facebook Inc.

(Facebook or the company) is a social network platform which enables users to share ideas, opinions, pictures and activities. Political Factor Users and governments have been expressing privacy concerns which could harm the companys strategy to use user information to deliver effective advertisement. While the class action law suit filed against the company could potentially imply damages of more than $15 billion if successful, the claimants could stifle Facebooks ability to collect data about its users and hinder its ability to grow advertising revenues. Similar concerns were expressed in other countries as well. For instance, German data protection official also warned Facebook investors during its IPO that the social networks operational performance is based on practices that breach European privacy rules. In addition to the legal aspects, Facebooks users continue to regard the platform as a private space which could limit the companys prospects. In a survey conducted, for instance, more than 50% of respondents said they felt not safe at all using Facebook to make purchases. Excessive advertising or privacy fears could lead to a mass exodus of users, which threatens the growth prospects. Economic Factor Facebook has over the years recorded strong growth rates compared to its peers. The companys revenues in FY2011 grew by 88% compared to FY2010. The revenues grew at a CAGR of 119% during 2009-11. Googles revenues increased by 30% in FY2011 and its revenues grew at a CAGR of 27% during 2009-11. The revenue growth rates highlight the companys inherent ability to drive growth, Facebook being the market leader with strong potential in a relatively underpenetrated market of social network advertising. Facebook also enjoys low expense base which has enabled it to drive higher margins compared to its peers. In FY2011, the companys operating margins were 47.4% and net profit margins were at 18%. Comparatively, Googles operating margins during FY2011 were 30.9% and net profit margin was 25.6%.

High margins compared to peers indicate better aligned cost structure at Facebook. The company will be well positioned to sustain low advertising rates due to its low expense base which will provide competitive advantage. This is of particular importance amid the doubts of effectiveness of social media ads. The company will be able to compete better given its low price. Facebook also enjoys strong cash flows. The companys operating cash flow margin in FY2011 was 41.7% which is higher than 38.4% in Google during the same year. High operating cash flow margin at Facebook reinforces the earnings quality as it indicates that the company is able to effectively convert sales into cash. Furthermore, the company converted 12.6% of its sales into free cash flow. The ratio of free cash flow to sales is a measure of how much of a companys revenue is transformed into cash. The companys high cash flow generation capability indicates that the company enjoys high financial flexibility. Facebook faces several challenges in terms of monetizing its reach and drive revenues. The companys free cash flow position enables it to invest in expansion inorganically. Facebook will be able to fund its expansion plans at feasible rates. Social Factor Facebook forayed into mobile application market with the launch of App Center and thereby took the first step into monetizing the mobile user base. App Center is a new place for people to find social apps. The App Center gives developers an additional way to grow their apps and Facebook provides the insights that facilitate apps to be successful. The App Center can be accessed on the web and in the iOS and Android Facebook apps. The App Center does not sell these mobile apps but rather directs users to apps on Android and iOS stores. Facebook does not earn revenues as the operating system owners are the only players that can sell apps. However, Facebook will promote social apps that use Facebook login which is a requirement to be listed on the App Center. Consequently, Facebook has more users utilizing its network even if it is just a login feature. This further enables Facebook to collect more data on its users which in turn enables the company to further its core targeted marketing

proposition. In addition, Facebook also intends to sell non-platform-specific apps, or HTML5 apps. Facebook is estimated to take 30% fee for app sales. Through App Center, the company intends to foray into the domain so far dominated by operating system owners. Facebook is encouraging developers to build apps for the platform-agnostic standard of HTML5 instead of for proprietary operating systems. So far, mobile platform proprietors had access to user data and earned the related advertising revenues. But through HTML5 apps Facebook can direct the user activity data to itself. With the App Center, Facebook is expected to be a fore runner in creating a mobile social experience, a potential market that is largely untapped. Technological Factor Facebooks ads are yet to be proved for effectiveness due to the inherent business model that the company adopts. Google is well poised to capture the online ad market which Facebook significantly lacks in. Facebook relies on display ads which are known to generally hurt the user experience, and are not as efficient at producing revenues. For instance, according to the estimates, Facebook makes about 1/10th of Googles revenues even though they have two times the pageviews. Further estimates indicate that Googles search revenues per pageviews are at 100-200 times that of Facebooks. Furthermore the estimates indicate that the average click-through rate (CTR), a way of measuring the success of an online advertising campaign for a particular website, of an ad on the Google Display Network is 0.4% which is estimated to be about 10 times as high as the typical Facebook ad. The comparison suggests that Google currently offers advertisers more value in terms of both options and results, in comparison to Facebook. This is because Google captures audience with purchase intent. Google earns through ads displayed when people search for something to buy or hire, and also it does not need to drive the demand but rather focuses more on channelizing the existing demand. On the other hand, Facebook has positioned itself as a platform for socializing with friends. This aspect reduces the effectiveness of advertising in Facebook. The questionable

effectiveness of Facebook ads was also highlighted by the most recent announcement by General Motors dropping its paid ads on Facebook primarily because the ads were not effective. Earlier, several other retailers such as Gamestop to JC Penney withdrew from Facebook.