Friday, July 8, 2011

Why Facebook May Really Be Worth $100Bn

I wrote my last post about how Facebook was a bubble, so now I am going to eat my words and explain why I think Facebook might be worth its price after all.  

I have long been a FB-apostate when it came to seeing the platform’s monetization potential: big, yes, but $100Bn big?  Now however I’m starting to see the light.  And it's not because of advertising.

I believe that Facebook has won the online identity war, and the spoils will be enormous.

Companies like MSFT and GOOG have forever been trying to create a single identity for users to use across the web, from MSN Passport cum Windows Live, to the simply titled Google Account (or is it Google Profile?) cum Google+.  Other, parallel efforts have focused on being a one-stop destination for all things online, from the Yahoo! Portal to iGoogle. But FB has actually done it, and not as a bolt-on afterthought but as their core competency (granted the portal was Yahoo's core competency, they just weren't very competent at it).  Because identity is a natural monopoly, this makes FB’s dominance of this space difficult to challenge.  

The Problem with Multiple Online Identities

People may talk about wanting to have different identities in different online contexts, but the reality is that all of these identities are exhausting to maintain.  We think that b/c we can do this in real life – be a different person at work, place of worship, or a bar – we should be able to do this online.  We want to avoid having these identities clash.  But in real life we shift identities intrinsically, with very little conscious curating, as many pieces of psychology research have shown, and furthermore, real life identities are separated by the physical and temporal boundaries they exist in.  And even in real life identity clashes are inevitable; we've all experienced the awkwardness of running into a boss or professor at a nightclub, after we or they have had one too many drinks.

Online, where identities are much more publicly visible and personal branding much more explicit it is just plain prohibitively expensive from a time and effort point of view to manage too many social network identities.  I just about manage to keep my primary online identities up-to-date, reasonably curated, and properly permissioned on privacy settings - I consider LinkedIn, FB, and Twitter to fall into this category; I would need a full-time social media expert to keep track of the proliferation of accounts in various states of disarray that I have on Hashable, Plancast, Dinevore, Foursquare, TripIt, MeetUp (which actually requires a separate profile for each meetup you join), Google Profile, Disqus, Tumblr, Blogger, Doostang, etc.  And that doesn't even take into account the MySpace, Friendster and Plaxo profiles that are still drifting out there somewhere in the ether.

Google+'s Challenge

There is a certain "natural monopoly" that the incumbent social networks have established, according to the two main categories of identity in modern life: FB for personal, LinkedIn for professional.  

Other sites have caught on among particular niches:

-Social niches: StackOverflow for programmers, Flickr for serious photographers, Fitocracy for fitness buffs, etc., due to the relatively self-contained nature of the overlap between the real-life needs of these communities and the feature sets of their virtual counterparts.  

-Geographical niches: Orkut for Brazil, RenRen for China have also flourished among those who don't need to connect outside of them.  

Everyone else who has tried to compete for the broader identities, and here I would list Friendster, MySpace, Bebo, Eons, Classmates, Doostang, Plaxo, etc., have fallen by the wayside as they either couldn't garner a comprehensive network effect or didn't target a sufficiently self-contained community to be a niche site.  

Twitter is the exception that proves the rule, as it's not really a social network but rather a public broadcasting platform, and far from pervasive outside of the digerati.  
This is the challenge that new social network entrants face: social media identity fatigue, and strong, pervasive incumbents.  

Google+ may create value for Google by adding social information to its data store, but I can't imagine people going through all of the trouble they have gone through to rebuild their Facebook identities and social graphs.  As a result it is hard for me to see Google+ becoming a serious Facebook competitor in the sense of a broad-based online identity.  Like Quora last winter, Google+ is the hottest item in the tech world at the moment, but will the interest continue once people satisfy their curiousity and have to deal with the long slog of managing another online identity over time?

What's the Value of an Identity?

The ability to own an individual’s online identity brings so many abilities to extract rent - not only in the form of advertising, but in virtual currency (like an app store), paid content, or even real currency processing on a B2C level - that $100Bn of value really does become believable. As Facebook’s tendrils reach out across the web, with Facebook Connect and Facebook Comments, expect to see more of these rent extractions.  

Facebook is already the number one distributor of casual online games, and is—or close to—distributing Netflix, Skype, Warner Brothers, etc.  Taking 30% of payments for an ever-expanding list of items builds a significant non-advertising revenue stream, to the point where I can see Facebook no longer being a primarily advertising-driven business.  Zynga alone is expected to contribute over $400MM to Facebook's top line in virtual currency payments this year (plus easily over $100MM in advertising, although this number is harder to break out).  Facebook, not Apple, could become the leading distributor of online content (could this be part of the motivation behind Facebook's foray into mobile handsets?). 

On the advertising front, the fact of being a distribution channel - regardless of the revenue split - makes inventory on the site that much more valuable, getting advertisers closer to the point of sale as possible.  And that’s without even getting into the customization of ads and recommendations according to the social graph, which is already old news.

The Skype Announcement and Facebook’s Intentions Made Plain

Mark Zuckerberg’s announcement on the Skype partnership Wednesday confirms that Facebook is indeed planning on going in the direction of being a one-stop destination for the delivery of online content and consumer services.  Zuckerberg has smartly moved from focusing on the metric of how many users are on his platform to how active those users are. 
Some of Zuckerberg’s key points, from C-Net’s live-blogging of the event

·        Regarding the rumor of 750M confirmed users, Zuckerberg says it “was not reported because the company doesn't think that's a metric worth tracking.”

·        Sharing per user is the new key metric, and is doubling year over year, “with features like profiles, photos, newsfeed, platform apps, comment likes, the like button, groups and messages.

·        “The last 5 years have been about connecting people, and the next 5 years are about connecting the apps. What you're going to see is people building social networking into their apps. Netflix is a good example of wanting to build social stuff. Now that there's social infrastructure out there, people are going to do that.”

Now imagine a world in which sharing expands not only in quantity, but also in features, including paid media and services.  And imagine Facebook as the owner not only of that sharing, but of the distribution itself.  TechCrunch interviewed Andrew Bosworth, Facebook Director of Product Engineering, who delivered a similar message about Facebook as infrastructure:
“It’s not about what Facebook does in terms of the apps space, it’s about what the social infrastructure enables to be built. As much as we have some things that we’re working on, I think some of the most exciting things are things we’re not working on, that somebody else should be working on to fill out those bubbles on that law of [exponential growth of] sharing graph”

So there you have it.  Facebook is the most popular destination on the web, and owns individual identities and the social infrastructure.  This is Facebook’s value proposition, not the ability to serve ads for things sold elsewhere, no matter how well targeted based on social data.

The Potential for Backlash

The counterargument to what I have laid out above is that having one company own the online identity is that this creates privacy issues, and consumers will rebel.  Business Insider wrote about Facebook's attempt to win the war for online identities back in 2009, but in 2011 it looks like the war is over.  Even Friendster and MySpace use Facebook Connect, and TechCrunch looks thrilled to be using Facebook Comments.  It's no wonder that China wants to buy a significant piece of Facebook, or that we should be concerned by the idea (I can envision, as surreal as it might be, a political backlash in the US interfering with an attempt by China to make such a purchase).  But short of outright, scary censorship by China, it's hard to imagine people abandoning Facebook any more than they abandoned Microsoft in the 90's and most of the 2000's because it was too powerful.  And Facebook's hold on users is arguably stronger even than Microsoft's at its heyday.  Therefore I predict that while people will continue to gripe about Facebook, the switching cost to abandon it will just be too great to see an exodus.  Consumers don’t often vote with their feet against monopolies – that’s why we have government regulation in this area.  People generally just deal with the inconvenience.

Some might point to Friendster or MySpace as examples of incumbents that lost the social networking lead, and say that Facebook risks a similar fate.  The difference is that those sites led at a time when social networking was still a relatively niche phenomenon – how many users over 40 were ever on Friendster or MySpace – while Facebook has not only made membership mainstream but also usage and sharing.  This is why Zuckerberg is stressing the exponential increase in the amount of sharing per user on Facebook; Facebook has become qualitatively different from its predecessors, not just bigger.

The other potential for backlash comes from the developer community.  Facebook like Apple, has a nasty history of taking the most popular third-party features and building in-house alternatives to them, or of imposing seemingly unfair conditions on developers or content distributors.  However given Facebook’s unmatched reach and engagement, I don’t foresee an exodus of contributors to their social ecosystem.  Rather the examples illustrated above point to the opposite trend.

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