Thursday, October 17, 2013

Facebook's Missed Opportunity to Change Advertising As We Know It

It wasn't supposed to be this way. Those seemingly random ads that appear on the right side of your Facebook news feed were supposed to be hyper-relevant, super interesting, laser targeted and perfectly suited to each users' interests. At least, that's what Facebook said in its IPO, hyping the social network's ability to allow advertisers to target "specific interests that (users) have chosen to share with us on Facebook or by using the Like button around the web."

The word "relevant" appears 38 times in Facebook's Registration Filing, but relevance is not what Facebook advertising is delivering, is it? In the last week, friends like Forrester Senior Vice President Josh Bernoff have complained of seeing ads offering jobs in restaurants and New Yorker Nate Elliott was served ads for real estate in Denver. And in an example of retargeting rum amok, I continue to get ads for mens' shavers even though I shopped online and purchased one a month ago.

How did it come to this? The problem is that Facebook did not do anything to protect the value of the "like." Had brands collected authentic "likes" from authentic "fans," that data could have supported advertising based on actual consumer preferences. Alas, brands raced to collect meaningless fans and Facebook allowed the practice, so we find ourselves at a place where no one is happy--brands complain of their inability to reach all those meaningless fans without opening up the checkbook and users cannot rely on friends' "likes" as a meaningful signal of which brands they love versus which brands simply ran a sweepstakes on Facebook.

The biggest loser in this situation may be Facebook, itself. It strove to change the face of advertising, just like Google did a decade earlier. While other sites raced to amass "eyeballs" to which they could deliver ads, Google focused on serving the right ad to the right person at the right moment. In the end, those sites that chased eyeballs died while Google commands more than four out of every ten dollars spent on online advertising. That's what happens when you create a new, more relevant ad channel.

Facebook has not yet furnished a new, more relevant ad channel, and you can tell that even Facebook recognizes the situation. Gone is all the talk about "likes" creating bold, new ad targeting options; instead, Facebook today largely pushes the same sorts of digital advertising products as everyone else. You can upload your hashed email addresses to retarget ads to custom audiences. You can target your audiences demographically or by broad interest. And in Facebook's most recent announcement, you can serve ads to people who visit your websites or use your mobile apps.

If all that sound familiar, it is because it is--these ad options are little different than popular websites and ad networks have been offering for years. Of course, there's nothing wrong with selling "eyeballs" rather than evolving advertising in bold new ways, particularly when you have a monumental number of eyeballs to sell, but this puts Facebook advertising in the same competitive space as every other online ad option. While Google can command a premium for reaching people in ways advertisers find valuable, Facebook is offering substantially the same ad opportunities as Yahoo, CNN and other high-traffic sites.

For now, the undifferentiated ad strategy is serving Facebook well--it has doubled its stock price in the past three months, finally surpassing its May 2012 IPO price. But while many are bullish on the future of Facebook's stock price, I remain less so. (This is a good point to mention, I suppose, that I am not a financial advisor and the opinions expressed here are my own.)

Facebook is currently selling at a price/earnings ratio of 194 compared to Google's 27 and Apple's 13. The company has to increase its bottom line 700% to 1400% to bring its price/earnings ratio into the territory of comparable firms. While investors have cheered recent improvements in Facebook's earning, it is worth noting that the company's net income before taxes was up less than 10% in the first six months of the year. Investors may continue to buy Facebook stock at a tremendous price/earnings premium based on optimism, but that will not last forever; Facebook will have to deliver profound net income growth to keep its stock rising in the next year or two.

How can Facebook do this? With Facebook's user growth stagnating as the social network approaches saturation, revenue and income growth can only come from a limited number of different sources:

  • More ads: More ad impressions mean more ad revenue, but can Facebook continue to push more ads at users? We will likely find out, as Facebook may soon bring auto-run video ads to users' news feeds.  Given the increasing level of grumbling, serving even more ads to users seems a dangerous route, and Google+ and others would be happy to welcome today's social addicts if Facebook starts down the same path that doomed Friendster and Myspace.
  • Better ads:  Better ad opportunities can draw more of brands' ad budgets. This is why Facebook continues to evolve its ad platform with new products, and of course, the growth of usage and advertising on mobile is a bright spot for Facebook. Still, as Facebook mobile advertising becomes more common and familiar, the clicks (and ad prices) are likely to stagnate (which is exactly the same well-worn path that online ad performance and pricing has taken over the past fifteen years). In addition, while it is too late for Facebook to reclaim the value of authentic "likes," the company may yet be able with better text analytics and data mining to turn our posts and interactions into more valuable advertising for both users and marketers.
  • Different revenue streams: The best option for Facebook, in my opinion, is the one least evident in Facebook's recent actions, and that is for the social network to offer value-added non-advertising services that users would welcome. Facebook has tried and largely failed with offerings like gifts, but that doesn't mean this or other strategies may not be lucrative ways for Facebook to drive revenue diversification, income growth and higher stock prices. The growth of the sharing economy is one of the most profound changes occurring today, with double-and triple-digit growth for peer-to-peer companies such as Airbnb, RelayRides, Prosper, TaskRabbit and Lending Club. Today, the world's largest social network is sitting on the sidelines, but if it cared to innovate its business model as much as its advertising offerings, it could yet enter the peer-to-peer space in a way that would bring additional revenue streams for Facebook.

Facebook's IPO Registration Statement began with these words:  "Our mission is to make the world more open and connected." That is something the company has clearly achieved, but I see little of its mission evident in the company announcements in the past year or two. New advertising products may be cheered by Wall Street, but they do not make the world "more open and connected."  I hope Facebook does not forget its mission, because a world that is more open and connected economically is one that offers great benefits to consumers and Facebook alike.

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