FACEBOOK’S FLAWED MODEL IS A GAMBLE ON POTENTIAL
DIRECTOR OF CURRENCY RESEARCH, GFT
IS THE Facebook IPO a good investment opportunity? Naturally, to research that question I went to Twitter. Within minutes I was able to collect all the relevant information on the pros and cons of the IPO. Therein, in my opinion, lies the problem. Facebook is just not nearly as useful as its valuation implies.
I haven’t been on Facebook in weeks. My newsfeed is littered with comments from people I don’t know, in languages I don’t understand, doing things I couldn’t care less about. I have never looked at an ad on Facebook, much less even considered buying something from it. And although my personal stance may be extreme, my experience is hardly unique.
Facebook has not disclosed its click-through rates in its offering memorandum but, according to independent analysis from market research firm Webtrends, performed on more than 11,000 Facebook campaigns, the average click-through rate for Facebook ads in 2010 was 0.051 per cent, which is about half the industry standard of 0.1 per cent. The rate, paltry as it is, dropped from 0.063 per cent in 2009, pointing to a downward trend.
According to Peter Adriaens, a professor of entrepreneurship at the University of Michigan’s Zell Lurie Institute for Entrepreneurial Studies, “[Facebook] has talked about…the fact that it has about 40 per cent of all online banner ads, and that the cost per advertising paid to the company has gone up by 18 per cent, but it didn’t take it all the way through to the next step, to the click-through rate.”
Advertisers are now paying a premium to Facebook, on the assumption that the company can deliver a highly targeted audience, but the very poor click-through rate indicates that customers completely ignore those ads. And it is easy to understand why. Facebook is a social application and people simply hate mixing business with pleasure. Putting ads on Facebook is like turning the whole site into a massive multi-level-marketing company, like Amway or Nuskin. Who wants to buy soap while you are gossiping with your friends?
Contrast that with Google, a much more utilitarian piece of software that actually performs a productive function. Most people who shop gladly use Google and are readily susceptible to advertisements because they are in a transactional frame of mind. Little wonder then that Google ads have higher click-through rates and deliver much better tangible results to businesses.
Facebook is basically a glorified family photo album for the entire human race. As such, its acquisition of Instagram was quite astute (although at $1bn (£618m) many could argue that they overpaid). However, a photo album is not a business model. At its current valuation, Facebook will be worth as much as Google, although it earns only a tenth as much revenue. Furthermore, its sequential quarter-on-quarter growth is slowing – hardly a good reason to be uber bullish on the company.
Facebook’s popularity exploded precisely because its founder Mark Zuckerberg insisted on not polluting the site with commercial interruptions. However, now that it is becoming a public company, the pressure to monetise its social networking model could be Facebook’s undoing. If users find the Facebook experience too invasive, and advertisers find its platform unproductive, investor disappointment will surely follow.
There is only one scenario under which the company will become a screaming buy – legalised gambling. Presently, Facebook receives more than 15 per cent of its revenue from Zynga, but there are only so many people on this planet who are willing to waste their time playing Farmville and Mafia Wars. Online poker, however, is another story altogether. If Facebook can become the virtual casino to the world, its profit potential will be enormous. Until that time, I would pass on the stock.