Field Services: Making Money Advertising

For years, the conventional wisdom in Silicon Valley was that social networks were expensive to run, and didn’t make much money. So as Facebook grew by hundreds of millions of users over the past few years, many people wondered if it was in financial trouble.

Revenue, however, appears to have doubled every year since 2007. And at this point it appears to be increasing even more sharply.

Based on what we and others have heard, we’ve tracked Facebook making $150 million in 2007, slightly less than $300 million in 2008, and somewhere up to $800 million in 2009. A number of reports have suggested that it will make $2 billion or more this year, and we have also heard the same estimates in recent months — up significantly from the $1.1 billion number that the company loosely confirmed earlier this year.

How? Through growth in brand and performance advertising — payoff from years of investment — with revenue from its Credits virtual currency only starting to kick in.

But, aside from bits of information provided by sources close to Facebook, there is very little information available about how the latest revenue numbers actually break down. So here’s a closer look at what we think is going on.

Some high-level points, before we get started. Facebook’s user base has boomed from around 375 million at the beginning of the year to somewhere around 575 million today, with growth happening across the world, in all types of advertising markets (see our Inside Facebook Gold report for more details on Facebook’s worldwide traffic). Engagement is also massive: Facebook says that more than 50% of users visit the site every day.

Facebook’s product development has focused on continuing to increase engagement and gathering more user data — factors that help it target advertising more accurately to more people more often. And although we’re focusing on revenue here, we should also note that Facebook has made significant hardware and software investments to reduce infrastructure costs, helping it to become profitable as of late 2009.

Performance advertising

Zynga and other social gaming companies began utilizing Facebook’s self-serve advertising system in order to reach more users over the course of 2008 and 2009. Along with a smattering of online performance marketers, and a few early adopter small businesses and major brands, the developers provided significant boosts to Facebook revenue in past years.

That trend has continued, with local advertisers, social game developers and group buying sites like Groupon reportedly making massive investments. Advertisers have reported prices steadily rising as more of them figure out how to achieve their desired returns on investment. As of this past fall, the average cost-per click in Facebook’s largest market, the United States, is around one dollar. For developers interested in learning more, we’ll be examining how advertising is working for Facebook and developers at our Inside Social Apps conference in late January.

Facebook has been making a significant new effort to help performance advertisers spend more money. It introduced an advertising API last year that allows third-party service providers to place thousands of automated, highly targeted ads on behalf of clients. While that program has rolled out slowly, big search marketing businesses like Omniture have moved in to offer services to clients, and a dynamic ecosystem of startups are competing for clients as well.

Facebook also ended most parts of its original advertising deal with Microsoft, where that company ran banner ads on the site and split the revenue — the relationship is now more product-focused, on things like social features for the Bing search engine.

In addition to more users, more engagement, more advertisers, and the new options available through the API, that switch helped make even more inventory available to sell against.

Brand Advertising

Facebook has been trying to pitch Madison Avenue on the benefits of its advertising services for years, and all those efforts appear to be paying off now. Most major brands at least have a Facebook Page today, and dozens have created more sophisticated applications, Facebook integrations on other sites, and other campaigns designed to engage with users.

While Pages are free, Facebook upsells owners into its performance and brand advertising services. The home page ads are only available to companies that spend $50,000 or more, and include a variety of engagement-focused options, such as the ability to Like a Page or RSVP to an Event with a single click.

The company has also aggressively stepped up its sales efforts to large brands, building out its staff in New York City and many other offices around the world, and hiring a series of veteran salespeople away from other technology and media companies.

While there’s little information available about the amount of revenue now coming from large advertisers, anecdotal evidence suggests it is booming. For example, a number of Page management companies, like Buddy Media, are saying that they’re seeing significant new interest.

Credits

While still in its early stages, Credits will likely form another key revenue driver for Facebook in the future. This past year, the company made it clear to developers that Credits would be the only payment option for virtual goods in canvas applications. While many companies have not fully integrated Credits yet, expect them to in 2011. Also look for Facebook to expand Credits to the web and mobile devices — something that many have speculated about, but has not yet happened. If Credits proves to be a big success in 2011, we expect Facebook to quickly expand it beyond the home site.

In 1995 I remember waiting in lines to buy Windows 95. It effectively ended the design lead Apple had for 11 years in personal computers. From then on Microsoft had both the thought leadership and the market share. Apple ended up with less than 10% market share. Microsoft had most of the rest.

Lots of people think that Apple could repeat 1995 in 2011. This time with iOS instead of Macintosh OS and with Google in the place of Microsoft.

We forget one little thing: 1995 was different.

Here’s how.

In 1995 Microsoft had a HUGE marketshare lead with DOS. That meant it had a huge army of developers who didn’t want to switch over to Apple’s system, which they saw as very closed and inflexible. I remember developers coming into the consumer electronics store I helped run in the 1980s and they’d complain bitterly about Apple’s policies (Apple was far less flexible back then than it is today and forced developers to fit into a “look and feel” set of guidelines).

But I look at who is making money. Back in 1995 developers were mostly making money from DOS. Remember, this caused WordPerfect and Borland to make bad bets. They bet on DOS for too long, while Bill Gates went and built some of the first and best Macintosh apps. The lesson, though, doesn’t pass from 1995 to 2011. Today where are most of the developers making their money? iOS (according to Sephora, Starbucks, OpenTable, eBay, and many other developers). So, Android has to convince developers to switch, or do both platforms at same time. That’s quite different.

Plus, back in 1995, who owned the best distribution and supply chains? Microsoft did. Today? Apple does. Apple didn’t have stores back in 1995 which will ensure its products get seen in the marketplace. Back then Microsoft could outspend Apple for shelf space at Frys and other retailers. Plus, Microsoft’s model of having many OEMs building hardware for its OS was far superior to Apple’s approach. Today that’s not really true, because the OEMs aren’t really able to bring that much value to the table and Apple has the best supply chains in China locked up (I visited one of them about two years ago and keep in touch with the folks there and that’s still the case). So, it’s not very likely that a Google phone will ship with better screens or better materials. At least not in volume. That is a huge difference from 1995 to today.

Other differences? Apple has outspent Microsoft on Advertising around the world. Look at this picture. It’s in Paris subway. Apple bought every square inch of advertising space (it bought the entire subway system’s advertising space, it seemed, iPad ads were plastered down the entire trackway). Google isn’t able to get its message there. That didn’t happen in 1995. Remember how dominant Microsoft’s advertising was back then? Microsoft even convinced the Empire State Building to change its colors that evening.

Let’s go back to how closed Apple is. Most apps this month got approved in less than a week. Some even got approved in less than four days. During the Christmas rush. Is this as good as Android’s (you can ship in minutes) policy? No. But, on the other hand, there are quality controls which consumers appreciate. The apps — overall — ARE better on iOS than on Android. Just check out TweetDeck. It crashes every few minutes on my Android phone. Twitter isn’t nearly as nice. Facebook isn’t as nice. And most apps aren’t as well designed, nor crash resistant, as on iOS.

I am sensing a switch, though. Fred Wilson is leading the charge. But other developers are grumbling about Apple and want there to be an alternative and they are all comparing notes with each other. “How’s Angry Birds doing with its advertising-only Android apps?” they ask. Very well, the answer comes back. So that means more developers will take the bet on Android, but so far I haven’t seen many go “Android only.” Why not? Because they know most of the PR comes from journalists who use mostly iOS devices and most of the best users are on iOS devices too (Sephora’s lead mobile developer told me 80% of the users who pull out a mobile phone in her stores are using iOS, that is echoed by nearly every developer I talk with). Even Swype, which has been kept from delivering their keyboard on iOS devices showed me a prototype of it running on an iPad and the inventor whispered “if Steve Jobs wants to talk, we’d love to ship this on iOS.”

So, when someone says that Apple is repeating the mistakes of 1995 (yes, I’ve been guilty of saying that in the past couple of years too) you should tell them that 2011 is not even close to the same set of conditions as 1995 has.

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Thursday, January 6, 2011

Making Money Advertising

Performance advertising

Brand Advertising

Credits

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