Lyons: Facebook's Roar Becomes a Meow

Facebook was going to become the new Google, the Silicon Valley hypemeisters claimed. Millions of people would join this social-networking site, advertisers would rush in and revenues would skyrocket. But something went wrong. The users arrived—there are now 110 million of them—but the money hasn't kept up. Revenues this year, according to researcher eMarketer, will be $265 million, well below what Facebook's 24-year-old founder and CEO Mark Zuckerberg was predicting eight months ago. What happened? Sure, the faltering economy has made advertisers skittish. But Facebook's main problem is not the economy.

The fact is, this is an entertaining and sometimes even useful Web site, but it's simply not a very good moneymaker. And there's no indication that Zuckerberg and his team will ever find a way to turn it into one.

The Palo Alto, Calif.-based Facebook is squeezing less than two-and-a-half bucks of out each member over the course of an entire year. Back in the good old days, America Online squeezed up to $20 in subscription fees out of each user every month. Facebook doesn't charge subscription fees, nor do any of its big competitors. Few, if any, users would be willing to pay them. Hence Facebook must rely on advertising. But Facebook members don't want to look at ads, either. They're using Facebook to keep in touch with friends. Putting ads in front of them is like hanging out at a party and interrupting conversations to hawk merchandise. "I am annoyed by the ads and generally click the 'thumbs down' icon, hoping they will disappear, but they don't," says Amy Hashimoto, a physician in Hinsdale, Ill., and a daily Facebook user.

In contrast, the beauty of Google—which is on track to have more than $20 billion of revenue this year—is that people who use a search engine are already looking for something. So Google can send targeted ads based on their search terms and people actually appreciate the help. That's why "paid search" advertising accounts for 41.8 percent of all online ad spending, according to eMarketer. It's also why Facebook is struggling. Avenue A/ Razorfish, a leading online ad agency, bought online ads worth $735 million last year, but only $55 million—a mere 7 percent—went to social-networking sites like Facebook, MySpace and others. Jeff Lanctot, chief strategy officer at Avenue A/ Razorfish, sees Facebook as a communication tool, akin to e-mail or instant messaging. Those are useful things but not great vehicles for running advertisements. Facebook, Lanctot says, has been "a victim of unrealistic expectations." (Facebook would not provide anyone who would talk on the record for this article.)

Somehow the difference between Google and Facebook wasn't apparent to investors. Zuckerberg raised $500,000 only four months after launching the site in 2004, and $40 million more over the next two years. Last year Microsoft paid $240 million for a 1.6 percent stake, valuing Facebook at $15 billion. Facebook insists that "social graphs" (relationships among members) hold tremendous value for advertisers. But unlocking that value requires advertisers to dream up new ways of interacting with customers—basically, to invent a new kind of advertising. Even Facebook has no idea what will work. Its first big attempt at new-age advertising, a system called Beacon, tracked what Facebook members did on other Web sites and told their friends about it, enabling a form of word-of-mouth advertising. But users freaked out over privacy concerns, and advertisers backed away last fall.

The Beacon fiasco points out a fundamental weakness in Facebook's business model, which is that Facebook's ability to make money is determined by the degree to which its users will allow themselves to be exploited. Show too many annoying ads, or send ads that are so personally targeted that they're creepy, and you'll drive members away. But one of Facebook's great strengths is its ability to target very narrow, specific audiences. That ability draws advertisers like Nike, MTV, Pepsi, Dos Equis and 7-Eleven.

Facebook's latest gambit involves "engagement ads," in which advertisers create Facebook pages so that members can become "fans" of the brand and spread word to their friends. Jon Gibs, vice president of media analytics at Nielsen Online, thinks the idea might have some legs. (He recently became a fan of a kind of hot sauce.) Gibs is also heartened by recent Nielsen statistics that show Facebook doubled its monthly unique U.S. visitors to 38 million in August 2008 from 19 million last year. Also, the average Facebook user now spends 100 minutes per month on Facebook compared with 60 minutes a year ago. "Facebook has a tremendous amount of future potential," Gibs says. "Their challenge is just, what is the magic bullet?"

With the economy collapsing, and advertisers zipping their pocketbooks shut, it may take a while to find out.