Chapter 8 Facebook: Building a Business from the Social Graph

8.1 Introduction

It’s hard not to be awed by what Mark Zuckerberg has created. An effort launched from his college dorm is now a species-level phenomenon.L. Grossman, “Person of the Year: Mark Zuckerberg,” Time, December 15, 2010. Roughly one in every eight people on the planet has a Facebook account—an amazing track record given that Facebook is technically banned in China (taking about 20 percent of the world population off the table).J. Cassidy, “Facebook: The Ultimate Dot-Com,” New Yorker, May 16, 2012. Want to connect to customers? Facebook is increasingly the place to be. The firm has ranked as the most visited site in the United StatesL. Sumagaysay, “Facebooking More Than Googling,” Good Morning Silicon Valley, December 30, 2010. and is tops in display advertising.M. Walsh, “Facebook Drives 31% of Display Ads in Q1,” MediaPost, May 4, 2011. Global growth is on a tear, with an excess of 80 percent of Facebook users outside the United States.D. Kerr, “Facebook to Inaugurate New Office in Dubai,” CNet, May 23, 2012. Facebook is solidly profitable; in 2011 the firm earned about $1 billion on some $3.7 billion in revenues. And Facebook has accomplished all that with fewer employees than Google has job openings.J. Evans, “Can Anything Stop the Facebook Juggernaut?” TechCrunch, November 25, 2010.

8.2 Does Facebook Want to Eat Your Firm’s Lunch? Enveloping Markets across the Internet

Facebook isn’t just a collection of personal home pages and a place to declare your allegiance to your friends. Facebook is gradually turning on features that allow it to leverage its massive user base to encroach on a wide swath of Internet businesses. Consider photos. Google, Yahoo!, and MySpace all spent millions to acquire photo sharing sites (Picasa, Flickr, and Photobucket, respectively). But to become the web’s leading photo sharing service, Facebook didn’t acquire anyone. The site simply turned on a substandard photo-sharing feature and quickly became the biggest photo-sharing site on the Web. Facebook users now post over three billion photos each month.J. Kincaid, “Facebook Users Uploaded a Record 750 Million Photos over New Year’s,” TechCrunch, January 3, 2011.

Video is also on the rise. YouTube will get you famous, but Facebook is the place most go to share clips they only want friends to see.F. Vogelstein, “Mark Zuckerberg: The Wired Interview,” Wired, June 29, 2009. Facebook users share video at a rate ten times greater than those on Twitter,P. Sawers, “Facebook Drives 10 Times More Video Shares Than Twitter as Online TV Viewing Rises Sharply,” The Next Web, Febraury 15, 2012. and services like Viddy are bringing in tens of millions of new users who capture and share video via their mobile devices.L. Segall, “Video Apps Battle to be the Next Instagram,” CNN Money, May 11, 2012 And with all those eyeballs turning to Facebook for video, why not become a destination to watch movies and TV shows, too? Facebook has worked with major studios to stream “rentals” of blockbusters that include The Dark Knight, the Harry Potter films, and Inception. Netflix integrates so tightly with Facebook that the firm’s CEO sits on Facebook’s board.

Figure 8.1 Is Facebook Coming after Your Business?

Facebook has turned on features and engaged in partnerships that compete with offerings from a wide variety of firms. In this example, Warner Bros. has partnered with Facebook to offer streaming video rental.

Source: Used by permission of Facebook.

Facebook has become the first-choice communication service for this generation, and with Facebook’s unified messaging feature, the site will prioritize e-mail, text messages, and chat in a single inbox, bubbling your friends ahead of the spam. It’ll even give you a facebook.com e-mail address.M. Helft, “Facebook Offers New Messaging Tool,” New York Times, November 15, 2010. Look out Gmail, Hotmail, and Yahoo!—if users check mail within Facebook, they may visit the big e-mail players less often (meaning less ad revenue for the e-mail firms).

Facebook is a kingmaker, opinion catalyst, and traffic driver, so media outlets want to be friends. Games firms, music services, video sites, daily deal services, media outlets, and more, all integrate into Facebook’s Ticker, each hoping that a quick post of activity to Facebook will help spread their services virally. While in the prior decade news stories would carry a notice saying, “Copyright, do not distribute without permission,” major news outlets today display Facebook icons alongside every copyrighted story, encouraging users to “share” the content on their profile pages. Great for Facebook, but a sharp elbow to Digg.com and Del.icio.us, which have both seen their link sharing appeal free-fall, even though they showed up first.D. Lyons, “Digg This: A Cautionary Tale for Web 2.0 Companies,” Newsweek, October 24, 2010; M. Arrington, “Yahoo Sells Delicious to YouTube Founders,” TechCrunch, April 27, 2011. And despite all the buzz about Twitter, Facebook drives far more traffic to newspaper sites.S. Kessler, “For Top News Sites, Facebook Drives More Traffic Than Twitter,” Mashable, May 9, 2011.

Facebook Office? Facebook rolled out the document collaboration and sharing service Docs.com in partnership with Microsoft. Music? Payments? Facebook is hard at work on that, too.J. Kincaid, “What Is This Mysterious Facebook Music App?” TechCrunch, February 2, 2010; R. Maher, “Facebook’s New Payment System Off to Great Start, Could Boost Revenue by $250 Million in 2010,” TBI Research, February 1, 2010.

As for search, Facebook’s tinkering there, as well. Google indexes some Facebook content, but since much of Facebook is private, accessible only among friends, this represents a massive blind spot for Google search. Sites that can’t be indexed by Google and other search engines are referred to as the dark WebInternet content that can’t be indexed by Google and other search engines.. But while Google lacks access to Facebook’s portion of the dark Web, Facebook has repeatedly expanded its partnership with Microsoft’s Bing, linking private Facebook content with search. Content that Facebook users have “liked” can influence the ranking of Bing search results. A new social sidebar in Bing that lets you see and respond to Facebook friend updates allows users to ask friends questions and even surfaces friends who may be knowledgeable on a topic.R. Metz, “With New Look, Bing Gets More Organized, Social,” Technology Review, May 10, 2012. If Facebook can tie together standard Internet search with its dark Web content, this just might be enough for some to break the Google habit.

Facebook’s increasing dominance, long reach, and widening ambition have a lot of people worried, including the creator of the World Wide Web. Sir Tim Berners-Lee recently warned that the Web may be endangered by Facebook’s colossal walled gardenA closed network or single set of services controlled by one dominant firm..J. Evans, “Can Anything Stop the Facebook Juggernaut?” TechCrunch, November 25, 2010. The fear is that if increasingly large parts of the Web reside inside a single (and for the most part closed) service, innovation, competition, and exchange may suffer.

8.3 The Social Graph

At the heart of Facebook’s appeal is a concept Zuckerberg calls the social graphThe global mapping of users and organizations, and how they are connected., which refers to Facebook’s ability to collect, express, and leverage the connections between the site’s users, or as some describe it, “the global mapping of everyone and how they’re related.”A. Iskold, “Social Graph: Concepts and Issues,” ReadWriteWeb, September 12, 2007. Think of all the stuff that’s on Facebook as a node or endpoint that’s connected to other stuff. You’re connected to other users (your friends), photos about you are tagged, comments you’ve posted carry your name, you’re a member of groups, you’re connected to applications you’ve installed—Facebook links them all.A. Zeichick, “How Facebook Works,” Technology Review, July/August 2008.

Facebook was established in the relatively safe cocoon of American undergraduate life and was conceived as a place where you could reinforce contacts among those who, for the most part, you already knew. The site was one of the first social networks where users actually identified themselves using their real names. If you wanted to establish that you worked for a certain firm or were a student of a particular university, you had to verify that you were legitimate via an e-mail address issued by that organization. It was this “realness” that became Facebook’s distinguishing feature—bringing along with it a degree of safety and comfort that enabled Facebook to become a true social utility and build out a solid social graph consisting of verified relationships. Since “friending” (which is a link between nodes in the social graph) required both users to approve the relationship, the network fostered an incredible amount of trust. Today, many Facebook users post their cell phone numbers and their birthdays, offer personal photos, and otherwise share information they’d never do outside their circle of friends. Because of trust, Facebook’s social graph is incredibly strong.

There is also a strong network effectAlso known as Metcalfe’s Law, or network externalities. When the value of a product or service increases as its number of users expands. to Facebook (see Chapter 6 "Understanding Network Effects"). People are attracted to the service because others they care about are more likely to be there than anywhere else online. And that large user base has also attracted all sorts of firms and organizations looking to connect with Facebook’s masses. Without the network effect Facebook wouldn’t exist. And it’s because of the network effect that another smart kid in a dorm can’t rip off Zuckerberg in any market where Facebook is the biggest fish. Even an exact copy of Facebook would be a virtual ghost town with no social graph (see Note 8.21 "It’s Not the Technology" below).

The switching costsThe cost a consumer incurs when moving from one product to another. It can involve actual money spent (e.g., buying a new product) as well as investments in time, any data loss, and so forth. for Facebook are also extremely powerful. A move to another service means recreating your entire social graph. The more time you spend on the service, the more you’ve invested in your graph and the less likely you are to move to a rival.

8.4 Facebook Feeds—Ebola for Data Flows

While the authenticity and trust offered by Facebook was critical, offering News Feeds concentrated and released value from the social graph. With feeds, each time a user performs an activity in Facebook—makes a friend, uploads a picture, joins a group—the feed blasts this information to all of your friends in a reverse chronological list that shows up right when they next log on. An individual user’s activities are also listed on their profile. Get a new job, move to a new city, read a great article, have a pithy quote—post it to Facebook—the feed picks it up, and the world of your Facebook friends will get an update. Corporations love feeds, too! “Like” a firm on Facebook and the firm can post messages to your news feed, where you can “Like” new messages they send out, comment on them, and share the messages virally.

Feeds are perhaps the linchpin of Facebook’s ability to strengthen and deliver user value from the social graph, but for a brief period of time it looked like feeds would kill the company. News Feeds were launched on September 5, 2006, just as many of the nation’s undergrads were arriving on campus. Feeds reflecting any Facebook activity (including changes to the relationship status) became a sort of gossip page splashed right when your friends logged in. To many, feeds were first seen as a viral blast of digital nosiness—a release of information they hadn’t consented to distribute widely.

And in a remarkable irony, user disgust over the News Feed ambush offered a whip-crack demonstration of the power and speed of the feed virus. Facebook protest groups were formed on Facebook itself, and every student who, for example, joined a group named Students Against Facebook News Feed, had this fact blasted to their friends (along with a quick link where friends, too, could click to join the group). Hundreds of thousands of users mobilized against the firm in just twenty-four hours. It looked like Zuckerberg’s creation had turned on him, Frankenstein style.

The first official Facebook blog post on the controversy came off as a bit condescending (never a good tone to use when your customers feel that you’ve wronged them). “Calm down. Breathe. We hear you,” wrote Zuckerberg on the evening of September 5. The next post, three days after the News Feed launch, was much more contrite (“We really messed this one up,” he wrote). In an open letter, Zuckerberg apologized for the surprise, explaining how users could opt out of feeds. The tactic worked, and the controversy blew over.F. Vogelstein, “How Mark Zuckerberg Turned Facebook into the Web’s Hottest Platform,” Wired, September 6, 2007. The ability to stop personal information from flowing into the feed stream was just enough to stifle critics, and as it turns out, a lot of people really liked the feeds and found them useful. It soon became clear that if you wanted to use the Web to keep track of your social life and contacts, Facebook was the place to be. Not only did feeds not push users away, by the start of the next semester subscribers had nearly doubled! Facebook continues to refine feeds in several ways, including refining sharing into categories that include “Top Stories” that the site thinks you’ll be most interested in, “Recent News,” a “Ticker” for lighter content (e.g. music, games, location updates), and a “Timeline” that offers a sort of digital scrapbook of content that a user has shared online.

8.5 Facebook as a Platform

In May 2007, Facebook followed News Feeds with another initiative that set it head and shoulders above its competition. At the firm’s first f8 developers conference, Mark Zuckerberg stood on stage and announced that he was opening up the screen real estate on Facebook to other application developers. Facebook published a set of application programming interfaces (APIs)Programming hooks, or guidelines, published by firms that tell other programs how to get a service to perform a task such as send or receive data. For example, Amazon.com provides APIs to let developers write their own applications and Websites that can send the firm orders. that specified how programs could be written to run within and interact with Facebook. Now any programmer could write an application that would live inside a user’s profile. Geeks of the world, Facebook’s user base could be yours! Just write something good.

Developers could charge for their wares, offer them for free, and even run ads. And Facebook let developers keep what they made (Facebook does revenue share with app vendors for some services, such as the Facebook Credits payment service, mentioned later). This was a key distinction; MySpace (a larger firm at the time) initially restricted developer revenue on the few products designed to run on their site, at times even blocking some applications. The choice was clear: Facebook had rolled out the welcome mat and developers flocked to the site.

To promote the new apps, Facebook would run an Applications area on the site where users could browse offerings. Even better, News Feed was a viral injection that spread the word each time an application was installed. Your best friend just played a game? Maybe you’ll check it out, too. The predictions of $1 billion in social network ad spending were geek catnip, and legions of programmers came calling. Apps could be cobbled together on the quick, feeds made them spread like wildfire, and the early movers offered adoption rates never before seen by small groups of software developers. People began speaking of the Facebook Economy. Facebook was considered a platform. Some compared it to the next Windows, Zuckerberg the next Gates (hey, they both dropped out of Harvard, right?).

And each application potentially added more value and features to the site without Facebook lifting a finger. The initial event launched with sixty-five developer partners and eighty-five applications. There were some missteps along the way. Some applications were accused of spamming friends with invites to install them (Facebook eventually put limits on viral communication from apps). There were also security concerns, privacy leaks, and apps that violated the intellectual property of other firms (see the “Errant Apps” sidebar below), but Facebook worked to quickly remove misbehaving apps, correct errors, improve the system, and encourage developers. Just one year in, Facebook had marshaled the efforts of some four hundred thousand developers and entrepreneurs, twenty-four thousand applications had been built for the platform, 140 new apps were being added each day, and 95 percent of Facebook members had installed at least one Facebook application. As Sarah Lacy, author of Once You’re Lucky, Twice You’re Good, put it, “with one masterstroke, Zuck had mobilized all of Silicon Valley to innovate for him.”

Figure 8.2 Gaming on Facebook’s Platform Is a Colossal Business

Zynga, maker of MafiaWars, FarmVille, and CityVille, is estimated to be the second most valuable firm in the video game industry, generating north of $600 million in annual profits through the sale of virtual goods and by running advertising and promotions.

Source: Zynga.

With feeds to spread the word, Facebook was starting to look like the first place to go to launch an online innovation. Skip the Web; if you want to get social, bring it to Zuckerberg’s site first (you can almost feel Tim Berners-Lee shuddering). A programmer named Mark Pincus wrote a Texas hold ’em game at his kitchen table.J. Guynn, “A Software Industry @ Facebook,” Los Angeles Times, September 10, 2007. Today his social gaming firm, Zynga, is one of the world’s most valuable video game firms, a publicly-traded, multi-billion dollar powerhouse that has launched over three dozen apps and attracted over 230 million users worldwide.D. MacMillan, “Zynga Enlarges Its War Chest,” BusinessWeek, December 17, 2009. Zynga games include MafiaWars, FarmVille (which boasts some twenty times the number of actual farms in the United States),D. MacMillan, P. Burrows, and S. Ante, “Inside the App Economy,” BusinessWeek, November 2, 2009. and CityVille. Playfish, the U.K. social gaming firm behind the Facebook hits Pet Society and Restaurant City, was snapped up by Electronic Arts for $300 million plus. And Disney bought Sorority Life maker Playdom for over three quarters of a billion dollars.B. Barnes and C. Cain Miller, “Disney Buys Playdom in $763 Million Deal, Becoming Hollywood Leader in Social Games,” New York Times, July 27, 2010. Lee Lorenzen, founder of Altura Ventures, an investment firm exclusively targeting firms creating Facebook apps, said, “Facebook is God’s gift to developers. Never has the path from a good idea to millions of users been shorter.”J. Guynn, “A Software Industry @ Facebook,” Los Angeles Times, September 10, 2007.

But legitimate questions remain. Are Facebook apps really a big deal? Just how important will apps be to adding sustained value within Facebook? And how will firms leverage the Facebook framework to extract their own value? A chart from FlowingData showed the top category, Just for Fun, was larger than the next four categories combined. That suggests that a lot of applications are faddish time wasters. Yes, there is experimentation beyond virtual Zombie Bites. Visa has created a small business network on Facebook (Facebook had some eighty thousand small businesses online at the time of Visa’s launch). Educational software firm Blackboard offered an application that will post data to Facebook pages as soon as there are updates to someone’s Blackboard account (new courses, whether assignments or grades have been posted, etc.). We’re still a long way from Facebook as a Windows rival, but the platform helped push Facebook to number one, and it continues to deliver quirky fun (and then some) supplied by thousands of developers off its payroll.

8.6 Advertising and Social Networks: A Work in Progress

If Facebook is going to continue to give away its services for free, it needs to make money somehow. Right now the bulk of revenue comes from advertising. Fortunately for the firm, online advertising is hot. For years, online advertising has been the only major media category that has seen an increase in spending (see Chapter 14 "Google in Three Parts: Search, Online Advertising, and Beyond"). Firms spend more advertising online than they do on radio, magazine, cable television, or newspaper ads.D. Takahashi, “Internet Ads Finally Surpass Newspapers,” VentureBeat, April 14, 2011. But not all Internet advertising is created equal. There are both signs that social networking sites are struggling to find the right ad model and trends suggesting that advertising on social networks could be a money-gushing bonanza.

Google founder Sergey Brin sums up early frustration with social media advertising, saying, “I don’t think we have the killer best way to advertise and monetize social networks yet,” that social networking ad inventory as a whole was proving problematic and that the “monetization work we were doing [in social media] didn’t pan out as well as we had hoped.”“Everywhere and Nowhere,” Economist, March 19, 2008. GM pulled a $10 million account from Facebook just days before the social network’s IPO, claiming that paid advertising on the network was simply not effective.J. Muller, “GM Says Facebook Ads Don’t Work, Pulls $10 Million Ad Account,” Forbes, May 15, 2012.

Why has advertising on social networking sites been such a tough nut for some to crack? Firms face two key challenges: content adjacencyConcern that an advertisement will run near offensive material, embarrassing an advertiser and/or degrading their products or brands. and user attention. The content adjacency problem refers to concern over where a firm’s advertisements will run. Consider all of the questionable titles in social networking news groups. Do advertisers really want their ads running alongside conversations that are racy, offensive, illegal, or that may even mock their products? This potential juxtaposition is a major problem with any site offering ads adjacent to free-form social media. Summing up industry wariness, one Procter & Gamble manager said, “What in heaven’s name made you think you could monetize the real estate in which somebody is breaking up with their girlfriend?”B. Stone, “Facebook Aims to Extends Its Reach across Web,” New York Times, December 1, 2008.  An IDC report suggests that it’s because of content adjacency that “brand advertisers largely consider user-generated content as low-quality, brand-unsafe inventory” for running ads.R. Stross, “Advertisers Face Hurdles on Social Networking Sites,” New York Times, December 14, 2008. 

Now let’s look at the user attention problem.

Getting Creative with Promotions: Does It Work?

Facebook and other social networks are still learning what works, and Facebook, app firms, and advertisers have begun experimenting with all sorts of models. Many feel that Facebook has a unique opportunity to get consumers to engage with their brand, and some initial experiments point where this may be heading.

Many firms have been leveraging so-called engagement adsPromotion technique popular with social media that attempts to get consumers to interact with an ad, then shares that action with friends. by making their products part of the Facebook fun. Using an engagement ad, a firm can set up a promotion where a user can do things such as “Like” or become a fan of a brand, RSVP to an event and invite others, watch and comment on a video and see what your friends have to say, send a “virtual gift” with a personal message, or answer a question in a poll. The viral nature of Facebook allows actions to flow back into the news feed and spread among friends.

COO Sheryl Sandberg discussed Ben & Jerry’s promotion for the ice cream chain’s free cone day event. To promote the upcoming event, Ben & Jerry’s initially contracted to make two hundred and fifty thousand “gift cones” available to Facebook users; they could click on little icons that would gift a cone icon to a friend, and that would show up in their profile. Within a couple of hours, customers had sent all two hundred and fifty thousand virtual cones. Delighted, Ben & Jerry’s bought another two hundred and fifty thousand cones. Within eleven hours, half a million people had sent cones, many making plans with Facebook friends to attend the real free cone day. The day of the Facebook promotion, Ben & Jerry’s Web site registered fifty-three million impressions, as users searched for store locations and wrote about their favorite flavors.Q. Hardy, “Facebook Thinks Outside Boxes,” Forbes, May 28, 2008. The campaign dovetailed with everything Facebook was good at: it was viral, generating enthusiasm for a promotional event and even prompting scheduling.

In other promotions, Honda gave away three quarters of a million hearts during a Valentine’s Day promo,S. Sandberg, “Sheryl Sandberg on Facebook’s Future,” BusinessWeek, April 8, 2009. and the Dr. Pepper Snapple Group offered two hundred and fifty thousand virtual Sunkist sodas, which earned the firm one hundred thirty million brand impressions in twenty-two hours. Says Sunkist’s brand manager, “A Super Bowl ad, if you compare it, would have generated somewhere between six to seven million.”E. Wong, “Ben & Jerry’s, Sunkist, Indy Jones Unwrap Facebook’s ‘Gift of Gab,’” Brandweek, June 1, 2008.

Facebook, Help Get Me a Job!

The news is filled with stories about employers scouring Facebook to screen potential hires. But one creative job seeker turned the tables and used Facebook to make it easier for firms to find him. Recent MBA graduate Eric Barker, a talented former screenwriter with experience in the film and gaming industry, bought ads promoting himself on Facebook, setting them up to run only on the screens of users identified as coming from firms he’d like to work for. In this way, someone Facebook identified as being from Microsoft would see an ad from Eric declaring “I Want to Be at Microsoft” along with an offer to click and learn more. The cost to run the ads was usually less than $5 a day. Said Barker, “I could control my bid price and set a cap on my daily spend. Starbucks put a bigger dent in my wallet than promoting myself online.” The ads got tens of thousands of impressions, hundreds of clicks, and dozens of people called offering assistance. Today, Eric Barker is gainfully employed at a “dream job” in the video game industry.Eric is a former student of mine. His story has been covered by many publications, including J. Zappe, “MBA Grad Seeks Job with Microsoft; Posts Ad on Facebook,” ERE.net, May 27, 2009; G. Sentementes, “‘Hire Me’ Nation: Using the Web & Social Media to Get a Job,” Baltimore Sun, July 15, 2009; and E. Liebert, Facebook Fairytales (New York: Skyhorse, 2010).

Figure 8.3

Eric Barker used Facebook to advertise himself to prospective employers.

Of course, even with this business, Facebook may find that it competes with widget makers. Unlike Apple’s App Store (where much of developer-earned revenue comes from selling apps), the vast majority of Facebook apps are free and supported by ads. That means Facebook and its app providers are both running at a finite pot of advertising dollars.

While these efforts might be innovative, are they even effective? Some of these programs are considered successes; others, not so much. Jupiter Research surveyed marketers trying to create a viral impact online and found that only about 15 percent of these efforts actually caught on with consumers.M. Cowan, “Marketers Struggle to Get Social,” Reuters, June 19, 2008, http://www.reuters.com/news/video?videoId=84894. Brands seeking to deploy their own applications in Facebook have also struggled. New Media Age reported that applications rolled out by top brands such as MTV, Warner Bros., and Woolworths were found to have as little as five daily users. Congestion may be setting in for all but the most innovative applications, as standing out in a crowd of over 550,000 applications becomes increasingly difficult.Facebook Press Room, Statistics, April 29, 2010, http://www.facebook.com/press/info.php?statistics.

Consumer products giant Procter & Gamble (P&G) has been relentlessly experimenting with leveraging social networks for brand engagement, but the results show what a tough slog this can be. The firm did garner fourteen thousand Facebook “fans” for its Crest Whitestrips product, but those fans were earned while giving away free movie tickets and other promos. The New York Times quipped that with those kinds of incentives, “a hemorrhoid cream” could have attracted a similar group of “fans.” When the giveaways stopped, thousands promptly “unfanned” Whitestrips. Results for Procter & Gamble’s “2X Ultra Tide” fan page were also pretty grim. P&G tried offbeat appeals for customer-brand bonding, including asking Facebookers to post “their favorite places to enjoy stain-making moments.” But a check eleven months after launch had garnered just eighteen submissions, two from P&G, two from staffers at spoof news site The Onion, and a bunch of short posts such as “Tidealicious!”R. Stross, “Advertisers Face Hurdles on Social Networking Sites,” New York Times, December 14, 2008. 

Efforts around engagement opportunities like events (Ben & Jerry’s) or products consumers are anxious to identify themselves with (a band or a movie) may have more success than trying to promote consumer goods that otherwise offer little allegiance, but efforts are so new that metrics are scarce, impact is tough to gauge, and best practices are still unclear.

Facebook Ads: Massive Upside and Huge Growth

Concerns over Facebook’s ad model were underscored when growth slowed in the two quarters prior to the firm’s IPO.H. Blodget, “Well, Now that Everyone Has Sobered Up, Let’s Figure Out What Facebook is Actually Worth…” Business Insider, May 21, 2012. For all these challenges and limitations, however, Facebook advertising had grown at a rate strikingly similar to Google’s early ad growth trajectory.Eric is a former student of mine. His story has been covered by many publications, including J. Zappe, “MBA Grad Seeks Job with Microsoft; Posts Ad on Facebook,” ERE.net, May 27, 2009; G. Sentementes, “‘Hire Me’ Nation: Using the Web & Social Media to Get a Job,” Baltimore Sun, July 15, 2009; and E. Liebert, Facebook Fairytales (New York: Skyhorse, 2010). There are several reasons for this spectacular growth.

First is the advertising appeal of precise targeting. Large advertising networks have tried to meticulously track users to develop a profile of their demographics, likes, and interests. At Facebook, the site knows all about you because you’ve told it the details—your age, the things you’re enthusiastic about, where you live, your relationship status. This opens up all sorts of targeting opportunities to even the smallest of advertisers. In one example, a wedding photography studio targeted ads at women aged 24 to 30 whose relationship status was engaged—that’s like sticking a flier in front of precisely everyone you want to reach and not wasting a dime on anyone else. The firm, CM Photographics, reports that just $600 in Facebook ads resulted in nearly $40,000 in revenue.M. D’Onofrio, “Social Networking Sites Using New Advertising,” BrandingIron, November 18, 2010.

Another key comes from leveraging social engagement in the ads themselves. Adding a “like” button to an ad allows firms to turn their advertising message into a trusted referral from users’ friends. Making ads more social allows advertisers to engage consumers to comment on content, RSVP to an event, and more. Many of these ads are designed to allow interaction within the ad that keeps them on the page so that users aren’t faced with a choice to deviate from their “hike.” And while user “Likes” and other updates might be lost in the constant scroll of the news feed, Facebook also lets advertisers pay to create sponsored stories, allowing advertisers to turn a member’s Facebook actions (status updates, check-ins, “likes”) into an ad on the right-side of the screen.

Facebook Engagement Ads and Sponsored Stories

These videos show how both engagement ads and sponsored stories work.

Source: Used by permission of Facebook.

Click to watch: https://www.facebook.com/video/video.php?v=10100328087082670

(click to see video)

While Facebook’s overall click-through rates are low, Facebook execs argue that people remember ads better and are more likely to make purchases when their friends endorse products. Says one ad exec, “If you’re an advertiser, there’s nothing better than converting customers into unpaid endorsers.”B. Stone, “Why Facebook Needs Sheryl Sandberg,” BusinessWeek, May 16, 2011. Perhaps most critical—if someone “likes” your firm’s page, you’ve got ’em. You can now post status updates that show up in a user’s feed, allowing your message to appear in the same stream as postings from friends and to further spread virally. Users, of course, can turn off firm messages if they “unlike” a firm, and users are in control of their social ad participation through Facebook’s privacy settings, but this ability to connect to customers in a way that enables continued messaging and promotion is a huge draw for advertisers and gives Facebook ads a unique appeal that none of its rivals can match.

While Facebook doesn’t sell banner advertisements, the products described above are considered display ads. Facebook serves three times more display ads than anyone else online.M. Walsh, “Facebook Drives 31% of Display Ads in Q1,” MediaPost, May 4, 2011. As for the increased spending by advertisers on Facebook, only time will tell if GM’s experience is an anomaly or a troubling trend and if Facebook can create new promotional mechanisms to further fuel growth.P. Kafka, “Facebook Isn’t Eating Google’s Lunch Yet, but It’s Getting Hungry…,” AllThingsD, March 13, 2011.

Key Takeaways

• Issues of content adjacency and user attention can make social networking ads less attractive than ads running alongside search and professionally produced content sites.
• Google enjoys significantly higher click-through rates than Facebook. Rates are lower since users of social sites are there to engage friends, not to hunt for products. They are less likely to be drawn away by clicks.
• Display ads are often charged based on impression. Social networks also offer lower CPM rates than many other, more targeted Web sites.
• Many firms have begun to experiment with engagement ads. While there have been some successes, engagement campaigns often haven’t yielded significant results
• Despite concern, Facebook ads have grown at a tremendous rate and are highly profitable.
• Facebook ads offer advantages of improved targeting and social engagement. Ads allow customers to endorse a firm’s offerings and to virally share a message with others. Facebook can leverage customer engagement in its own ads. And Facebook allows firms to continue to send messages to the news feeds of users who have “liked” their presence on Facebook.

Questions and Exercises

1. How are most display ads billed? What acronym is used to describe pricing of most display ads?
2. How are most text ads on Google billed? What’s the appeal for advertisers?
3. Contrast Facebook and Google click-through rates. Contrast Facebook CPMs with CPMs at professional content sites. Why the discrepancy?
4. What is the content adjacency problem? Search for examples of firms that have experienced embarassment due to content adjacency—describe them, why they occurred, and if site operators could have done something to reduce the likelihood these issues could have occurred.
5. What kinds of Web sites are most susceptible to content adjacency? Are news sites? Why or why not? What sorts of technical features might act as breeding grounds for content adjacency problems?
6. If a firm removed user content because it was offensive to an advertiser, what kinds of problems might this create? When (if ever) should a firm remove or take down user content?
7. How are firms attempting to leverage social networks for brand and product engagement? What advantages do ads on Facebook offer advertisers that they can’t necessarily get from competing online ad alternatives?
8. Describe an innovative marketing campaign that has leveraged Facebook or other social networking sites. What factors made this campaign work? Are all firms likely to have this sort of success? Why or why not?
9. Have advertisers ever targeted you when displaying ads on Facebook? How were you targeted? What did you think of the effort?

8.7 Privacy Peril, Beacon, and the TOS Debacle: What Facebook’s Failures Can Teach Managers about Technology Planning and Deployment

Conventional advertising may grow into a great business for Facebook, but the firm was clearly sitting on something that was unconventional compared to prior generations of Web services. Could the energy and virulent nature of social networks be harnessed to offer truly useful consumer information to its users? Word of mouth is considered the most persuasive (and valuable) form of marketing,V. Kumar, J. Andrew Petersen, and Robert Leone, “How Valuable Is Word of Mouth?” Harvard Business Review 85, no. 10 (October 2007): 139—46.   and Facebook was a giant word of mouth machine. What if the firm worked with vendors and grabbed consumer activity at the point of purchase to put it into the news feed and post it to a user’s profile? If you rented a video, bought a cool product, or dropped something in your wish list, your buddies could get a heads-up, and they might ask you about it. The person being asked feels like an expert, the person with the question gets a frank opinion, and the vendor providing the data just might get another sale. It looked like a home run.

This effort was named Beacon. Some forty e-commerce sites signed up, including Blockbuster, Fandango, eBay, Travelocity, Zappos, and the New York Times. Zuckerberg was so confident of the effort that he stood before a group of Madison Avenue ad executives and declared that Beacon would represent a “once-in-a-hundred-years” fundamental change in the way media works.

Like News Feeds, user reaction was swift and brutal. The commercial activity of Facebook users began showing up without their consent. The biggest problem with Beacon was that it was “opt-out” instead of “opt-in.” Facebook (and its partners) assumed users would agree to sharing data in their feeds. A pop-up box did appear briefly on most sites supporting Beacon, but it disappeared after a few seconds.E. Nakashima, “Feeling Betrayed, Facebook Users Force Site to Honor Their Privacy,” Washington Post, November 30, 2007. Many users, blind to these sorts of alerts, either clicked through or ignored the warnings. And well…there are some purchases you might not want to broadcast to the world.

“Facebook Ruins Christmas for Everyone!” screamed one headline from MSNBC.com. Another from U.S. News and World Report read “How Facebook Stole Christmas.” The Washington Post ran the story of Sean Lane, a twenty-eight-year-old tech support worker from Waltham, Massachusetts, who got a message from his wife just two hours after he bought a ring on Overstock.com. “Who is this ring for?” she wanted to know. Facebook had not only posted a feed that her husband had bought the ring, but also that he got it for a 51 percent discount! Overstock quickly announced that it was halting participation in Beacon until Facebook changed its practice to opt in.E. Nakashima, “Feeling Betrayed, Facebook Users Force Site to Honor Their Privacy,” Washington Post, November 30, 2007.

MoveOn.org started a Facebook group and online petition protesting Beacon. The Center for Digital Democracy and the U.S. Public Interest Research Group asked the Federal Trade Commission to investigate Facebook’s advertising programs. And a Dallas woman sued Blockbuster for violating the Video Privacy Protection Act (a 1998 U.S. law prohibiting unauthorized access to video store rental records).

To Facebook’s credit, the firm acted swiftly. Beacon was switched to an opt-in system, where user consent must be given before partner data is sent to the feed. Zuckerberg would later say regarding Beacon: “We’ve made a lot of mistakes building this feature, but we’ve made even more with how we’ve handled them. We simply did a bad job with this release, and I apologize for it.”C. McCarthy, “Facebook’s Zuckerberg: ‘We Simply Did a Bad Job’ Handling Beacon,” CNET, December 5, 2007. Beacon was eventually shut down and $9.5 million was donated to various privacy groups as part of its legal settlement.J. Brodkin, “Facebook Shuts Down Beacon Program, Donates $9.5 Million to Settle Lawsuit,” NetworkWorld, December 8, 2009. Despite the Beacon fiasco, new users continued to flock to the site, and loyal users stuck with Zuck. Perhaps a bigger problem was that many of those forty A-list e-commerce sites that took a gamble with Facebook now had their names associated with a privacy screw-up that made headlines worldwide. Not a good thing for one’s career. A manager so burned isn’t likely to sign up first for the next round of experimentation.

From the Prada example in Chapter 3 "Zara: Fast Fashion from Savvy Systems" we learned that savvy managers look beyond technology and consider complete information systems—not just the hardware and software of technology but also the interactions among the data, people, and procedures that make up (and are impacted by) information systems. Beacon’s failure is a cautionary tale of what can go wrong if users fail to broadly consider the impact and implications of an information system on all those it can touch. Technology’s reach is often farther, wider, and more significantly impactful than we originally expect.

8.8 One Graph to Rule Them All: Facebook Reaches across the Web with Open Graph

Facebook’s Open Graph offers the world a glimpse of the breadth and depth of Mark Zuckerberg’s vision. The initiative places the company directly at the center of identity, sharing, and personalization—not just on Facebook but also across the Web.

With just a few lines of HTML code, any developer could add a Facebook “Like” button to their site and take advantage of the social network’s power of viral distribution. A user clicking that page’s “Like” button automatically would then send a link to that page to their news feed, where it has the potential to be seen by all of their friends. No additional sign-in is necessary as long as you logged into Facebook first (reinforcing Facebook’s importance as the first stop in your Internet surfing itinerary). The effort was adopted with stunning speed. Facebook’s “Like” button served up more than one billion times across the Web in the first twenty-four hours, and over fifty thousand Web sites signed up to add the “Like” button to their content within the first week. (Facebook now includes several new verb options beyond “like.”)J. Brodkin, “Facebook Shuts Down Beacon Program, Donates $9.5 Million to Settle Lawsuit,” NetworkWorld, December 8, 2009; and N. Devore, “Facebook Moves Beyond the “Like” Button, Introduces New Verbs to Timeline,” OBI, “Jan. 25, 2012.

Facebook also offered a system where Web site operators can choose to accept a user’s Facebook credentials for logging in. Users like this because they can access content without the hurdle of creating a new account. Web sites like it because with the burden of signing up out of the way, Facebook becomes an experimentation lubricant: “Oh, I can use my Facebook ID to sign in? Then let me try this out.”

Other efforts allow firms to leverage Facebook data to make their sites more personalized. Firms around the Web can now show if a visitor’s friends have “Liked” items on the site, posted comments, or performed other actions. Using this feature, Facebook users logging into Yelp can see a list of restaurants recommended by trusted friends instead of just the reviews posted by a bunch of strangers. Users of the music-streaming site Pandora can have the service customized based on music tastes pulled from their Facebook profile page. They can share stations with friends and have data flow back to update the music preferences listed in their Facebook profile pages. Visit CNN and the site can pull together a list of stories recommended by friends.J. Valentino-DeVries, “Facebook CEO Zuckerberg on Plans to Dominate the Web,” Wall Street Journal, April 21, 2010. Think about how this strengthens the social graph. While items in the news feed might quickly scroll away and disappear, that data can now be pulled up within a Web site, providing insight from friends when and where you’re likely to want it most.

Taken together, these features enlist Web sites to serve as vassal states in the Facebook empire. Each of these ties makes Facebook membership more valuable by enhancing network effects, strengthening switching costs, and creating larger sets of highly personalized data to leverage.

8.9 Is Facebook Worth It?

It has often been said that the first phase of the Internet was about putting information online and giving people a way to find it. The second phase of the Web is about connecting people with one another. The Web 2.0 movement is big and impactful, but how much money is in it?

Now that Facebook is a publicly traded company, we can get real numbers on revenue, profitability, and growth, and we can use these numbers to compare Facebook against its rivals. In the quarter prior to its IPO, Facebook’s rate of revenue growth was 45 percent, down from 55 percent the prior quarter, which was down again from triple-digit growth the quarter before that.H. Blodget, “Well, Now that Everyone Has Sobered Up, Let’s Figure Out What Facebook is Actually Worth…” Business Insider, May 21, 2012. Usually at IPO time, markets like to see accelerating, not decelerating, growth. Facebook went public at a nosebleed rate of 65 times 2013 EPS (earnings per share). For comparison, still-growing Google traded at 13 times 2013 EPS at the time of Facebook’s IPO. At IPO, Facebook’s market cap was about half of Google’s, but if we compare the business in which Facebook and Google most closely compete, display advertising, both are roughly the same size (Facebook at 14 percent of the US market and Google at 13.8 percent), but Google’s display business is growing faster.C. Boulton, “Google to Pass Facebook in Display Ads in 2013,” eWeek, February 26, 2012. Google also had more cash than Facebook had revenue, and Facebook’s free cash flow is actually negative. This can be blamed on the cost to build data centers to support services users get for free (e.g., storage costs for the upwards of 300 million photos uploaded to Facebook each day).J. Cassidy, “Facebook: The Ultimate Dot-Com,” New Yorker, May 16, 2012. Table 8.1 "Comparing Facebook and Google at Comparable Periods in Time" shows a comparison of Facebook and Google at comparable stages.

Facebook went public as an 8-year-old, while Google went public after five years. Facebook’s revenues at IPO were $3.7 billion—about 2.5 times Google’s $1.5 billion revenues when it went public. Facebook’s $1 billion in profits the year before it went public equate to about ten times Google’s pre-IPO annual profit of $106 million. And Facebook’s market cap at IPO was about $104 billion, over four times Google’s post-IPO value of $23 billion. But the comparison isn’t Apples-to-Apples (no pun intended). Roll the clock back and 5-year-old Facebook (roughly the age of Google at IPO) actually lost $56 million on revenues of just $272 million. Google as an 8-year-old brought in $10.6 billion in revenue and $3.5 billion in profits, and it sported a market cap of over $150 billion. The 8-year-old comparison also isn’t quite a fair one since capital rose during Google’s IPO (and secondary offering where it sold still more stock), helping to fuel the firm’s growth over those three years. Still, 8-year-old Google made about as much profit as 8-year-old Facebook did in revenue. As TechCrunch points out, the five-year compound annual growth rate for each firm’s revenue during comparable periods (2002–2006 for Google and 2007–2011 for Facebook) was almost exactly the same: 89 percent a year.

Figure 8.4 Revenue of Google and Facebook in Billions of Dollars

Figure 8.5 Revenue per User (2011)

While Facebook has, at times, been the Web’s most visited destination, its user base generates far less cash on a per-person basis than many rivals do, including only about one-sixth of Google’s per-user figure.J. Yarrow, “Here’s How Much a Unique Visitor Is Worth,” BusinessInsider, January 5, 2011.

When considering a firm’s value, it’s also important to realize that just because the market is willing to pay a high price for a firm’s stock, it doesn’t mean that the firm is actually worth it. A firm’s stock price is supposed to reflect the net present value of a firm’s future earnings, and unrealistic expectations can distort value. Facebook’s stock plummeted following its IPO, losing about a third of its value in a little over two weeks. Much remains to be demonstrated for any high Facebook valuation to hold over the long term. As the chart in Figure 8.5 "Revenue per User (2011)" shows, Facebook still lags well behind many of its rivals in terms of revenue per user; all that time spent on Facebook simply isn’t worth as much on a per-user basis as time spent on Google or many other services. Also consider the uncertainty as the firm tries to leverage the social graph. According to Facebook’s own research, “an average Facebook user with 500 friends actively follows the news on only forty of them, communicates with twenty, and keeps in close touch with about ten. Those with smaller networks follow even fewer.”S. Baker, “Learning and Profiting from Online Friendships,” BusinessWeek, May 21, 2009. That might not be enough critical mass to offer real, differentiable value to paying advertisers, and interest in deepening connections among users with “value-shallow” social graphs may in part have motivated Facebook’s mishandled attempts to encourage more public data sharing. The advantages of leveraging the friend network hinge on increased sharing and trust, a challenge for a firm that has had so many high-profile privacy stumbles.

Facebook does have a lot of potential in terms of upside earnings. First, Facebook ads run only inside Facebook.com, but Google earns about 30 percent of its revenue from ads it runs on third-party sites (referred to as the Google ad network). Next time you search the web, look for advertisements labeled “Ads by Google.” Google serves up these ads and splits the take with Web site operators. If Facebook creates its own ad network, it might be able to offer ad targeting that performs better than Google’s so-called AdSense product. Google targets ads on other Web sites based largely on keywords found on those sites, also using details it can glean from tracking a person’s web browsing history (see Chapter 14 "Google in Three Parts: Search, Online Advertising, and Beyond" for details). Facebook can do all this, but it could also add in all sorts of data from the dark web that Google can’t see: data from a user’s social activity, their highly-accurate personal profile, and more. Turning on such an ad network would be simple from a technical perspective. The tough part, however, would be creating an ad network sales force and rolling it out in a way that doesn’t cause a privacy debacle or lead to a deluge of scare headlines.

Over a longer term, what about Facebook TV? Facebook almost certainly wants to play a starring role in your living room, making the TV a platform for social activity: video chat, serving targeted ads, social entertainment recommendations, games, and all sorts of commerce. It will be tough to navigate the tensions of bandwidth-capping cable guys, channel owners, and hardware firms keen to build their own platform, but Zuckerberg has Reed Hastings on his board—and as much as the Netflix CEO has been derided following the Qwikster debacle, no one has built a further-reaching platform with consumer electronics firms than Hastings.

Steve Rubel wrote the following on his Micro Persuasion blog: “The Internet amber is littered with fossilized communities that once dominated. These former stalwarts include AOL, Angelfire, theGlobe.com, GeoCities, and Tripod.” Network effects and switching cost advantages can be strong, but not necessarily insurmountable if value is seen elsewhere and if an effort becomes more fad than “must have.” Time will tell if Facebook’s competitive assets and constant innovation are enough to help it avoid the fate of those that have gone before them.