Prepared for Purdue Entrepreneurship
Certificate Program
Team Analysis & Discussion
Spring 2007 © Hank Feeser
Thomas S. Rogers of TiVo, with Mark Zuckerberg of
Facebook
Pierre Hotel in
Manhattan 11/09/06 at the annual FourSquare conference.
Source: http://www.nytimes.com/2006/11/10/technology/10deal.html
Facebook
Case Study: Offline behavior drives online usage
written
by Nisan Gabbay on November 5th, 2006
Facebook was launched in February 2004 by Harvard undergrad
students as an alternative to the traditional student directory. Its popularity
quickly spread to other colleges in the US by word of mouth, and the site now
registers close to 15M monthly UVs and over 6B page views per month. Facebook
has completed two rounds of venture financing at very high valuations, the
first at a valuation of ~$100M and the second at ~$550M (valuations are
unconfirmed). These valuations were driven by the multiple acquisition offers
that Facebook has reportedly turned down (the latest was a rumored $750M
offer). Facebook is already generating significant revenue, so despite all the
valuation and web traffic metric hype, it has also established a very real
business.
Interviews conducted: Noah Kagan,
early product manager for Facebook. Noah will soon release an e-book on
Facebook, with good insight on the social networking space. You will be able to
download the book at Noah’s blog, okdork.com. I have had plenty of informal
conversations with people close to Facebook over the last two years, while not
formal interviews, I would regard these as quality sources – employees,
investors, and competitors.
Thank to Nick Macey, a student at
the University of Utah for helping in the research and writing of this case
study, and providing the ever valuable user perspective as a current college
student.
Key
success factors
Provide pre-existing offline
community with a complementary online service
Facebook had its initial success
with college students by providing an information service that was not
available offline – an interactive student directory containing each student’s
class schedule and social network. Before Facebook added the feature sets it
has today, it was simply a more complete student directory. Facebook did not
create a community where one never existed before; rather they provided an
important information and communication service to a pre-existing offline
community.
While students already had a loose
affiliation with all fellow students at a college, they didn’t have an easy way
to learn more about their fellow students outside their direct social network.
Given the large class sizes at most universities today, students don’t have the
opportunity to interact with very many of their fellow classmates during class.
I remember the days I spent at Berkeley in 200+ student lecture halls scanning
the crowd for attractive girls or previous acquaintances. Facebook organized
students by class schedule for the first time, making it possible to learn more
about that classmate you might have a crush on. Although I am highlighting one
particular use case, initial Facebook usage was indeed driven by dating type
activity – checking people out, learning more about crushes, light stalking
type of activity, etc.
The larger picture here is that
Facebook created a high utility online service for enabling pre-existing social
behaviors within an offline community. This makes for an interesting lesson
learned: it’s easier to piggyback off a pre-existing community with offline
behaviors that drive online service usage.
Restrict user registration (and
other behaviors) to build desired online service
Facebook made important product
decisions that ensured harmony and trust between the offline community and the
online service created. Facebook originally limited membership to those users
who could verify they had a “.edu” e-mail address for the college they attend.
Facebook also placed limits on the ability to search or browse users to the
college that the user attends. These measures aim to make users feel that the
site is exclusive and limited to members in their offline community (colleges
and universities). In the early days of Facebook, something like 30% of users
actually posted their cell phone number on their profile. I’m not sure whether
this statistic is still valid, but it supports the notion that users trust who
is viewing their profile.
Facebook has recently opened its
doors to users outside the .edu networks. To accomplish this, they have created
“networks”. High schools, employers and geographic areas are, essentially, what
colleges were to the original Facebook. When you join one of these “networks,”
you can only view others in the self-designated network. Additionally, Facebook
has implemented a number of privacy controls that allow users to control
exactly who gets to see the information they provide.
Aggregation of a series of deeply
penetrated micro communities
Facebook is a more compelling
advertising opportunity than other social networking sites because of deep
penetration within a series of micro communities (college campuses). If a local
advertiser wants to target a particular college campus, Facebook is the best
way to get the advertiser’s message to that audience. CPM rates for local
advertising command a significant premium from advertisers because of their
more targeted nature. With 65% of users logging in daily and 85% weekly,
advertisers can run time-oriented campaigns very effectively. The large,
branded advertisers, who value reach, can advertise to nearly every student in
the 18-22 demographic in the US with one campaign.
Facebook will have ample opportunity
to diversify its revenue streams beyond traditional banner advertising due to
its deep penetration in these micro communities. Having the attention of 90% of
students attending a university lends itself to online classifieds, event
listings, e-commerce, and lead generation. Facebook should be well-positioned
to be a major player in online classifieds given the usage patterns of its user
base.
Built strong brand recognition
amongst user base and advertisers
The key to an online advertising
business targeting branded advertisers (advertisers looking for branding, not
just clicks) is having a strong brand that advertisers want to be associated
with. A perceived hot brand is what drives premium CPM rates. Two sites having
similar demographics and user usage patterns may have drastically different CPM
rates based solely on the perceived brand recognition and image factor. While
some people I spoke with disagreed, I believe that Facebook did a masterful PR
job - highlighting the impact that Facebook has made on the lives of college
students and their online media consumption in nearly every story written. How
often do you hear that 90% of Facebook users login to the site once per week?
Clearly the PR coverage came as a result of the tremendous viral growth, but
capitalizing on that PR to help build brand was a key success factor.
Founder(s) credibility with college
audience
The “face” of Facebook is Mark
Zuckerberg. Back in February 2004, when Facebook was founded, he was a student
at Harvard. Two other students, Dustin Moskovitz and Chris Hughes were the
second and third employees of the company. This added a level of credibility to
the site in the minds of the student users. It was something one of them had
created, not something fed to them by a “company” in the traditional sense. It
was a place that they could trust because one of their own had made it.
Adding to the underground feel of
Facebook was the viral spread of the site. It fanned out throughout Boston, and
then the Ivy League. Students at other schools had to wait in line until Mark
and friends could find time to add their school. This created even more buzz
around the product.
Launch
strategy
Prior to launching Facebook, Mark Zuckerberg
had experimented with a number of different web products. In fact, his first
attempt targeted at the Harvard student body was called FaceMash, which drew
criticism from the University and some students, prompting Mark to drop the
service.
Mark launched Facebook (at the time
called thefacebook.com) in February 2004. Once the site was ready for users,
the Facebook founders blasted e-mails to Harvard students to let people know
about the site. The team had access to the e-mail addresses of Harvard students
at each dorm. Thus e-mail marketing, viral feature sets, and word of mouth was
how Facebook was launched. Given the immediate positive reaction that Facebook
received at Harvard, Facebook began rolling out the service to other
universities. Facebook did not use a targeted geographic roll-out strategy in
the early days, they received registration requests from students at other
schools, and then prioritized which schools to open based on the number of
these requests. Interesting to note that this is how Craigslist rolls out to
new cities – based on user requests.
From what I understood, Facebook did
not receive any help from the schools themselves to promote the Facebook site
to the student body.
Exit
analysis
There has been much speculation in
the blogosphere and mainstream press regarding who will buy Facebook and for
what acquisition price. I have heard from reliable sources that Facebook did
indeed turn down acquisition offers for ~$750M earlier this year. Recent
reports have claimed Facebook is in acquisition talks with both Yahoo and
Microsoft for ~$1B. Is such a lofty valuation for Facebook justified? It all
depends on an evaluation of future growth prospects, but I think that there is
a misconception in the blogosphere that Facebook is not generating much
revenue. On the contrary, Facebook was generating almost $1M per week in
advertising revenue in Q1 2006. It is likely that Facebook will generate ~$50M
in revenue in 2006, up from ~$10M in 2005. Some reliable sources believe that
Facebook will do ~$200M in revenue in 2007. Given that Facebook has been
guaranteed $200M in revenue over three years by the Microsoft advertising deal,
the 2006 and 2007 revenue numbers seem attainable. If the 2007 revenue goal of
$200M is reasonable, a 5X forward revenue multiple does not seem to be an
excessive valuation multiple.
Many people also point to the fact
that Facebook is considerably smaller than MySpace from a site traffic
perspective and hence should have a lower valuation than the ~$500M that
MySpace was purchased for. This type of comparison based on unique visitors and
page views is clearly flawed because not all page views are created equal.
There are several good reasons why Facebook’s page views are more valuable than
those of MySpace:
1) Facebook’s core user base
(college students) is more desirable than MySpace’s core user base (teenagers).
Because college students have more disposable income and are more likely to
have credit cards than teenagers, they are more desirable from an advertiser
perspective.
2) Facebook represents a more compelling local advertising opportunity than
MySpace because Facebook can guarantee deep penetration of college campuses,
whereas MySpace cannot show the same types of local market usage patterns. The
CPM rates for local advertising campaigns are typically substantially higher
than national campaigns because of their more targeted nature.
3) Facebook is viewed as a safer option than MySpace for branded advertisers,
as Facebook has a less racy image than MySpace. In a market where advertisers
are still hesitant regarding user generated content sites, Facebook has done a
better job of brand positioning.
Another noteworthy part of the
Facebook story is how they masterfully handled the VC financing process,
limiting the amount of equity dilution to the founders. When Facebook raised
its first VC round of financing in April 2005, they negotiated a pre-money
valuation of ~$85M at a time when they were generating less than $500K per
month in revenue. Facebook was able to command such a high valuation by
courting both VCs and potential acquirers simultaneously. With term sheets in
hand to be acquired for $85M, Facebook was able to drive up the pricing on the
VC round. I remember discussing with VCs who participated in the bidding for
that first round how the price, which originally started at a $20M pre-money
valuation, just kept climbing week after week until Accel Partners finally won
the deal at ~$100M post-money. Hats off to Accel Partners for accurately
assessing the potential of Facebook in those early days. The prevailing wisdom
from other VCs was that Facebook would probably be capped at a $200-300M exit,
and hence a 2-3X return was not high enough to justify the risk, given the
youth and inexperience of the Facebook founders. Accel is likely to make a
8-10X return on its initial $13M investment in just 2 years. Facebook’s most
recent $25M round was rumored to have taken place at a $550M valuation after
turning downing a $750M acquisition offer. Once again, the Facebook management
did a great job of creating a competitive environment for their second VC
round. The one piece of information I would be curious to know is how
Facebook’s $500K seed round of financing was structured. That investment was
done at the end of 2004 by ex-PayPal exec Peter Thiel (when Facebook was
available on ~30 campuses). I’m guessing that $500K bought 5-10% if it was
structured as equity, but would have bought considerably less if it was
structured as convertible debt. If anyone can shed some light on the seed
round, please leave a comment below.
Food
for thought
The Facebook success story is most
interesting because of how daily offline social behavior drove usage of the
site. There are plenty of activities in our daily life that could benefit from
a complementary online product. However, if that offline behavior only occurs
once every few months, you have the challenge of user recall. Namely, will
users remember your service and know how to find it to fill their need.
Facebook demonstrates you have a great Internet service if offline behaviors
can drive nearly daily usage online. In the life of a college student, you are
meeting or interacting with new people nearly every day. It is human nature to
be curious to learn more about that person, hence you jump on Facebook.
Facebook fills a high value need for college users on a nearly daily or weekly
basis, consistently reinforcing the utility of the service, and building
goodwill with users. The issue of user recall is an import one for a web
entrepreneur to understand, particularly if the need they are addressing occurs
infrequently in the lives of their target users.
Another lesson that Facebook
reinforces is the importance of brand and PR buzz to advertising rates. The
amount branded advertisers are willing to pay for online advertising is hugely
subjective – it’s still more art than science. To get premium CPM rates,
entrepreneurs must establish a brand – not only with users, but also with
advertisers. Many social services do not have high click thru rates on ads
because people are not in the mind frame of looking for information when they
are using a social service. All social networking sites suffer from this “lack
of click thru” problem. While immersive advertising opportunities will
eventually displace banner advertising on most social services over time, for
the time being, traditional banner advertising is still a critical revenue
stream.
Finally, we can learn a lot from
Facebook by how they built initial trust between users and their service. While
these days it is easy to build a consumer Internet product, establishing trust
with users is not. As an entrepreneur, how quickly you can establish trust with
your users can be a critical success factor. Facebook built immediate trust via
the home page by showing only a select few colleges as being open to
registration. Coupled with the registration process, users immediately
understood that the site was exclusively for use by college students. This made
them feel comfortable disclosing information that people normally wouldn’t post
on the Internet. Simple, but very powerful. Facebook does give users control
over the information displayed on their profile and to whom it is displayed,
but only a small percentage of users actually change the default settings.
Thus, the key part of the trust equation is not features, but branding and
messaging about the service and who uses it.
Reference
Articles
“Facebook’s Critical Success Factors”, on Fred Stultzman’s blog
Unit Structures, May 17, 2006
Great blog post that discusses 5 key success factors for Facebook. Unlike my
analysis, this post has some detail on features that made the product sticky.
“Facebook
- The Complete Biography”, written by Sid Yadav on Pete Cashmore’s
Mashable! Blog, August 25, 2006
A detailed overview of Facebook from many perspectives, but provides a
particularly in-depth look at the product itself.
“Inside Facebook: Life, Work and Visions of Greatness”, an e-book by former
Facebook engineer Karel Baloun.
I thought the book was an interesting read from a human interest and start-up
culture perspective, but could have discussed the company more from a business
perspective. There is some good discussion on the vision and future direction
for Facebook, how the company does and will make money, and how they’ve built
trust with users.
“Dot-Com Bubble: Why It’s So Hard to Value Social Networking Sites”, from
Knowledge@Wharton (University of Pennsylvania business school), October 4, 2006
Article has a good discussion on how to value Facebook and social networking
sites. This article serves as a source for valuation and revenue numbers.
“Facebook on a roll, stay tuned”, by Matt Marshall on SiliconBeat blog,
August 29, 2005
Has some good insight and quotes on why the site has been successful.