Questions, QuestionsFacebook: Checking Under the Hoodie

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On the day of its monster IPO, I review questions central to Facebook: CEO, business model and strategy. (Full disclosure: I am a fan, though a skeptical one.)

Zuck as CEO

After Mark Zuckerberg’s appearance last week in front of investment analysts in New York, you’d think that the largest IPO in U.S.history hinged on the acceptability of  his attire, a hoodie sweatshirt. This was, to put it mildly, stupid. The main question about Mr. Zuckerberg is not his hoodie, but what’s under it – his mind and its ability to manage a large corporation, one that he wields considerable control over.

Zuck is not the first young entrepreneur to run a major company.  Silicon Valley turns these out on a regular basis.  Yahoo!’s Jerry Yang was 28 at its IPO in 1996.  The Great Steve Jobs was in his twenties when Apple raised its middle finger toward IBM in the 80s.  Google’s co-founders, Larry Page and Sergey Brin, were 31 and 30 respectively at its IPO.  But the road to greatness is never smooth.  Jobs, famously, was shown the door in 1985, but eventually returned, a wiser man, years later.  Yahoo! had some success, but also a lot of  trouble and continues to struggle.  Google’s life has been relatively calm, making its IPO in 2004 under Eric Schmidt, who is almost 20 years older than the founders.  Schmidt headed the company for 10 years before stepping aside for Page in 2010.

Much has been made about Facebook’s board of directors and Sheryl K. Sandberg, the 42-year-old COO, a former Google executive.  Zuckerberg’s debut in New York may have not have been impressive, but Facebook can still insist that Zuck is guided by a blue-chip team.  Coverage over the weekend pounded away at this, which, if nothing else, proves that Facebook has some great media relations support.  The New York Times ran a long profile that implied that Zuckerberg had the talent and vision to lead, and that he is willing to listen, seeking advice from Bill Gates and Steve Jobs.  The story also walked through a gallery of Who’s Who of Silicon Valley, Peter Thiel, Marc Andreessen, Sean Parker – all senior, experienced hands – who are advising Zuckerberg.  And, of course, there’s Sandberg, who did much of the talking during the road show.

Some of the headlines elsewhere were even more supportive — ZDNET: “Apple co-founder Steve Wozniak: Me + Steve Jobs = Zuckerberg.”   The story’s author, Emil Protalinski, disagrees with this in the subhead — Zuck has vision, but is no longer the technical force behind the company.  Still, Facebook had to be pleased with the headline, particularly as it began to make the rounds on Twitter.

What should we think then?  First, remember that nobody is ever as good, or ever as bad as their press coverage.  Heroes seem to always have a skeleton or two hidden away and serial killers always pay their rent on time and say hello to their neighbors.  Zuckerberg isn’t the Second Coming of Steve Jobs.  (In his twenties Steve Jobs wasn’t even The Steve Jobs.)  Second, a player is only as good as his team.  Just ask LeBron.   As the New York Times story attests, he has a team – a great one.  But does he listen to it? Up to now, he has shown that he doesn’t have to — stories abound that he made the Instagram purchase without consulting the board.  Many of these stories are told to show that he has the vision and will to succeed.  Still, it’s reasonable assume that some board members might have questioned the wisdom of buying an app that has no business plan and hasn’t made any money for a $1B.

My point is not to argue whether buying Instagram was a good decision, but that Zuck didn’t consult his board.  He took action and got sign off later.  The deal was significant – even for a company that is now valued at more than $100B.   This doesn’t bode well for Facebook as a company.  It is one thing to run a private company as if you are Louis  XIV (l’entreprise, c’est moi), but quite another if it is publicly held.

Conclusion: Analysts should be concerned whether Zuck will listen to his advisers.  Right now, I’d say he doesn’t have to and isn’t inclined to.

Relevance vs. Dominance

While there is considerable room for debate, I’m inclined to think that Facebook will be relevant, but not dominate, in the advertising market and the expectation of dominance is what is driving the IPO valuation to $100B and beyond.  We will have to wait a while to see how Facebook’s business model works out, or whether it can find a new way to raise revenue.  Right now it relies heavily on display advertising and that just doesn’t seem good enough.

Supporters say that it has a billion users and is continuing to grow.  But digital audiences have a way of wondering away from the crowd – Compuserv and AOL had huge (for their time) user bases and you could argue that these two companies serve as a good as any for analogy of MySpace and Facebook.  Yahoo! tried to maintain its dominant size by collecting companies and websites, increasing its offerings.  Initially that seemed to work, but eventually it users and employees became confused and exhausted.  It is still relevant, but it is not dominant.

Facebook has room to grow, but how much isn’t clear.  Budgets are flowing its way and that can be expected to continue for the next year or two.   GM’s ad budget, however, is flowing away from it and other advertisers may follow.  Many are still trying to get a handle on Facebook – how to use it and how incorporate it into the marcom mix.   There is growing concern that display ads just don’t work on Facebook and that’s where more than 70 percent of its revenue comes from.  Sure, Google can be upended, but right now ads work when people are searching, not when they’re socializing on Facebook.

Even if Facebook does capture significant share of advertising dollars, it appears that the $100B valuation is at the high end of optimism.  Shawn Tully at Fortune argues that it would have to grow to $61B in annual ad revenue, from its current $3B, to justify as an investment at this valuation: “So Facebook would need to go from a glamour name to capturing something like 8% of all of the world’s ad market in 12 years, grabbing business from the likes of Google and News Corp.  Can it happen? Sure.  But nothing spoils a Wall Street party like a sermon on the math.”

Apple has already shown us over the last 10 years that nothing is impossible.  But new kids come out of nowhere all the time to undermine the status quo.  (Just ask Myspace. ) These days its Pinterest, which has moved into No. 3 in social media views and may drive purchase decisions better than Facebook .

Conclusion: Facebook’s primary source of revenue  still hasn’t won over the industry. Facebook really needs be more persuasive on this or find another way to make money.  Even if it does, it will be a challenge to justify the huge IPO.

Toward Complexity

Remember how Facebook began and how it evolved? Thefacebook, as it was called then, was initially a platform for hooking up — a way for students to check out a classmate to see if they were available.  The most important aspects of an account then were “interested in” (as is meeting men, meeting women) and relationship status.  Since then, Facebook has evolved to focus on the feed and photos, which is great, but it has also continually acquired apps as it has grown, making its interface ever more complex.  Yahoo! started off as a index of the Internet and formed into a site that tries to do everything, none of it really well.  Google, yes, has added a lot to its offering, but it still has a streamlined interface and it knows it does one thing well: search.

Facebook has tried hard to retain simplicity, for example, borrowing the group concept from Google+ and sorting the news feeds (Top Stories vs. Most Recent), but it keeps banging up against the Dunbar’s number,  which says most people can have only about 50 close friends and meaningful relationships with a 150.  What this means for Facebook users is that the more connected you are beyond 150, the less engaged you are.  More connections means viewing more photos of the lunches and cats of people you vaguely know.  Less personal relevance to the user makes the news feed less interesting.  Less interesting means less engagement (and updating).

Hence, Facebook’s efforts to break your connections into groups and sort your newsfeed.  Your post now has a 20 percent chance of being seen by your friends, which leads us back to less engagement.  Dunbar’s number indicates that networks are less beneficial after they expand beyond a certain size.

Sure users can go int0 Facebook and set up groups, or let Facebook do it for them, but a number of  platforms are already offering immediate and simple solutions:  Limited network social platforms, or as I call them, unsocial media that intentionally limit your connections and protect your privacy or, at least, limit public exposure of private information.  These include Path – which limits users to 150 connections.  There are other platforms, too, that appear unrelated at first, but that may steal users’ time, such as Line, sort of an instant Twitter list made from and limited to your contacts.

Lastly, privacy doubts will continue to haunt Facebook.  In many ways, this may be its weakest point.  Facebook’s ubiquity means that it is used more than it is trusted; the social networking incarnation of Windows.

Conclusion:  The strategy maintaining size by adding offerings is similar to Yahoo’s failed strategy of being “everything to everyone” in the late 90s.  Complexity kills.  This, combined with a human inclination (if Dunbar is right) toward platforms offering immediate limited networks will continue to challenge Facebook.  The company, no doubt will survive, it may even prosper, but what about the small investors who bought into the IPO?