Everything’s changin’ when I turn around
All out of my control
I’m a mobile
Avril Lavigne, “Mobile”
As we noted in a previous Underdisclosed PRO Report, we believe that Facebook believes that the future of its business is in mobile.
Facebook’s recent Form 10-K for the fiscal 2012 continues to validate this theory. A continuing theme around Facebook’s discussion of the risks related to its business revolves around its ability to execute its mobile strategy.
Why is this important? Mobile is the future. The most important and revealing quote from the Form 10-K:
“We expect mobile usage to increase at a faster rate than usage through personal computers for the foreseeable future, particularly in developed markets, and our success in ramping up mobile monetization will likely have a material impact on our financial performance.”
Where the money comes from.
Facebook makes money primarily from advertising. Most of that revenue comes from personal computers. The issue is that Facebook has not figured out how to counter the business forces that promote mobile, where the revenues are more difficult to come by. For example, Facebook has stated that:
“we anticipate that the rate of growth in mobile usage will exceed the growth in usage through personal computers for the foreseeable future and that the usage through personal computers may decline or continue to decline in certain markets, in part due to our focus on developing mobile products to encourage mobile usage of Facebook. For example, during the fourth quarter of 2012, the number of daily active users (DAUs) using personal computers declined modestly compared to the third quarter of 2012, including declines in key markets such as the United States, while mobile DAUs continued to increase.” [Ed: Emphasis ours.]
- Our principal revenue source (DAUs from personal computers) is declining
- This decline is a worldwide phenomenon
- Business trends are moving away from our principal revenue source
How new revenue sources generate less money even as users gravitate to them.
The move to mobile involves fewer ads, as Facebook explains:
“product changes and changes in user engagement generally offset in their impact on the average number of ads per user. For example, the shift to greater mobile use generally reduced ads per user, while the introduction of ads in News Feed increased the number of ads per user.”
The increase in use in new markets also results in lower prices per ad, as Facebook explains:
“The rate of change in number of ads delivered also differs by geography, driven by factors such as mobile penetration. For example, Europe and Rest of World increased at a faster rate than the United States and Asia.”
“The increase in price per ad in the United States was partially offset by an increased percentage of our worldwide ads being delivered in the Asia and Rest of World geographies where the average price per ad, while growing on a year-over-year basis, is relatively lower.”
As a result, Facebook sees the future in mobile, the source of growth. However, this presents challenges, particularly:
Being successful in the desktop personal computer environment does not mean you know how to do mobile.
Clint Eastwood as Harry Callahan in “Magnum Force”
Facebook sees its limitations in mobile and has been trying to fix it. Yet, it does not even know where or how to address the challenges. For example, for all of its data mining and [Ed.: alleged] privacy violations, Facebook is not even sure of the who, where or how of its mobile users. For example, Facebook has stated that:
“Our user engagement patterns have changed over time and can be difficult to measure, particularly as users engage increasingly via mobile devices and as we introduce new and different services.”
“Some of our historical metrics through the second quarter of 2012 have also been affected by applications on certain mobile devices that automatically contact our servers for regular updates with no user action involved, and this activity can cause our system to count the user associated with such a device as an active user on the day such contact occurs.”
Continuing a theme, as Clint Eastwood said in ‘Heartbreak Ridge,’ “I can’t fix it if I don’t know what’s broken.”
I couldn’t find the quote on YouTube, but here is the Siskel and Ebert review. We side with Ebert on this one.
Facebook began showing ads in daily News Feeds in early 2012 and has only generated a small portion of its revenue in that way. In addition, it does not generate mobile revenue through Payments, its gaming infrastructure. As a result, Facebook has warned that if users increasingly access it through mobile instead of personal computers:
- It may not be able to develop revenue strategies to take advantage of it; and
- It may incur excessive expenses in this effort.
Facebook continues to warn that it may experience negative revenue effects if mobile use increases because its “ability to monetize is less proven than it is from use on personal computers.”
In addition, simply putting Facebook lite on iPhone, iPad, Android or [enter name of other mobile platform here] is not likely to be successful without more strategy on developing mobile products for mobile users. Facebook continues to warn that it may feel negative impacts if it is unable to continue to “develop products for mobile devices that users find engaging, that work with a variety of mobile operating systems and networks and that achieve a high level of market acceptance” or if “users adopt new technologies where Facebook may not be featured or otherwise available.”
As we previously stated in our previous report, this is why Facebook bought Instagram.
- It was not because of photos.
- It was not because of its user base.
- It was not because of consolidation in the social networking industry.
“[W]e believe that some of our users, particularly our younger users, are aware of and actively engaging with other products and services similar to, or as a substitute for, Facebook. For example, we believe that some of our users have reduced their engagement with Facebook in favor of increased engagement with other products and services such as Instagram. In the event that our users increasingly engage with other products and services, we may experience a decline in user engagement and our business could be harmed.”
It is difficult to make money in mobile, where the ability to generate revenue from current revenue sources is limited and profit margins are tighter.
Facebook’s revenue source is primarily ads [Ed. But we repeat ourselves.]. Facebook explains that its advertising revenue is generated by displaying ad products on the Facebook website or mobile app and third-party affiliated websites or mobile apps. Marketers pay for ads based on the number of impressions delivered or the number of clicks made by users. Further, impressions are considered delivered when an ad is displayed to users. The number of ads shown is subject to methodological changes as it continues to evolve its ads business and the structure of its ads products.
Translation: Facebook is trying to figure out how to get more ads out of mobile and how to raise margins.
Mobile advertising is new to Facebook. As it explained, “[F]or the year ended December 31, 2012, we estimate that mobile advertising revenue as a percentage of advertising revenue was approximately 11%. As mobile advertising was not offered prior to the first quarter of 2012, comparisons to prior year are not meaningful.”
While advertising prices on personal computers is increases, in part due to ads in News Feed, advertising prices are being pressured by international and mobile, where:
- advertising prices are lower; and
- where international use is also being driven by mobile.
As Facebook explained:
- [T]he increase in price per ad in the United States was partially offset by an increased percentage of worldwide ads being delivered in the Asia and Rest of World geographies where the average price per ad, while growing on a year-over-year basis, is relatively lower.
- The lower volume of ads per mobile user is partially offset by the higher price per ad for mobile, and it is investing to try to make our mobile ads more valuable over time.
- For the year ended December 31, 2012, Facebook estimates that approximately 23% and 11% of its ads revenue came from mobile products, respectively.
Translation: As mobile makes us a larger percentage of Facebook’s ad revenue, (i) the higher price for a mobile ad DOES NOT make up for the lack of volume, and (ii) Facebook still trying to figure out its mobile revenue strategy.