Facebook and the Emerging Social Networking Industry

William Clark, Ilya Loksha, Matthew Ornelas-Kuh

Introduction
With Microsofts recent purchase of a 1.6% stake in Facebook for $240 million [1], expectations
for Facebooks future revenues are virtually astronomical. Indeed, our revenues are expected to
grow more than 200% to over $300 million in 2008 [2], but we clearly have a ways to go before
we can justify our implied $15 billion valuation. It has proven surprisingly difficult to generate
large advertising revenues from social networking websites, so to maintain our current level of
growth we must carefully consider our strategy going forward.
It is our opinion that Facebook needs to focus primarily on deepening its penetration and level
of service in its core market of college-age students, even at the expense of expanding to
broader markets. Facebook must maintain its unique brand as a clean, professional social
network for older students, without allowing users and application makers to corrupt the style
of the site. Furthermore, Facebook must consider ways to gain the cooperation of the colleges
themselves, in order to deepen its college student user base. Finally, we must look for
alternative sources of revenue, as advertising has historically failed to deliver solid revenues on
social networking sites.
To understand the reasoning behind this strategy, a brief SWOT analysis is instructive.
Strengths
Facebooks greatest strength is our network of subscribers; specifically, the detailed
information we obtain from each and every user. The fact that the post college age group is one
of the highest spending demographics helps to make our customer base, and subsequently our
detailed data, highly valuable. With such extensive data, it is easy for us to tailor our product,
whether it is the advertising we employ now, or some other form of marketing in the future.

Another strength is the advent of our new open format platform. Allowing customers to
develop their own third party applications, while still keeping the clean Facebook style,
differentiates our product extremely well. Indeed, MySpace, our largest competitor, has
developed a reputation for being messy and at times incomprehensible. Combined with our
already existing features, third party applications not only increase our ability to reach potential
subscribers, but also give existing users a more rewarding experience.
Facebooks other strengths include relationships with other companies such as Amazon and
Microsoft, the ease of use of our website, and, potentially, the users that transition from
students to alumni. Leveraging our detailed database and our professional relationships with
other companies could develop into profitable business ventures in the future. Keeping our
website clean and easy to use ensures that we continue to gain and retain subscribers. And
finally, since alumni wield tremendous power and influence over their alma maters, the fact
that our college student customer base eventually become alumni could prove to be quite
advantageous in future dealings with higher education institutions.
Since Facebooks inception, our reputation as a classy and clean social networking site has
remained strong. With the addition of each feature, we continue to impart the highest value to
our demographic compared to our competition.
Weaknesses
Facebooks greatest weakness is that we have so far been unable to generate nearly as much
revenue as might be expected from our large user base and the corresponding user profile
information, which ought to help us deliver targeted advertising. This problem is shared by
Myspace and other social networking sites at the moment, the prevailing wisdom is that it is
in general very difficult to monetize social networks, and we will need some big new ideas
before social network advertising can fulfill the grandiose expectations that have lead to
Facebooks current valuation [3].
The main difficulty is that social networking sites suffer from extremely low click-through-rates
on their ads, despite their presumably excellent potential for highly targeted advertising.

Facebooks CTR has been reported as 0.04% [4], and our 2007 revenues were about $150
million, or only about $2.20 per user per year [2]. In comparison, Myspaces revenues from ads
alone were over $30 million per month in March 2007 [5], or at least $3.50 per user per year,
though their CTR is reportedly nothing to brag about either [6]. Though Myspace is doing better,
even they have failed to meet the revenue targets set forward by Fox, its parent company [7].
Myspaces limited advantage in advertising may be attributed to their more content-oriented
services, in contrast to Facebooks communication-oriented service. Customers are less likely to
click on an ad while talking with their friends than while browsing a site for user-created
content [3].
Our other major weakness is the issue of privacy. Social networking sites like Myspace and
Facebook have been exposed to increasingly negative publicity about the dangers of posting
personal information online, and the potential for stalking, identity theft, and general invasion
of privacy [8-10]. At this point Myspace has a substantial reputation as potentially unsafe, and
Facebook may be reaching that point as well. Such a reputation may pose a significant problem
if we wish to expand our college student user base at this point, universities are far more
likely to discourage the use of Facebook than to endorse it. As the cooperation of universities
would be highly beneficial, we may need to consider revising our privacy policy to address their
concerns.
Threats
One of Facebooks biggest threats is that the social networking industry has low entry barriers,
and is currently viewed as having potential for high profits [1]. The only inputs required to
produce a social networking site are a team of programmers and a batch of servers, both of
which are readily available with a small investment of capital. Furthermore, while there is of
course a large network externality effect that causes users to prefer well-established social
networking sites over new entrants, because the social networking services themselves are
almost invariably free to use, users can readily adopt a new network without sacrificing their
use of Facebook. Thus, there is little we can do to prevent another social networking site from
growing at a pace that matches or exceeds our own, though by the same token we will not lose

our existing customer base unless we allow a very similar social network to develop and beat us
at our own game.
At the moment, there is little rivalry between the currently established social networks. The
other major networks with a large North American user base offer a significantly differentiated
service for example, Myspace is geared toward user content creation through highly
customizable profiles [11], and LinkedIn focuses on professional and business networking [12].
Other large social networks offering services similar to Facebooks, such as Hi5 and Friendster,
are largely concentrated in foreign markets [13]. Myspace is our biggest direct rival, but they
cater to a mass-market type of user base, while our user base is closer to the high-end side
of the spectrum, mainly consisting of college students. Thus, the main threat of competition for
our own users comes from new entrants, which may emulate Facebook and develop some
critical new feature to draw our customers away. This threat, however, is significantly mitigated
by the Facebook App platform. New social networking application providers looking for broad
exposure are likely to develop a Facebook App rather than attempt to start their own rival
social network.
Opportunities
As the internet has shifted from being a novelty to one of the fixtures of American life, several
avenues of expansion have opened for internet companies. Three major areas are of particular
interest for a company like Facebook. First is the better use of user information for the
purposes of targeted marketing and user service. Second, companies can work on delivering a
streamlined purchasing/spending system within this targeting system, so that transactions
happen more easily, and hopefully more frequently. Finally, user-created content is, justifiably,
an extremely important aspect of many modern internet companies.
Facebook, like several other internet sites, has access to a large amount of information about
its users. Since users are required to log into the site in order to use it, it is always aware of
which set of database entries corresponds to the current user. As a result, the opportunity for
extremely finely targeted advertising is present. With the ability to select ads on a per-user

basis, which hasnt been practical in any other medium prior to the internet, it should be
possible for a company to offer advertisers the ability to specify very particular criteria for the
viewers of an advertisement. For example, a concert ticket agency would be well-served by
advertising all of their upcoming concerts specifically to fans of the bands in the cities where
the concerts will occur. An internet company that could offer this sort of ultra-finely targeted
advertisement should be able to charge substantially more per ad.
In addition to using their own databases, a company could take advantage of the opportunity to
link databases with other companies. If Facebook were to work with Amazon, for example,
they could offer users lists of favorite books, movies, and music in order for Amazon to more
successfully target users with suggestions. In exchange, Facebook could gain information about
what sorts of items (category and price range) users are inclined to buy online, thus allowing
further specific targeting of ads.
Another avenue for the use of information that is specific to social networking sites is the ability
to harness friend lists for advertisement. An advertisement that points out, for example, that
several of a users friends have recently purchased a certain brand of computer, or a particular
video game, might be effective at harnessing peer pressure to influence users purchases.
As a complement for targeted advertising, Facebook could offer a streamlined purchasing
system, to encourage users to make more quick purchases. If the company were to work on
partnerships with its most prominent advertising customers, users could be presented with
quick, or even single-click, purchasing of the products being advertised to them. Also, using the
contact information, it would be easy to send gifts to friends who are having birthdays, or for
other occasions. This service could make internet-savvy consumers happier with the site, as it
would become a convenient place for socially-motivated shopping.

More importantly,

Facebook should be able to charge some sort of commission, or at least a higher ad cost, for
advertisements that directly lead to sales like this.
As social networking sites are maturing, they are beginning to offer more all-inclusive
experiences. Instant messaging, dating services, music applications, journal hosting, and other
such applications are helping to lock users in to spend more of their time on Facebook,

MySpace, or other such sites. A good source of services like these, which could be further
expanded by Facebook, is user-created content. Already, Facebook has released a developer
platform, in order to allow applications to be written and deployed on the site. Two major
directions of improvement could allow the site to better harness the power of its users. The
first is to more actively integrate popular and well-written applications into facebook.com.
Googles gmail is one of many applications that were integrated into google.com after being an
employees side project. Facebook could similarly make the best applications into core features,
so that all users of the site would have access to them without having to find and download
them. The other direction is easing the challenges of developing applications and other content
so that users with less programming expertise could develop their own applications. In either
case, improving user-created content on facebook.com wouldnt directly increase revenues, but
would serve as a method to expand the services of the site, and more strongly latch on to users,
in order to keep them on the site.
The danger, however, with user-created content is that it threatens to remove the major
differences between Facebook and the larger MySpace. The two are mainly differentiable
because of a different demographic, and because Facebook explicitly maintains a uniform
interface and graphical style, whereas MySpace encourages extreme customization of each
users page. In order to still please their older audience, which is largely college students and
graduates, Facebook should work to maintain distance from the MySpace, lowest common
denominator model, rather than try to fight over users, and ultimately face a price war for
advertisers.
A Strategy for Facebook
The key to maintaining control of the college-age social networking market is to develop a
collaborative relationship with the colleges themselves. At the moment, Facebook is
understandably considered to be a waste of time by college administrators, but in fact both
Facebook and the college stand to gain from some degree of collaboration.
On the colleges side, the obvious benefit is organizational services such as class registration,
organization of clubs and activities, advertisement of events or purchase of required textbooks

can all be implemented in a centralized and highly convenient manner using the Facebook
platform. It is not difficult to imagine a set of free online applications that are vastly superior to
the hodgepodge of online services many colleges provide at the moment, usually at significant
expense.
For Facebook, the most obvious benefit from a close relationship with a college is that the
college could help bring new users into the network. At new-student orientations, for example,
colleges could promote their Facebook groups, and encourage students to join them. As a
result, new students without accounts would be compelled to create them.

Other

opportunities for colleges to take advantage of Facebook as a coordination and communication

tool would, in addition, all serve as free marketing of the site, to ensure maximum penetration.
With cooperation from a college, Facebook could then offer many services in order to tie users
in to the website, and encourage them to visit it frequently. If users were able to keep their
course schedules updated on Facebook, it could be used to help form study groups or, if
professors were to get accounts, to enable communication about scheduling changes, guest
speakers, etc. (In a more far-fetched scenario, registrars could be linked to the site, therefore
automatically keeping students schedules up to date) Facebook is already widely used to
schedule and organize parties and other events, and increasing penetration would only increase
the viability of this feature. In addition, the site could specifically promote clubs and teams
using the site to organize themselves. All of these features would server to make sure
Facebook becomes a one-stop organization and communication site for any college student.
With an established base of college students and a high penetration into that demographic, the
important issue for Facebook would be how to monetize its users. Perhaps the most promising
method to do that would be to work with Amazon (with which Facebook already has a working
relationship) to sell textbooks and other college supplies to students. If it were to maintain
accurate information about the classes that students are in, the site could work with Amazon to
deduce which textbooks and reference books correspond to which class based upon students
purchases, and then offer a shopping cart prefilled with the required books to users who
havent yet bought them from Amazon. This form of advertising, which seems like it would be

highly effective, could be a very strong revenue stream for Facebook. Similar targeting for
things like job advertisement, summer courses, and other services that are specific to college
students could similarly be made more accurate, and thus more profitable, given a close
relationship with colleges and a deep penetration into the student demographic.
Most of these changes do not introduce new vulnerabilities to rivals. The strength of
Facebook's ability to serve colleges is basically proportional to its penetration into the student
population, so the main effective way to compete with Facebook at securing college
participation would be to grow to rival it in size. As we mentioned before, many of the existing
features of Facebook help to preclude this from happening. It is conceivable that attempting to
move in as a more dominant controller of college student networking would encourage percollege rivals to spring up, if students/administration feel that Facebook is encroaching. The
diversity and stability of the services we offer should help discourage such small scale
competitors, though, as the costs to effectively compete at a small scale should be prohibitively
high. Particularly with the changes to the privacy policy mentioned above, we should face no
new threats to our customer base.
Leveraging a college-age audience for more focused advertising
In addition to deepening its user base, Facebook can further capitalize on the college students it
already has now by increasing the total amount of advertising and applications dedicated to
products that sell well in that particular age group. For example, an application in the spirit of
iTunes is likely to be profitable, as a large portion of digital music consumers are college-age
[14]. Facebook already has an application called iLike [15], which offers music-integration
services similar to those of Myspace, but we can take that a step further and actually sell music
directly from the Facebook website. There would be a definite synergy in the integration of a
service that allows instant music purchases together with a service like iLike, which allows users
to share their playlists and music samples with friends.
This avenue of expansion faces extremely high levels of competition from Myspace. Typically,
Myspace has marketed itself as a music-centric networking site by, among other things, offering
customizable music players on each user's homepage very early after its launch. As it has

developed, Myspace has established itself as a very powerful promotional tool for bands of any
size, often serving as the primary website for a band. As a result of this, attempting to move
into music marketing risks a strong reaction from our rival, causing them to leverage their tools
and content to push us out of that market. As a result, we should only focus on music vending
inasmuch as we can maintain it as specifically within our demographic and non-threatening to
Myspace's hegemony on that front.
Other potentially lucrative targets for focused advertising and services include DVDs, video
games, books, and clothing. Facebook could greatly benefit from its current relationship with
Amazon by extending their integration to allow something like Amazons one-click-shopping
directly from the Facebook website. We could take a small fee for each purchase Amazon
receives through the Facebook website, and Amazon would benefit from the deal through a
modest increase in sales. Furthermore, these types of consumer items are naturally conducive
to producing social peer pressure ads, in which an ad mentions which friends of yours like a
particular band, movie, game, or brand. These may potentially produce significantly higher
click-through-rates than generic, impersonal banner ads.
This faces little risk of competition, as Amazon and other vendors have deep budgets for
marketing of this sort, provided it is successful. We only have to be concerned, as in most of
the points mentioned above, if we fail to hold on to our position as a unique provider for our
specific demographic.
Retention of users after college
As for the future, Facebooks college base holds very promising potential returns. Students
eventually graduate and go on to lead successful careers. With their sharp increase in
disposable income, retaining people past college is a profitable and yet still untapped possible
revenue source. With Facebooks already existing extensive information on each of its
subscribers, the value added by retaining them past the college age is quite large. LinkedIn has
already demonstrated the existence of demand for and the value derived from professional
networking. Facebook could leverage its existing knowledge of its subscribers to recruiters and

corporations looking to hire. Corporations themselves could even develop profiles and third
party applications to educate potential hires. This would allow further leveraging for Facebook;
this time leveraging info and perhaps a streamlined resume and application process to students
for desirable companies to work for.
Learning from LinkedIns approach, Facebook could tailor a whole separate site and/or profile
structure for new young professionals. This would increase the switching cost when comparing
Facebook to other professional networking sites. (Facebook could also just outright buyout
LinkedIn and incorporate it into their business model). Now that the former college students
have a career, they are more apt to spend money and thus be more responsive to online
advertising. Furthermore, this prospect of subscriber retention could further help Facebook
with potential dealings with college institutions themselves. Successful demonstration of
subscriber retention could persuade colleges that Facebook does indeed have the means to
boost alumni contributions, the main motivation for said institutions to join Facebooks
community.
Through catering to the job interests of soon-to-be-graduating students, and then their future
change in spending habits and preferences, Facebook can retain their subscribers past
college. Leveraging their vast database of information would also allow Facebook to assimilate
companies and recruiters looking to hire. Moreover, successful subscriber retention would help
Facebook demonstrate to college and university institutions that they can help them boost
alumni contributions, which is a large motivator for said institutions. All around, retaining
people past college is lucrative for all parties involved: graduates/young professionals/alumni,
corporations, higher education institutions, and, of course, Facebook.
Conclusion
Though our future revenue projections are extremely aggressive, it will be possible to meet
them if we focus exclusively on the college-age user base that has served us well so far. By
offering increased integration with the overall college experience as well as more elaborate

advertising schemes than simple banner ads, Facebook can realize its potential for future
growth.

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