailers are offering more on the Facebook platform and for Facebook that means a cut. It won't be able to take the same 30% it gets from Zynga, but if say, J. Crew, starts offering shopping without leaving Facebook, if the social network takes even 5%, that could be meaningful to its bottom line.

There is a way that Facebook could make money with integrated applications and services. 
Let’s take Spotify for example.  Spotify did backflips given the opportunity to partner with Facebook and leverage the network’s massive audience, an audience who spends 15% of their total Online time on the social network.  Facebook and Spotify have a streaming pact that allows the cloud-based music service on the profile pages of millions -- note that you must have a Facebook account to access Spotify, this is key. And Spotify was happy to enter into this agreement for free, especially given their recent gargantuan competition in the forms of Amazon Cloud Player and Google Music.

Right now, no money is changing hands.  It’s actually been a dream of Zuckerberg for quite some time to have a music platform on the network with many previous plans going the way of the “Facebook Poke.”  The partnership with Spotify signifies how Facebook is flexing its muscles in the media space, offering services that keep people within the social network, rather than scouring other parts of the web for content.

So, how can this partnership become lucrative for Facebook?  My hunch?  Spotify is trying to get bought by Facebook. And why not? Instagram, with 10 million active users, recently sold to Facebook for a billion dollars. Imagine what Spotify could sell for with 8 million more users than Instagram, plus an already established advertising platform?

If Facebook bought Spotify, almost all of Spotify’s 18 million users are already plugged in using their Facebook accounts. Users’ Spotify activity is already seamlessly integrated into Facebook. Spotify already has an ad platform, the main way that Facebook makes money. And finally, Spotify already has apps, which are a major part of Facebook’s brand platform.  All this will become the property of Facebook. 

With music being integrated into the social network, movies and TV shows (think Hulu) are bound to find their way in too, especially as people become more inclined to consume their content in a social way.  Why listen to a great new song by yourself when you can hear it with your friends too? 

Facebook may charge for some things eventually, but access to your account and normal activities will definitely not be one of them.

The one thing that all of Facebook’s revenue generating models have in common is that they rely on a critical mass of users to be successful. Facebook has that, and would never risk losing it by charging people for basic access to the tools that make its multi-billion dollar business work.

By Jennifer Pricci


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