Facebook’s IPO: Are those adds worth $100bn

In the eight years since Facebook first appeared online, the site has gone from a way to waste time to a social necessity. Today (especially for younger users) not having a Facebook account is akin to not having a mobile phone, in that you are likely to be left out of the loop by friends and work colleagues. Now the internet giant’s recent IPO suggests that this social necessity could be worth up $100bn as a company.

Facebook was founded in 2004 by Harvard University undergraduate Mark Zuckerberg, and since then has taken the internet by storm. First it became the world’s largest social network with over 800 million users. Then the site replaced Google in its position as the internet’s most visited site. Now Zuckerberg and his team have earned a new record after raising over $5bn from an initial public offering, the largest ever for an internet firm. More than just a commercial success, Facebook has added new terms to the popular lexicon such “to friend” and has redefined the use of the verb “to like” online. Brands large and small have rushed to establish fan pages on the website and entire real world conversations focus on events which took place in the entirely virtual social network.

What is interesting about Facebook’s petition to be partially floated on the Stock Exchange is that the information they have released has given us a rare glimpse at the numbers behind Facebook’s success. Facebook and other internet companies that offer a free service lack a traditional revenue stream upon which to draw. Most fall back on the tried and tested method of advertising. The value of an advertisement on a website is determined by the “click through rate” in other words the percentage of users who click on an advertisement to be taken away from the page which they were browsing to one which they had not intended to visit, prior to seeing the advert. Research has suggested that click through rates for most websites are very low as most users are resistant to the idea of following links online. This is partially due to a legitimate concern about internet security but also a response to the degree to which users are saturated with banners and links tempting (often unsubtly) users to leave behind what they were interested in the first place. This has prompted concerns that that this revenue model has become out dated and that many internet firms might be overvalued.

Facebook has relieved that a substantial amount of their $1bn annual net revenue comes from advertising, leading to speculation that intelligent internet advertising is having a degree of success in tempting users. Firms like Facebook use the personal information supplied to them to customise their advertising space to a user’s tastes, and thus boost the click through rate. This in turn makes advertising space on Facebook more valuable, not simply because of the larger audience but because of a greater degree of success. Try, for an experiment, changing your relationship status to “engaged” and witness the barrage of wedding goods and services that will come out of Facebook’s proverbial woodwork to tempt you to their pages. Often the advertising is more subtle than this, and usually it is from a trusted website. It is this clever use of Facebook’s greatest asset (its members’ data) which makes it a viable company.

However, all is not rosy in Zuckerberg’s world. Internet users are becoming increasingly aware about how their data is being used. The wealth of information which Facebook has built up is also a liability as the public demand restrictions on how this data is used. Facebook’s privacy settings are becoming increasingly complex, which is creating an incentive for uses to switch to a network that is more mindful of privacy.

For now Facebook retains its dominant market position, and the necessity of having an account means this situation is unlikely to change soon. The site has seen off competition from a variety of other social networks seeking to challenge its dominance, and even Google entering the fray with their Buzz and later Google+ services have had little effect on the state of the market.

Facebook should be applauded for changing the way we relate to one another. Upon meeting a new friend at a party it is easier (and seems less forward) to connect with said person via Facebook than to ask for a phone number – mainly because it is also easier to remember a name rather than an 11 digit number.

However, Facebook would do well to consider an alternative revenue model as users become more concerned about privacy. It is also worth considering that the click through rates of intelligent advertisements will eventually fall as users become tried of their saturation, just as we all became tired of banners atop websites in the early days of the popular internet.

This week Facebook’s founders and executives will be congratulating themselves after their IPO sets another record for the company – but if the site’s meteoric rise proves one thing, it is how quickly the internet can change and how complacency is severely punished. For further proof of this, simply ask anyone who still has a MySpace account.