Also read our counter-argument: Why Facebook will never make a significant profit
Facebook isn’t making much profit from its users right now. Its ads aren’t anything special, and few people click on them. Moreover, Facebook executives don’t seem to care. “We made the decision to continue to grow our headcount quickly in 2013, particularly in product development,” chief executive Mark Zuckerberg said Jan. 30 in the company’s earnings call. “This will likely cause our expenses to grow at a faster rate than we expect to grow our revenue this year, which means that we aren’t operating to maximize our profits this year.”
That has caused my colleague Christopher Mims, among others, to argue that Facebook will never make a significant profit. They argue that Facebook will always have slim margins and rely on sheer volume to generate a larger total sum. (Parallels are often drawn with Amazon, which seems content for now to stick with razor-thin margins.)
I think they’re wrong. Facebook’s competitive strategy—to get more users in more places before working out how to make money from them—will give it a virtual monopoly over social media across the globe. That’s a far more important long-term benefit than immediate profits for shareholders. And once the company has this monopoly, it can and will capitalize on it.
Its users are invested
Having had Facebook since high school—more than six years—I’ve invested what probably amounts to weeks or months in giving it information about myself. I’m not alone here; the median age of Facebook users is 22, and contrary to folk wisdom that “the kids don’t use Facebook any more,” it has come down from a high of 26 in 2007.
This is not an investment that anyone currently older than about 30 might understand. Facebook is more than a fun place to stalk people: It’s a history of my life, and the basis of my social life. I plan just about every organized social activity on it—in fact, I would have a hard time throwing a party or even just finding things to do on the weekend without it. When I’ve gone for a while without checking it, I’ve lost touch with friends or missed events that I wished had gone to—a painful reminder that I need to constantly be connected.
I wouldn’t invest that much in another platform without some serious persuasion. It would have to offer me some new abilities that Facebook doesn’t.
Beating competitors
There’s virtually no way for Facebook to lose its audience unless such a platform, offering new abilities, appears. And Facebook realizes this. When Instagram, which is little more than a photo-sharing app for mobile devices, became wildly popular, Facebook snapped up it and its 13 staff for $715 million. The company plans capital expenditures of $1.8 billion this year. That, in addition to its $9.6 billion in cash on hand, allows it to effectively scuttle any other company’s dreams of becoming a rival.
Indeed, the only real competitor would be Google. Like Facebook, it knows an enormous amount about its users—through their email, bookmarks, searches and more. But there’s a good reason why Google+, the social network it launched publicly 14 months ago, still trails far behind Facebook. There’s not much you can do on Google+ that you can’t do on Facebook, and people don’t have much incentive to make the switch.
As the chart above demonstrates, Facebook isn’t far from from global dominance. True, in a handful of places like China and Russia, home-grown social networks managed to become dominant first. But Facebook will soon be the go-to social media site for most of the world. The median age of the global population in 2012 was 28.4 years, skewed by a young population in emerging markets, where many people are still just about to come online. They will have many years to invest their time and social lives in Facebook, and they won’t be willing to give up that investment easily. This dominance gives Facebook some time to start turning a profit.
The big “M”—Monetization
How to do that? The key argument for why Facebook can’t make money is that its ads are just like any other ads on the internet; and that unlike Google’s ads, which are tailored to your internet searches, Facebook’s ads don’t answer a need that you have at the moment you see them.
But what about when you are arranging vacations and parties, making dinner reservations, booking tickets to concert or a game, buying clothing for your sports team or supplies for your art class, or anything else that requires coordination with groups of people? The current ways of doing this—emails, telephone calls, even online Google forms—are notoriously inefficient.
The key to Facebook’s business will be that it is so extremely useful for organizing groups of people around an activity. In its future updates, Facebook could connect its service to vendors like no other company. Everything about an event—agreeing on a time and place, making reservations, buying supplies, sending last minute updates, and so on—could be done through one interface, and when those things involve interacting with a retailer, Facebook could direct you to one. This is much more than just an ordinary ad, and Facebook can charge retailers for it.
Facebook’s recently-released Graph Search could give this kind of activity an extra boost. It helps you find people among your friends or their friends who share an interest. Want to create a book reading circle, or a running club, or get a group together to visit that museum that none of your regular friends is interested in? Facebook can help, and can then potentially make money from directing you to a vendor.
So the ads Facebook currently runs, and which make up its lackluster revenues, are just a sideshow—a first step into an industry of buying, selling, and planning that only Facebook is currently positioned for. Sure, the company will have to be nimble to stay ahead of potential competitors, both existing and unexpected; but if it does that, it can build on a wealth of information and investment in its platform that no other company has.