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Facebook: 100 billion dollar baby

Federico Torri Principal, Consulting

According to the Wall Street Journal, Facebook is planning to launch an IPO in the spring of 2012 with a USD100 billion valuation, reflecting the company's ability to capitalise on its extensive user base and traffic.

What is Facebook? Well, nothing special – it is us connected

A 'facebook' is a book that is made up of photographs of individuals, along with their names, published at the start of the academic year to help students, faculty members and staff to get to know each other better.

"[Facebook] was revolutionary because it was the first place that most people had on the internet, where they felt safe expressing their real self."1 The emergence of Facebook represented the sign of a growing demand for a single point of online contact to collect and convey relationships and experiences globally.

Why so valuable? Because there are lots of users actively engaged

Social network websites now reach 82% of the world's online population (in terms of monthly visitors), representing 1.2 billion users.2 The trend is now largely reflecting the Internet curve: as people begin to go online, they start to connect with each other.

To the detriment of other popular social networks, Facebook has already emerged as dominant player. The company is experiencing impressive growth in its user base (800 million active users to date) and this is occurring on a global scale (more than 75% of users are outside of the USA) with an ever-increasing level of engagement (on any given day, 50% of active users log on).3 This strengthens the business model through a network effect or externality: Facebook's services become more valuable to other users as each new user joins.

Even more significant is the amount of time users spend on the site: Facebook accounts for approximately 3 out of every 4 minutes spent on social networking sites, and 1 in every 7 minutes spent online.4 The time spent is taking share from web-based communication, email, and instant messaging, reflecting the emergence of social networks as a primary communication channel.

What is fuelling growth? Mobile devices, allowing on-the-go real-time interaction

Social networking is growing everywhere despite significant social and cultural differences between countries. Most people still accesses social networks via classic PC-based web interfaces, but mobile devices are providing the means to connect on the move and interact in real time, driving up customer addition – and also customer addiction.

How is Facebook making money? Essentially through ads and credits

The core revenue-generation method is display advertising. By using users' statistics, keywords, location and pages that other friends 'liked', the company provides advertisers the means to finely target potential customers through advertising posts. Facebook is also a leader in 'intermediary' schemes: it provides third parties with the market and the essential tools to develop profitable business models. Facebook also earns significant revenues through 'Credits', a virtual currency that enables users to purchase items in games and applications: Facebook retains 30% of the revenue earned through such Credits.

Figure 1: Facebook’s revenue model [Source: Analysys Mason, 2012]

Facebook’s revenue model

 What is the outlook? An IPO valuation of USD100 billion

Facebook recently underwent an overhaul in terms of design and user experience, introducing Timeline and Open Graph and offering expanded media features and developer tools. These improvements have had a remarkable impact on Facebook’s value and appeal.

As Facebook grows, its advertising and virtual currency models bring in multi-billion dollar revenues (estimated at USD4 billion in 2011), leading to a very high valuation. The company is hoping that this will be boosted further by recent enhancements such as Timeline and Open Graph, as well as expanded media features and tools for developers.

This year, Facebook is expected to own 72% of all revenues from social network advertising (estimated to be USD10 billion by 2013) and 6.1% of worldwide online ad spending. Facebook is already deriving significant value from its users (an estimated USD5 in revenue per user year), greater than other similar companies with a smaller size (for example, Skype at USD1.3, Zynga at USD3.6 and LinkedIn at USD3.3).

According to Reuters, Facebook enjoyed a 30% profit margin during the first half of 2011. For comparison, technology giants like Microsoft and Google have profit margins of over 33%, while LinkedIn has a margin of 4.5%. However in light of the rapid dynamics of the Internet industry, and in particular the way in which social networks such as MySpace have faltered, the sustainability and the weaknesses of the business model – especially in the long term – are still to be tested. In particular, if the usage statistics are already as high as reported, rapid growth in users or time spent online may not be sustainable: there may simply not be enough Internet users, or enough hours in the day. 

1 Mark Zuckerberg at F8 conference.
3 Facebook website.
4 Comscore.