Facebook: Not $$$ocial Enough?

Earlier this week General Motors decided to stop advertising on Facebook. GM made this announcement “after deciding that paid ads on the site have little impact on consumers’ car purchases” according to the Wall Street Journal (“GM Says Facebook Ads Don’t Pay Off”). Albeit, the total amount, $10 million, is but a tiny fraction of Facebook’s whopping $3.15 billion in reported 2011 ad revenues, the timing was not great. It was less than one week before Facebook’s much vaunted IPO.

So while the revenue loss is paltry, there are two larger concerns for Facebook. One, GM is the third largest advertiser in the US and their announcement might lead other advertisers to re-evaluate their advertising spend on Facebook. The second more worrying thing is that it is a major blow for a young company trying to convince the world that “social advertising” is not only effective but provides Return on Investment (ROI). In the short-term the impact may not be that great simply because Facebook is about to reach 1 billion active users (approximately 14% of the world’s population); and this number alone is hard for most advertisers to ignore. But as a public company, with shareholders, they will soon need to prove that they are worth their high valuation, in revenue terms.

Every company feels compelled to have a social advertising budget, even though there is scant evidence that these dollars generate any sales, or return on investment. The advertising and social marketing industry will have you believe they are effective sales drivers but the reality is that there are few independent studies or evidence to support this hypothesis. If you think about the number of times you have clicked on a Facebook ad or decided to make a purchase based on seeing someone’s status update (or wall post), you will likely reach the same conclusion. Facebook’s ad revenue actually fell in the first quarter of 2012 from the fourth quarter of 2011.

Here is something to ponder about Facebook’s current IPO valuation. According to Anant Sundaram (of Tuck School of Business at Dartmouth) the average price to earnings ratio for the majority of US companies, over the last one hundred years, has been around 15. Apple is at 15 and Google is apparently a little bit higher. However, Facebook’s price-to-earnings ratio is 100.

He goes on to say that “at current levels, it would take Facebook 100 years to generate enough profits to pay for itself. That number is so high because investors are betting Facebook’s profits are going to explode. Sundaram says, judging from this price these investors seem to believe that the company’s profits will double, and then double again, and then double again — all within the next few years. For that to happen, Facebook will need to attract 10 percent of all advertising dollars spent on the planet “across all media – print, billboards, radio, television, Internet.”  To put this in perspective he adds that “Facebook had just over $3 billion in global ad sales. TV ad sales in the U.S. alone last year were $68 billion.” (NPR: “Is Facebook Worth $100 Billion?”).

Facebook recently tried a new revenue generation experiment in New Zealand by charging people two New Zealand dollars (US$1.53) a post to ensure that their own friends see what they write (Wall Street Journal: “Facebook Gets Religion for Revenue”). Are your status updates and posts on Facebook valuable enough to start paying to share it with your friends? I know mine are not and never will be.

Let’s just say I am holding off buying Facebook shares because I don’t believe they have a real revenue model, yet. That is not say that they will not find a Google like search cash cow but let’s just say ad banners on the site are not the Holy Grail that Mark Zuckerberg wants us to believe.

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