Facebook – The Rise Of The Social Machine

All men’s gains are the fruits of venturing (Herodotus)

Into The Valley

With it’s rolling fruit orchards, the area to the south of San Francisco Bay in California, known as the Santa Clara Valley, must once have seemed like the unlikeliest of locations to give birth to a technological revolution; its main claim to fame, up to the 1950’s, was as the Prune growing capital of the United States. Yet to those in the know, the signs had always been there. From the 1930’s, with a large US Navy base nearby (Hunters Point), a world class university (Stanford) and a ready market for new technological marvels (like ASDIC and RADAR), the area began to accumulate high – tech electronics firms. Typical among them was an electrical component manufacturer, founded by two electronics students from Stanford, who scored an early success when their revolutionary new oscillator design was selected by Disney to test the newly – invented stereo sound systems that they were installing in cinemas across the US so that could they show their latest blockbuster, Fantasia.

Fast forward to 1953; the firm was by now a world renowned scientific instrument maker and the tardis – like wallet of the US Defence Department at the height of the Cold War is pouring money into technological research; the company moves from its traditional home in Palo Alto to posh premises in the newly opened Stanford Business Park. The two former Disney contractors where called William Hewlett and David Packard and the company that they founded is now the world’s biggest supplier of computer hardware and IT services. Little did they know it then, but historians would one day look back on that move and name it as the symbolic foundation of the one of the greatest technological-commercial phenomena in human history – Silicon Valley.

From Swords to Ploughshares

In 1969, Stanford University became one of the four original nodes of a newly written software program that could network computers together using the public phone system, known as ARPANET, specially designed to withstand a nuclear attack by re-configuring itself if a node was destroyed – the forerunner of the Internet. From the early green – screen days of the late 80’s and early 90’s it was obvious that there were two things that the Internet brought. First was the ability to link your computer to another and access its functionality – as soon as a computer was connected to the Net it became more feature rich. The other was the seemingly limitless possibilities for instant – and free – communication with anyone, anywhere in the world sitting in front of a similar device. Email and threaded message boards proliferated as did a system for sending small messages back and forth – IRC (Internet Relay Chat) – never heard of it ? Yeah, you have – just add a # and pastel shade and call it Twitter. So it was then, that from very early on, the internet had two distinct types of user – those who were interested in accessing content and functionality, and those for whom the Internet was primarily a communications medium. My first internet connection was so that I could get my own email address. It also tells you something important about Silicon Valley – never underestimate its ability to put a shiny wrapper on an old idea and call it something new.

Online communities were a feature of the Net from day one with systems ranging from public access sites like USENET, to subscription based communities such as CompuServe in the US or CIX in the UK; the forerunners of what we would today call internet social networking. The appeal of sites like Friends Re-United and MySpace showed that it wasn’t just the old schoolfriends that were being found and multimedia content being shared that brought in the punters. It was the vast amount of social interaction going on in the comment boxes underneath it all that was the real appeal of the site. And so it was that, inevitably, someone thought of bringing all that together into a single, integrated, configurable social networking environment. Originally designed for use by US college students, the functionality and simplicity gave it an appeal that spread like wildfire among the wider populace following its launch in Feb 2004, the same year as Google’s IPO. By the time of writing the site has an estimated 850 million users worldwide and its founder is about to launch its stock market flotation, one of the biggest in US corporate history. The site is of course Facebook and its founder, still only 27, is Mark Zuckerberg.

Perhaps inevitably, considering its origin as a system for college students, Facebook has frequently drawn the charge from its critics that it is essentially a trendy toy for western teenagers with little intrinsic value, but an examination of the demographics of its user base shows this to be manifestly untrue on both counts. Whilst the biggest age band is 18 to 25 (30%), there are twice as many users who are over 25 (60%) and 20% of all Facebook users are over 45. We can therefore say that most Facebook users are adults aged between 18 and 45; and most of the rest are adults over 50, with a small proportion (less than 10%) who are under 18. There are more women than men, 54% to 43%, with 3% declining to answer.

By continent, Europe has the most users (source internetworldstats.com)

Europe

27%

Asia

23%

North America

24%

South America

19%

Africa

5%

Middle East

2%

Oceania

1%

The ten biggest countries by user base in millions with the penetration rate (population / Facebook users)

USA

156

50.1%

India

44

3.7%

Indonesia

43

17.8%

Brazil

38

18.8%

Mexico

32

28.5%

Turkey

31

40.2%

United Kingdom

30

48.5%

Philippines

26

27.6%

France

24

36.4%

Germany

23

27.5%

Note that US and UK have penetration rates of 50% – half the population are on Facebook; both demographically and commercially, that is the Facebook heartland. The lowest (of the 213 countries on Facebook) is the Vatican City which has only 20 registered users. China, containing 25% of the world’s population has just 485,000 registered users, 0.04%, making it 94th on the list – below Ethiopia and above Cambodia.

As for its spread, something with that phenomenal growth rate across so many age groups, geographies and cultural areas has to have at least something going for it beyond its undoubted “trendiness”. Facebook spreads because it gives people something that they want in way that makes them keeping coming back and telling their friends to do the same.

“We’re so happy we can hardly count”

“Facebook was not originally created to be a company. It was built to accomplish a social mission — to make the world more open and connected,” said Zuckerberg, in the CEO’s letter appended to the IPO filing. This being Silicon Valley, the “we’re different and out to save the world” line is an essential part of the process – there was a similar load of tosh from Google when they floated; goes with the territory, I’m afraid.

From the very outset, Facebook was a profitable venture aided by a built in advantage that Google never had. Google is a “frictionless” site, you go there, find what you want then … you go somewhere else – a major problem for the company when it first started since it survived by selling advertising. Facebook, in comparison, is a “sticky” site – you go there and you stay; and advertisers love a captive audience.

Industry analyst Richard Holway, recently quoted in the Times, has compared the Facebook valuation to Google’s 2004 float and concluded that the figure being quoted now of $100bn is overcooked, but also thinks that they will probably get it. Furthermore he says “. You all know that I believe Facebook has won the social media race. It has already been hugely disruptive and I believe will change radically how we interface with the internet. Indeed, how we interface with everything and everybody. It is simply game-changing. In a few years time, Facebook will be as important as Google is today or Microsoft was in the 1990s”

In 2004 when Google floated it was posting revenues of $3.2bn and a net income of $400m – it’s value was $23bn. Facebook in comparison will go into its IPO with revenues of $3.7bn and a net income of $1bn. By applying the same PSR (Price / Sales Ratio) to Facebook as applied to Google at IPO, then Facebook might be worth $27bn; if the same P/E (Price / Earnings Ratio) is used then Facebook would be valued at $57bn. Google’s share price at IPO was $85, but that soon skyrocketed; in Dec 2007 Google shares were changing hands for $714 each; they have since fallen back and are currently at about $600. Many Google employees holding share options became paper millionaires overnight, and the same will undoubtedly happen at Facebook.

The key challenge is going to be revenue growth, but how much more can they make from advertising; have they pulled in most of what is there already ? Google’s margin at IPO was 12%, it’s now 26%, but Facebook is already on 27% – where is any profit growth going to come from ? Can they break into the Chinese market ? The latter may prove to be the most challenging of all – aggressively marketed local alternatives like Renren, Sina and Tencent are in competition plus there is a political culture that has very different ideas as to what people should be allowed to do online. Facebook may have to suffer the same dilemmas as Google did if they want to stay in China.

With the hype, and some cold hard facts, the issue that $100bn seems too high won’t matter, they will most likely get it anyway. Every tech fund manager is going to want to cash in – many of their bonuses are tagged to the tech indices so no one will want to miss out. Holway judged that it would peak early and be only a mediocre stock going forward, before leaving us a final thought on the business side “Let’s say back in Aug 04 when Google IPOed, you’d invested $1000 in both Google and Apple. Your $1000 of Google shares would be worth a tidy $7000 today. But your $1000 of Apple shares would be worth $15,300. Be interesting to see what a similar $1000 investment today in Facebook, Google and Apple will be worth in 2020. Point being that there are probably better homes for your hard earned money.”

A Social Machine for a Social Animal

The biggest growth area for Facebook right now is the burgeoning number of handheld devices, smartphones and tablet computers. This tells us something important about its appeal – the interface is very simple and intuitive, perfect for use on a small portable display. Its aim is to be far more than a Social Networking site, it’s to be no less than an alternative means of accessing the internet. Existing systems such as Windows or Mac grew up to serve the needs of their main customer base – the business community. Their systems are complex and feature rich, but for the many who want only to use it for social networking, they are cumbersome and expensive. Many already have Facebook as their homepage, but it aims to be more than that. Facebook should be thought of as an alternative operating environment for accessing the Internet, geared exclusively to communication and social interaction.

Facebook has grown in the era of “The Cloud”, a technology that allows you to store all of your data online and leaves you needing only a small low power handheld device to access it. Expect the advent of the Facebook-tablet, Facebook-phone or even a Facebook-tv. The site will now act as your primary gateway to the Internet, in addition to its existing functionality it will offer a web browser and both video and audio calling facilities. Tailored links to Home Shopping resources can be made available as can a wide variety of Home Entertainment as pay-per-view streams – whether online music and films, Sky Sports, MTV, iPlayer, IPTV – whatever we deliver now, but all integrated into one package AND with the facilities to interact with your friends and family across the world while you are doing it.

Do all that and you will have offered a great many people just about everything they want from the internet; which will not only have become a lot more fun for them, it will have become a great deal simpler as well. Now imagine that it comes on a cheap mass-produced Tablet or Smartphone with a ISP deal that gives you enhanced bandwidth priority and you can begin to see that Facebook, or something like it, could be a major player in the home shopping, online dating, telephony and home entertainment markets. So you see, I don’t accept the argument that there is no way but advertising to make money from Facebook and I don’t accept the argument that there is nothing there that anyone will pay for. There is and they will – if you can get the service product right.

That is the true nature of the technical and commercial challenge that Facebook has before it, and that is the reason why there has been such a fuss over its IPO. With the post – Steve Jobs Apple rapidly completing its transition from a “computer” company to a “home entertainment” one the really interesting interaction of Facebook with the rest of Silicon Valley may not just be the one with Google and its rival Google+ system, but the interaction of Facebook with Apple – and they won’t necessarily be rivals, they might well be partners. Could Facebook deliver the subscribers and can Apple learn to produce a tablet that doesn’t cost the earth ? Because if they can’t them I’m sure Hewlett Packard could.

More to the point, however, can they both attract the premium content ? I can think of one of content provider that would be popular and would underline the “family friendly” ethos that will be essential for the service to succeed – Disney.

What’s that you say – heard it all before ? Sure you have – from Google, their Chrome Notebooks and Google TV are on the market now and the Chrome Smartphone is about to hit the high street. But remember that captive audience I mentioned before … you can bet that Mr Zuckerberg and his investors have thought of that already.

Get this one right Mark, and the sky really is the limit.

Copyright ©2012 Savereo John

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