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Facebook 2020: $100 Billion Superstar or Failure


This essay investigates the likelihood of Facebook keeping its superstar status by 2020. Using a Political, Economic, Social, Technological and Legal (PESTL) analytical structure supported by a brief examination of the valuation methods used by Facebook for the Initial Public Offering (IPO) as well as a Five Forces assessment the question will be broken fully into elemental parts to reach a conclusion. The key issues discussed in this report are the effects of the highly speculative valuation of the company before and during its IPO regarding its future; the political forces responsible for on-line privacy, data exchange controls and breach of confidence laws; barriers to entry to China and the world’s general current economic situation. Lastly the motives and cultural differences of Facebook users, opportunities shaped by the 4G mobile technology, the ability of users to influence Facebook strategic management, the entry of a new market player, the bargaining power of advertisers, threat of substitute and the rivalry between Facebook and Google are also discussed.

Table of Contents

2. Analysis
a. Financial Valuation and Methods Analysis
b. Political Analysis
c. Economic Analysis
d. Social Analysis
e. Technological Analysis
f. Legal Analysis (Privacy)
g. Bargaining Power of Suppliers (Facebook Users)
h. Threat of New Entrants
i. Bargaining Power of Buyers (Advertisers)
j. Threat of Substitute
k. Rivalry Among Existing Competitors (Facebook vs Google+)
3. Conclusion

 

2. Analysis

 

a. Financial valuation and methods used

Friday the 18th of May 2012 saw the IPO of Facebook on the Nasdaq exchange. At the end of the first day’s trading, one share was traded at $38 setting the total value of the company at $104 billion making it the third largest IPO in the US history (BBC, 2012). A comparison of this figure with the market’s optimistic valuations in the run up to the IPO could easily lead one to the belief that the company is a $100 billion superstar and would be unlikely, by 2020, to lose its superstar status. Nevertheless the IPO success of Facebook is not as obvious as it seems. By the 25th August 2012 a single Facebook share was worth $19.41 (Google Finance, 2012). The $38 share price Facebook achieved during its IPO was a result of intervention by banks responsible for the floatation of the company. According to Tim Worstall, the banks who led the IPO bought shares in order to keep its price above the level speculatively forecasted before the IPO at $38 per share (Forbes, 2012). It is therefore unlikely, considering its last year net profit of $1 billion that Facebook will keep its current high market value, neither it can possibly remain as attractive to investors as it was before May 2012 (Bloomberg, 2012).

This valuation becomes even more unstable when the methods used in calculating the figure are considered. As noted by Peter Cauwels and Didier Sornette from the Swiss Finance Institute the valuation of firms such as Facebook requires new, often untested methods as Facebook as a commercial venture has no equivalent in existing economic sectors. The growth of Facebook’s community of users, who can be seen as an audience for advertisers, is an important factor for future valuations (ETH, 2011). Cauwels and Sornette’s suggest using community size as the main valuation foundation, however this method is somewhat flawed due to the fact that the community of users do not directly contribute to Facebook’s cashflow. Facebook’s revenue model is similar to those of TV stations, radios and printed media whose primary income comes from the sale of advertising space to other companies. So, if valuations based on multiples of future earnings and the capitalisation of future cash flows are suitable for TV stations, radio and printed media they are certainly the most appropriate for the valuation of Facebook.

b. Political

The political landscape, particularly in the European Union (EU), is changing towards tighter data flow controls and restrictions for data transfers between the EU and the US. On the 6th December 2012 Viviane Reding, the Vice-President of the European Commission and EU Justice Commissioner, urged MEP’s to work on new legislation that is more appropriate for the EU’s digital economy. The suggested reforms include legislation regarding easier access to one’s own data, better data portability so that it is simple for users to transfer their data between providers and the right to be forgotten. These reforms may affect Facebook’s ability to monetise on their social data in the future. (Europa.eu, 2011).

Facebook’s European risk could be more than compensated for by gaining access to China’s 500 million internet users. The Chinese government’s policy on social media is unfortunately determined by fear of being infiltrated by a Western social network site. Even though Facebook’s image and its users’ culture is probably less politically motivated and opposed to censorship in comparison to Google, the website has still been blocked in China for the last three years (Observer. 2012). At the moment however, the future still looks bleak for Facebook in China. The government’s discriminatory policy led the local sites such as Sina Weibo, Renren, Tancent, and Wechat to dominate the local market leaving virtually nothing left to its foreign competitors (Mashable.com 2012).

c. Economic

Facebook could take advantage of the prospect of further economic downturn in the Western hemisphere by positioning themselves as an inexpensive way for businesses to promote themselves. Dr Dennis Pitta of the University of Baltimore wrote in 2010 that due to difficult economic circumstances promotional budgets have shrunk and companies increasingly use social media as a more cost effective means of reaching target audiences when compared to traditional advertising channels such as print and TV (Pitta, 2010). Mr John Monks, a marketing strategist at LBI marketing agency, when asked about the most important driving force behind companies venturing into on-line marketing said that the perception the managers have of competitive advantage shifted significantly towards the importance of the cost advantage (Monks, 2012).

The demand for Facebook’s social advertising services is driven not by hard analytical data available to companies on the effectiveness of this new marketing channel but purely on a speculative basis encouraged by the need for cost-cutting. The engagement by businesses of social media will soon generate enough data for companies to realise its true effectiveness and whether it works for them or not. This may lead to some companies who recently invested in social media marketing to withdraw from the arena as the returns just do not make the investment worthwhile. Many large companies (the very ones whose ad budget Facebook need to attract the most), FMCG brands and discounters in particular, will find it increasingly difficult to engage in conversation with their customers via social media sites as social media users tend to talk only about things they perceive as interesting. Only the brands that are used by consumers to enhance their personal image have the chance to be successful.

d. Social

The way we consume and interact with media and peers has changed significantly in recent years, particularly in places where access to fast broadband is widely available. The growth prospects for Facebook are determined by our understanding of social media sites and their role in the modern society. In order to predict Facebook’s future one has to be aware of what motivates current Facebook users to utilise the site. According to Hemant, Sashittal and Sriramachandramurthy, the largest Facebook demographic cluster of 18-25 years olds cited voyeuristic peering into others’ lives as the main reason why people engage in cyber socialising (Hemant et al. ). Secondly, people want to create an idiosyncratic identity for themselves, and thirdly they are driven by inner narcissistic propensities. Considering social network sites users’ motives the potential of Facebook in driving sales is low. Any explicit non-branding marketing activities on Facebook designed to generate sales are therefore unlikely to be successful. Given the findings of Hemant et al. the most positive thing that can happen to companies is word of mouth endorsements about brands that are likeable and in some way useful in the enhancement of self image.

The largest demographic group of Facebook’s users in 2020 is likely to be today’s 7-11 year olds. An understanding of how this group interact with brands is therefore imperative to the future of Facebook as a brand promotion medium and its suitability as such to different kinds of brands. Nairn, Griffin and Gaya Wicks in their research about the relationship between brands and children found that this group viewed brands primarily as sources of fun and entertainment. Children’s acceptance or rejection of particular brands is used by them to denote group membership or role in their social relations (Nairn, Griffin and Gaya Wicks, 2008). The concept of “cool” as described by Nairn et al. is highly complex and becomes both extremely important and extremely fragile in the case of social network sites. Facebook, in their attempt to sustain a leading position and to keep current market value, might be tempted under pressure from consumer brands to more aggressively push commercial messages across via its website to the users. Should this happen Facebook might loose some of its “cool” and become less attractive to brands for the purpose of branding.

People’s use of brands for self image enhancement is a common trait of modern society but the extent to which cultures use brands for self expression and augmentation of the self differs from country to country. Countries whose cultures score is high on individualism, in accordance with Geert Hofstede’s list of national cultural variables, are more likely to tolerate interference of marketing to their private conversations on Facebook (Hofstede, 2004). As a result, in 2020 the USA, UK and a few other individualist cultures will continue to be the most profitable markets for Facebook. Other cultures aligned to Hofstede’s less individualistic traits will still be less keen on being interrupted by brands on their social network sites accounts.

e. Technology

Facebook’s technology is one of their most important assets. Since its beginning in 2004 it has progressed to the point where users can now manage their accounts from home and remotely; upload photos and video when mobile; and comment on friends’ posts using PC’s, tablets, mobile phones and interactive TV sets. People store a large amount of unique data on Facebook’s web servers which is difficult to transfer to another server. The ease at which Facebook users navigate the website and the difficulty of switching to another social media site such as Google+ is a lock-in strategy that Facebook is pursuing and this is going to, for at least the next few years, give them a solid competitive advantage over their rivals.

The network effect is fundamental to Facebook’s growth and will, in the future, help them to stay ahead of their competitors in terms of community size. Early adoption of 4G compatible functions will boost Facebook’s image as a leader in social media technologies and innovation and ensure user loyalty. Mobile social technologies can also make Facebook more attractive to advertisers and market research organisations increasing Facebook’s bargaining power on the marketing services market.

 f. Legal

Facebook’s use of technology described in the previous paragraph may be limited by the introduction of new laws regulating the relationship between a social networking site’s desire to hold data on their users, and the right to privacy of those same users. Laws based on the notion of a breach of confidence are being increasingly used by lawyers, in the USA and in the UK in particular, as basis for the right to privacy of a site’s users (Marsoof, 2011). According to the UK’s Health and Safety Executive, a breach of confidence takes place with the disclosure of information which has a commercial value including personal information about individuals and this law continues to widen in accordance with development of technology and changes in society (HSE, 2012).

In 2007 details emerged about a scheme where Facebook used user’s shopping data to help companies advertise on the network. A spokesman for MoveOne.org, a social campaigning organisation, highlighted at the time that Facebook users were outraged that the information about their private purchases made on other sites is being shared without their permission to companies such as Blockbuster and STA Travel (The Independent, 2007). Since the publication of the Independent’s article, there have been no major protests against Facebook’s privacy policy. However, the debate about privacy on-line is unlikely to go away. By 2020 legislation will have come into force in some countries which will enfranchise users of websites to protect their personal data. Facebook will thusly be left no choice but to reform their data handling practices or cease operations in these areas. Either way this change will have a negative effect on Facebook as a brand and as an attractive marketing medium.

 g. How powerful are the Facebook users?

Calling Facebook a superstar company would not be considered in 2012 as a bizarre statement. Facebook’s success over the last few years is due to the rapid growth in its number of loyal users. It is they, with help of Mark Zuckerberg and few others, who created Facebook. Are the 901 million strong community powerful enough to influence Facebook’s strategic direction? According Dr Peter Levine Facebook is an egocentric network where users can’t see the group from a community or social perspective (Levine, 2009). Facebook users can’t search the network for people of the same interests who may be interested in influencing Facebook’s strategic management. As users neither can we determine who is central to a network surrounding a cause, so we cannot select the most influential network node to rally around. Considering what is and what is not allowed on Facebook today and how the system responsible for the flow of data is configured, users are powerless in influencing Facebook’s management unless they unite on third party platform such as Google+ or Twitter. Nevertheless, this should not be considered as a negative. Facebook’s management independence in decision making is a key to the successful future of the company.

h. Threat of New Entrants

The article about social medial sites on Wikipedia.org contains a long list of 203 social media sites. Most of those social networks are dedicated to specific language or point of interest communities. The largest are Facebook – 901 million users, Twitter – 500 million users, Sina Weibo – 300 million users, LinkedIn – 160 million users (Wikipedia, 2012). The rivalry between the already existing, top social media websites is intense and the chance that new entrants, at least by 2020 will pose a serious threat to Facebook is low.

i. Bargaining Power of Buyers (Advertisers)

The bargaining power of advertisers is determined by their understanding of what can be achieved with Facebook as a marketing channel. Sir Martin Sorrell, chief executive of WPP Plc. has said that unlike Facebook advertising, companies have a good understanding of possibilities available to them from television advertising, where guidelines and 30 second long spots are clearly defined. Working with social media is more difficult and the results harder to measure (Sorrell, 2012). Advertising on Facebook is a good example of a “long tail” where specific advertising messages are targeted at niche needs but from a single market perspective all of Facebook’s 901 million users are immaterial to an advertiser wanting to target people of specific needs specific markets. The alternative to Facebook for large consumer goods companies are TV shows and channels, such as the X Factor or Yesterday, which are designed to target large chunks of fragmented audiences in specific markets. The Small and Medium Size Enterprises (SME’s) on the other hand, have a choice between Facebook and Google AdWords. For them to target specific types of Facebook users on a cost per 1,000 impressions basis is minimum 5,000 Euros (Irish Times, 2010). Google AdWords is a direct response advertising medium with no minimum spend restrictions. Considering the SME’s cash flow constraints Google AdWords might be preferred by them advertising medium.

j. Threat of Substitute

Is a substitute to Facebook capable of undermining their position on the market by 2020? Judging by the opportunities the large Facebook user community create for marketers and the initial IPO valuation it would be attractive to argue that there is no company capable of offering marketing solutions on a comparable scale. But the question that should be asked first is; what are the marketing solutions Facebook is genuinely good at and what is Facebook’s Unique Selling Proposition (USP)? The problem with assessing Facebook as a business is that the company is too young so the data available to marketers about Facebook’s performance as a marketing channel is not yet conclusive. Analysts can assume Facebook might be good at branding and generating word of mouth (positive and negative) but the true cost or benefit of this to advertisers is still unknown. By 2020 there will be enough data about Facebook’s performance as a marketing medium to make an assessment and therefore the identification of substitute will almost certainly be possible. The likely substitutes over the next 8 years that might evolve are the digital interactive media capable of monitoring their users’ behaviour, for example; interactive TV channels.

k. Rivalry Among Existing competitors (Facebook vs. Google)

Miguel Helft and Jessi Hempel posit that Google+ is the first serious threat to Facebook since the latter overtook MySpace to become the largest social networking site in the world (CNN, 2011). But the rivalry between the two internet giants is founded on two quite dissimilar user engagement principals. Facebook’s advertising philosophy is to facilitate their users’ discovery of products and services for consumption by exposing them to the choices made by peers. Google’s is that the users should be able to find what they are looking for and Google’s role in it is to facilitate and enhance the accuracy of search. These two distinct business models helped Facebook and Google to grow fast over the last few years but at some point in time by 2020 the market for on-line ads will saturate and it is highly unlikely that either Google or Facebook will sustain their current revenue growth without directly taking market share from each other.

The rivalry between Facebook and Google is not likely to ease in the next few years. In November 2010 Google stopped letting Facebook automatically import its users’ email contact data for the purpose of friend finding (Reuters, 2010). In March 2011 the search company released an update for its Android mobile operation system that blocks Facebook from embedding its social service into Android as it would like (FT, 2011). In May 2012 Facebook secretly hired Burson-Marsteller, a PR firm, for a smear campaign against Google to undermine their new social service Google+ (Guardian, 2011). What we have seen so far is technological and PR tactics both firms embarked on to undermine one another but the intense competition is not yet a key driver for better customer value. The bitterness and competitive persistency of both Facebook and Google in 2020 is liable to turn into a price war. The price of online ads will fall, reducing the total value of the market in a way reminiscent of the fall in value of the UK’s broadband market during 2011/12 (Keynote, 2012). Should this be the case Facebook’s total market value and its attractiveness to investors will go down with it.

3. Conclusion

There is no straight answer to the question whether Facebook in 2020 will keep its $100 billion superstar status or if it will fail. Based on the above information though, it is highly unlikely that Facebook will be anything near the $100 billion behemoth it was at the time of its IPO. The fact that the company’s value was initially falsely inflated, coupled with external variable factors like Google’s continuing popularity and stricter privacy and data laws in their key markets (over which they have no control) leads to a conclusion that it would be impossible for them to regain their initial valuation. Due to their huge user community, low possibility of viable competitors entering the market and clear attractiveness to brand advertisers and new users alike they will remain extremely valuable and popular, but at a more reasonable valuation.

 

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