This blog-post is part of a blog series, where we understand the businesses of two tech giants who have revolutionized our lives: Facebook and Amazon. As we understand and analyze their mission, business model, leadership, and valuations - we will reach a conclusion to which side investors should take. This post focuses on understanding Facebook's business model and how to value it.
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"To give people the power to share and make the world more open and connected" , is how Facebook states its mission.
At its heart, it's a social media company which owns the largest social media platform this world has ever seen. The platform consists of 1.59 Billion MAUs (Monthly Active Users), and humanity has truly never collectively seen such a virtual environment before.
As the mission states, by giving 'Power to share', Facebook gives more and more ways for people to engage, and in the process it keeps building their life's timeline in such a way that they'll never want to let go.
One of the best things about a social media business (as against a conventional media business) is that it is a 'self publishing platform'. Facebook does not have to invest in content, and run the risk of investing heavily in content that users might not like. Here, users create content themselves and it being their own (or friend's) content - they do like it. And in the process of telling their friends, family or the world about whatever they're doing and wherever they're going, they tell something really important to Facebook - they tell them what the corporations in the entire world want to know about the consumers. Yes, Facebook gets your 'data'. Each picture you upload, check in you do, each time you like - you tell Facebook what kind of places you go to, what kind of people you're with and what are things you like (and might buy?).
While 'Facebook sells your data' is a controversial way of saying it, putting it nicely - it curates your information to get you the most relevant ads. Yes, there's the word - 'Ads'. Looking at how it makes money, you can call Facebook an 'internet ad-tech company'. It basically sells ads - and that's how it generates revenues.
Think of Facebook as a company that owns life-long bill-board rights to the most populated country in the world (with population of ~1.6 Billion people). In addition to bill board rights, it also owns the technology to make and run 'smart bill boards' - i.e. where a same bill board might show you a different ad if you're above 60 years old and like to cook, than to me - who is a 26 year old and likes to invest. You see a crock pot on sale, and I see a discount on Wall Street Journal's annual subscription. Isn't that genius? Putting the vastness of the country and the bill board technology together, you can say that Facebook owns almost infinite advertising real estate. It will continue to score accelerated ad revenue as it start to puts up ads in other parts of the country (monetizing), as far as people have reason to stay and they don't flee the country (Facebook platform).
Now while each ad isn't worth a lot, you can imagine that there's minimal extra cost in putting that ad in there if you already own the real estate- thus, the revenue number for the business aren't huge, but margins are great (it's Non GAAP margin in 2015 stood at 60%). The more people use the platform, the more information people share, the better ads they get, and more money Facebook makes. That's the business model basically.
On the other side of the argument, you can say that the whole model is based around a single platform - Facebook; and the world has seen many platforms like MySpace, Orkut, etc come and go. They have been popular with youth in past and youth is known to change its preferences at the pace of fashion. While in my opinion, Facebook is definitely not Orkut 2.0 and its difficult to assume people fleeing altogether, every now and then a 'new killer app' does end up piquing interest of the millennials. This is important because every new app takes away their time and attention. Everyone eventually has 24 hours in a day, and Facebook (sadly) can't do anything about it. Thus any other way in which people start spending their time, they have less time left for Facebook.
I often say - more than MAUs, or DAUs, if there's a metric that Facebook would really care about, it should be called TET - 'The Eyeball Time' (I made it up) - i.e. the cumulative amount of time eyeballs are looking at a Facebook feed. With Facebook having reached the most of internet connected population (ex-China) on Earth and hours/day remaining constant, Facebook's growth is centered around the assumption that it will not let anybody else eat into the eye-ball time you currently pay to its platform (Yes, it's not free).
Thus by nature, Facebook's business model is designed to recognize eyeball distractions beforehand and acquire them. That's what they did with Instagram and Whatsapp. Now they also own your eyeball time when you're uploading cat-photos on Instagram, or talking to your dear ones on WhatsApp. While this does sound simple, this carries a couple risks:
a) Either Facebook ends up paying a lot for an upcoming distraction, but cannot make much (revenues and profits) out of it, or
b) There comes a distraction which is powerful enough and doesn't agree to get sold to Facebook (Eg: Snapchat).
In the long run, a lot of value will or will not be awarded to Facebook's business model based on how its management tackles both of the above issues. So far, management's track record has been flawless - It has: i) converted whatever it has acquired into enviable growth engines, and ii) kept its product so user-friendly that its users have not gotten distracted, even after putting up ads.
There you have it. Facebook's business model, how they make money and how to value it. Whether you are a user, parent of users, employee, or an investor - share with me your perspective (in comments) on "What do you think of Facebook - it's business and it's future?" No single person is ever right, but we collectively - often are.
For the next blog in the series, we will do a deep dive analysis into Facebook's current valuations. If you're interested to be the first to know when it gets published, subscribe here.