The REAL Problem with Facebook

It isn’t the IPO, which really was fine (potential shenanigans with the numbers aside).  Anytime someone gives you billions of dollars and you suddenly find that you’re officially worth even more billions of dollars than that, you’re having a good day.

No, that’s not it.

I’ve been saying (and even writing) this for years: online advertising is a generally bad way to make a living.

When I was at Geocities (you remember GeoCities…we ruled the 90s web!), a typical banner ad got between 1 and 1.5% clickthrough.  Sometimes a lot more if it was a highly targeted banner in a specific part of the site.  We even got a little ticked when it went below 1%.  We charged people $20 or $30 (or more) to display 1000 banners to site users.  We had hundreds of millions of visitors every month.  Feel free to do the math.

It’s now 2012, and use of interactive stuff (web and everything else) is way, way bigger.  Millions more ads have been stuck in places that they have no business being, and the average click through rate has plummeted.  It didn’t happen overnight either.  It’s gradually deteriorated from the 1% or so that I mentioned before down to something more like .05% to .1%, and advertisers are scarcely able to get much more than $1 for every thousand ads served.

The only way the business gets good is at truly massive scale.  Imagine you had a site that had 10,000,000 page views per month.  That’s pretty darn big.  You’d have one of the 4 or 5 thousand biggest websites in the world.

But if you had four or five ads you sold on each page at industry averages, you’d be in to make about 50 grand a month in ad revenue.  That may sound like a lot to you if it’s going straight in your pocket, but it’s probably not.  Running a site like that is usually expensive and requires staff, equipment, content and who knows what else.

In other words, if advertising at the industry average levels of monetization if your business model, you are losing money.

Unless you’re gigantic.  Merely “really big” doesn’t do it.  Even Yelp, one of the 50 or so biggest sites in the world, still loses money despite its scale and at sub-$100 million in revenue, is small given the size of its audience.  And that’s a truly colossal website.

Then you get to Facebook, which makes Yelp look small.  It’s highly profitable, for sure, but it’s still based almost entirely on low-value advertising for revenue, and both the response rates and CPM on that will, inexorably, continue to drop.  Usage goes up and the numbers of ads per page probably goes up, but the underlying value of the advertising continues to drop.  Unless they get another revenue vector in their business model, this is the leaky boat they will have to keep rowing.

I know what your’e saying: what about targeting?  Targeting ads to make them more effective and therefore more valuable is the future, and it has been ever since the early days of the web.  I’ve heard this same thing again and again and again and again and… If I could offer you a 50% increase in the performance of an ad or a program, is that an amazing improvement?  Yes, you might think.  But if it’s a 50% improvement on a truly dismal, almost non-existent and ever declining response rate, it’s also nearly immaterial.  Going from .05% click through to .075% click through is, undeniably, much better, but it’s still terrible.  And next year, it’ll be .065%.  Ugh.

It’s not to say Facebook can’t deal with it, but eventually, the only way to deal with this strategic issue is to come up with a new business model.  They have all the resources and brainpower in the world to do that, so let’s see what happens.