Hi Roy et al,

I'm quite obsessed with Facebook from a number of perspectives. I'm a
numbers guy, and the numbers don't add up, for sure.

I pretty much understand most Internet businesses. Games, for
example, are popular, because they catch people's attention. You can
then upsell them on virtual goods. I saw this happen with my kids on
clubpenguin.com. I made them spend their own money when they were 8,
and wanted to buy penguin bucks. This was a good lesson a year later,
because they lost interest, and that $30 would have gone to, say, a
better hockey stick.

Facebook's business model is based on ads. We tried it out at bivio,
and found it quite worthless to advertise there. GM said the same
thing recently. In case you hadn't heard the news, here's an article:

http://online.wsj.com/article/SB10001424052702304192704577406394017764460.html

Google's model are ads, too, but it's quiet a bit different. Google
has two different revenue generators: AdSense and AdWords. AdWords is
the buy side: You purchase keywords, and if Google sees those keywords
in searches or elsewhere, they'll display your ad for a fee. You only
pay if the user clicks on your ad (aka click-through), and you get to
set your budget on a daily basis. Keywords on searches make sense.
Internally, Google calls their home page "Saudi Arabia", because it
just pumps out cash every second. A majority of their revenue comes
from that one page. Keywords can be very expensive, e.g. $10 for a
click-through.

Google has lots of "properties". YouTube, for example, generates
billions of hits. It's purely statistical if people are clicking on
ads or not. The more hits, the more revenue. Demand Media, Inc.
(DMD) has lots of properties, too, e.g. eHow, which you probably run
into every now and then when you search. Demand Media uses the
"content mill" approach to getting "real estate" on the Internet. The
content is very low quality, but that doesn't matter, particularly,
because again, it's a statistical thing: the more articles and videos,
the more clicks. It's hard to know the exact count, but there are
likely to be a million articles on Demand Media's properties. This is
an amazingly large number.

DMD IPO'd in 2011. It generates about $300M revenue with a market cap
of $800M. That's what I might guess it would do.

Google's AdSense program generates revenue by placing advertising on
other people's sites. You sign up for AdSense, and Google places ads
that match your content. Many, many sites use AdSense, and it gives
Google quite a bit of revenue. Remember, Google doesn't have to
operate those sites.

Facebook's ad model is classic display ads, just like Yahoo and
MySpace and any other site with display ads. The difference with
Facebook is that they know a lot about you. But so does Yahoo. If
you search on Yahoo for something, and they go to a news page, you
will notice that the ads relate to what you just searched on.
Marketing techniques on the Internet (and elsewhere for that matter)
are quite refined. There's a a lot of psychology that goes into it.
This is why Yahoo repeats its ads with knowledge about what you just
searched on.

Unfortunately for Facebook, it's more like a newspaper. In the news
business, it's all about faces unless you are a big paper like the New
York Times or WSJ. Facebook has elevated the line "it's all about
faces" to an entirely new level. They have literally cornered the
market on personal news. It's an incredibly awesome feat, but the
question remains: is it worth more than other businesses which
generate revenue from faces?

My personal guess that it isn't. We already know this, frankly,
because Facebook is already the largest site on the Internet. If
having that much traffic was worth something, it would, frankly, be
generating a lot more revenue.

One of the advantages of Google is that there are millions of
businesses in the world which need some type of marketing. Google has
very good locale identification, and you can target ads. One of my
Internet businesses used this feature to generate quite a few hits for
a small amount of money, about the same amount as a display ad in a
hometown newspaper. And, unfortunately, with about the same
effectiveness. The business is a free public service so you would
think the traffic would get people to use the service, but it didn't.
That's ok for Google, because somebody else is starting a company
right now, and they'll use Google. It's simply the cheapest way to
advertise right now, and lets you test the efficacy very easily. This
is in contrast to Groupon (GRPN), which is very expensive, and
attracts "cheapskates" looking for a good deal. Most businesses which
try Groupon do not come back. This is why GRPN's stock price is
tanking.

It's important to realize that you can run a business on advertising
alone. Many businesses do a great job at this. I have a friend who
writes a popular blog, and does very nicely for himself. However,
he's a one man operation with almost free hosting. His blog is also a
lead generator for seminars and such.

When you add this all up, you can see that Facebook's popularity does
not necessarily translate into a business model with a sustainable
revenue stream. Unlike my friend, Facebook has a massive web
infrastructure. It has to solve problems that no one in the world has
had to solve, quite literally. They have some very smart engineers,
and they have to pay them. They also have to buy lots of computers,
which requires power, A/C, and fire suppression. You have to backup
all those computers. You have to be prepared for cyberattacks. And
so on. This is all very expensive, and given the phenomenal growth,
they can't have "done it right". In the computer biz, we call this
"Technical Debt", and they are accumulating lots of it, especially
given how public their interfaces are. Therefore, their operations
and R&D expenses are rather high.

Then there's the business side of things. Facebook has to sell their
advertising model. You can read in the GM article that Facebook ad
people were trying to help GM be more effective with their ads. FB
failed, and GM pulled out. That's the nature of sales: you have to
have a good product, or your customers won't come back. Rupert
Murdoch found that out with MySpace.

I talk more about MySpace, Apple, and Google in the following article
on my personal website:

http://www.viarob.com/my/page/Facebook_is_a_NOP

It's a fairly dense article that takes on Facebook's efficacy in
detail. GM's pullout this week further corroborates the hypothesis
put forth in the article.

Cheers,
Rob

Here's an interesting viewpoint from Nightly Business Report
May 14.
http://www.nbr.com/videos/video?id=1638871853001