Where does Facebook go from here

Reach is fine, but where are the revenues going to come from?

Facebook co-founder Mark Zuckerberg has always favoured reach over revenues. The strategy was successful as Facebook overran rivals Friendster and MySpace to become king of the social networking space. But Zuckerberg’s company faces an acid test this Thursday, when it announces their earnings for the first time after they turned public in May. Following a botched IPO and a subsequent drop in share price, Facebook has been under the gun, and questions been asked whether its worth the stratospheric $100 billion valuation, it commanded on debut. Wall Street will watch developments very closely. A Thomson Reuters poll projected that Facebook will clock $1.1 billion in second quarter revenues on earnings of 12 cents a share. According to a new forecast from Brian Wieser, senior research analyst at Pivot Research Group, the company will grow 32 per cent this year to $4.2 billion and $12.6 billion by 2017.

But will this assuage investor fears on current growth prospects?
Facebook earns most of its money from personalized ads displayed to its users, contributing to 85 per cent, the rest comes from subscription revenues from games and other apps. Revenue growth is closely linked to user growth, which has been dipping, especially in U.S., its biggest and most lucrative market. According to a Wall Street Journal story that cited ComScore numbers, U.S. user growth has dropped to 5 per cent, down from 89 per cent a little over two years ago, growth last year was at 24 per cent. This was to be expected, Facebook already reaches out to 71 per cent of the 221 million U.S. users. Emerging markets like Brazil and India are expected to offset the dip from the developed world, but while they may contribute sheer numbers, they are low in advertising dollars. Compared to $9.51 in advertising revenue per user in the U.S. and Canada, Asia and the rest of the world contributes only $1.79 and $1.42 per user. 

Meanwhile advertisers are questioning the efficacy of advertising on the site. A few days before the IPO, GM pulled out all its $10 million from Facebook, claiming that the social networking giant’s advertising credentials were largely unproven. Facebook faces an uphill task of convincing current advertisers to stay, and figuring out how to make more money from less lucrative markets, and especially mobile. Search engine Google was in a similar spot when it favored proving its search technology first and then thinking of monetization. Google started spouting wads of cash after it unlocked the holy grail of search advertising when it launched AdWords (sponsored ad links) and AdSense (external web publisher ad program). Zuckerberg and his team are fully aware of that they face similar challenges in the social networking universe. In 2010, they snagged Gokul Rajaram, the engineer behind Google's lucrative AdSense engine, to head its advertising products division. Rajaram’s efforts were unveiled last month, when they launched Facebook Exchange, a technology that tracks user behavior on third party sites and then serves targeted ads. So for instance, a user who was on an auto site looking for an SUV, will see offers from Hyundai or Ford the next time he logs onto Facebook. The second thing debuted, is the more interesting and perhaps more profitable, in the future. It also takes rival Google’s AdSense initiative head-on. Facebook ads have started appearing on Zynga, analysts say that this will soon extend to third party sites. This is still an experiment, no telling evidence has emerged on how users and external sites are going to respond, but it’s a step in the right direction.

Importantly, Facebook has started taking stabs at its biggest Achilles heel- mobile. One of the main reasons for the mismanaged IPO and drop in share price was because Facebook, disclosed rather late that users were increasingly using mobile to access the site, an area where it makes little or no money. The $1 billion Instagram buy was just the first step in conquering mobile. Zuckerberg for long had realized that Facebook’s future is closely linked to unlocking the full potential of mobile. Just being another app on a smartphone without having full control on their mobile browsing habits won’t cut it. Last year rumors started doing the rounds about a Facebook phone codenamed ‘Buffy.’ Many Apple engineers that have worked on the iPhone have been recruited to work on the project. This could be a smart move. Among consumers polled in the U.K. one-third of them said they would switch to a Facebook phone and 73 per cent thought of the phone as a ‘good idea’. Mobile revenues maybe negligible currently, it nevertheless has a huge upside. This must gladden investors as they ponder whether to sell the stock or hold onto it.

Analysts point out to other ways that Facebook could make money: launch a search engine to compete with Google and a payment platform to take PayPal head on. While there is no indication on the search engine, the payment platform has already been launched. Now users can use their local currency to buy Zynga games and other app purchases. Combine the payment platform with mobile and you have a killer combination for online purchases.

Zuckerberg’s strategy to ‘build the audience base and the advertisers will come’ may not have borne fruit completely yet. But whatever happens this Thursday, Facebook’s growth potential stands on a steady wicket. However, it should be forewarned, that while it sweats to extract revenue from users, it should not forget that if it disgruntles them in the process, they might log-off, just like they did with Friendster and MySpace.