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One week following Facebook’s Q2 earning report, the company’s stock traded at its all-time low of $19.82. Investors seemed unhappy with revenue growth year-over-year and skeptical that Facebook had the tools in place to significantly increase its average revenue per user.
In fact (not adjusted for inflation), Facebook’s revenue performance in the years leading up to the IPO is extremely similar to Google’s historic performance preceding its IPO event.
Fig.1 Facebook revenue has failed to grow at the same rate that Google saw in its IPO year.
Being lined up next Google is generally a pretty flattering comparison. So where is the lack of confidence in Facebook rooted?
Both Facebook and Google were slammed with negative press leading up to the IPO. In some ways, the criticism of Google was more daunting. “People feared that in going public, Google would lose its prized objectivity and independence,” Eric Schmidt wrote for Harvard Business Review. The public feared that the IPO would break the Google team.
And the reservations about Facebook? Investors now fear that advertising on Facebook will remain ineffective and that the Facebook advertising product itself is broken.
The earnings report and call were sobering because they finally raised questions about Facebook’s growth potential. Does Facebook have the ability to monetize its user base quickly enough to realize triple-digit growth for 2012? In the context of slowing growth, the Facebook Exchange carries some extremely significant expectations.
In order to become a more profitable business, Facebook has recently invested heavily in research and development. R&D accounted for 45% of all costs and expenses in 2011. While we expect some exciting developments in the near future, the Facebook Exchange is the most significant advertising tool released by Facebook since it became a publicly traded company.
In the light of extreme market pressure to grow, the Exchange may appear like a frantic attempt to appease investors. However, the Facebook Exchange has the potential to help Facebook, advertisers, and agencies continue to grow.
How will the Exchange work?
In the past, Facebook marketplace ads and sponsored stories could only be purchased through the Facebook User Interface or through an agency/ad tech partner with access to the Facebook Ads API.
Ad targeting through the UI was and will continue to be based on self-reported user information including demographic, geographic, and contextual targeting options such as education and work data, like and interest data, and data on how people are connected on Facebook. This knowledge is aggregated and maintained by Facebook. The advertiser never receives any identification knowledge about the users who see and interact with their ads. Facebook strips any information from the referring string. Even when advertisers apply tracking to URLs, there is no way to link the cookied shopper to a Facebook account.
User privacy remains a top concern. Accordingly, Facebook is working with DSPs not only because of their real-time bidding capabilities but also because of their ability to handle anonymous user information.
One major distinction is that Facebook Exchange buys can only run through the DSPs. The second major change is the ability to target ads using your own retargeting data or relevant 3rd-party data applied by the DSP.
The ad creation and purchase workflows will remain separate. Thus, it will remain impossible to take advantage of behavioral and interest-based targeting at the same time.
Advantages for Facebook:
The exchange has the potential to improve the platforms’ reputation as a successful direct-response advertising channel. The wide-ranging interest data that Facebook aggregates for each active user has been extremely exciting. Nevertheless, interest-based targeting has not proven successful at generating ecommerce anywhere near as profitably as paid search.
The improvement comes from incorporating the behavioral targeting options also available in traditional display advertising.
Data points such as users’ average time spent on site become much more appealing for Facebook as a publisher. Facebook instantly becomes a great, highly populated place to deliver time-sensitive advertisements such as ads relates to major sporting events or flash sales.
Advantages for advertisers:
The Facebook exchange provides existing advertisers with the means to retarget site visitors even when they are on Facebook. Past behavior is a stronger predictor of future behavior than interest data. As such, advertisers can expect a stronger conversion rate for well-executed exchange buys. Stronger initial purchase rates are very helpful to rules-based bidding systems that rely on a baseline of sales and orders in order to properly optimize advertising spend over time.
Advertisers new to Facebook do not have to develop any new capabilities or contract with a new agency apart from their existing display partner. For these new advertisers, Facebook effectively becomes just another publisher with remnant inventory. Display advertisers seeking more advertising coverage of their potential customers will spend incrementally to reach them on Facebook.
Advantages for agencies:
Brand advertisers interested in testing Facebook often looked at their agency partners as simple social media advertising platforms geared to create and test campaigns on Facebook. Often the advertising spend was disconnected from the content published to the brand’s Facebook page.
The advent of the Facebook Exchange allows agencies to rejuvenate conversations about Facebook as a performance channel. Moreover, there would be minimal ramp up to testing of the Facebook exchange compared to the targeting research that usually precedes Facebook advertising using the current interest-based targeting options.
The change also allows brands and their agency partners to focus on bigger challenges. Lack of direct response tools on Facebook has bolstered the popularity of customized Facebook applications and contests. However, the results of such campaigns remain difficult to track or translate to sales lift. Retailers will be able far more easily to track the sales associated directly with Facebook exchange advertising buys than to attribute downstream activity to their content and promotions-based social media expenditures.
So is the Exchange a game-changer?
As long as Facebook remained private, it could remain focused on the user experience. Now something needs to change. The platform must become more accountable to advertisers’ needs. The Exchange is a step in the right direction, but it is not a game-changing solution.
The Exchange has the potential to convert costumers by helping advertisers cherry-pick those lowest in the funnel. However, the Exchange is not coupled with innovative ad formats that demand the user’s attention. It is also not an innovation that would allow marketers to combine behavioral data with Facebook’s coveted interest data.
In the past, Facebook has been guilty of outsourcing of tech innovations to advertising agencies and ad tech companies. Technological investment around direct-response tools is still needed, particularly around mobile. The challenge will be difficult considering a strong legacy of outsourcing problems not related to the core Facebook user experience. Facebook has not even been able to build its own engaging applications, instead depending on partners like Wildfire Interactive (recently acquired by Google) to build the technology that drives promotions for the largest brand advertisers and for Facebook itself.
The social network tapped a great insight into humans’ once-secret motivations and behaviors. As a result, the company had remained focused on consolidating users to its platform. In the past, Facebook did so without investing in the technology needed to effectively earn revenue from its users.
This lack of technical capacity is especially worrisome for investors when we consider that the largest opportunity (the largest shift in consumer behavior) is toward mobile. Mobile is a challenge that Facebook must tackle with more intensity than it has the direct marketing challenge.
– Ruben Sanchez, RKG