Facebook Essay Example

an interactive student directory containing each student’s class schedule and social network.

Before Facebook added the feature sets it has today, it was simply a more complete student directory. Facebook did not create a community where one never existed before; rather they provided an important information and communication service to a pre-existing offline community. While students already had a loose affiliation with all fellow students at a college, they didn’t have an easy way to learn more about their fellow students outside their direct social network. Given the large class sizes at most universities today, students don’t have the opportunity to interact with very many of their fellow classmates during class.

I remember the days I spent at Berkeley in 200+ student lecture halls scanning the crowd for attractive girls or previous acquaintances. Facebook organized students by class schedule for the first time, making it possible to learn more about that classmate you might have a crush on. Although I am highlighting one particular use case, initial Facebook usage was indeed driven by dating type activity – checking people out, learning more about crushes, light stalking type of activity, etc. The larger picture here is that Facebook created a high utility online service for enabling pre-existing social behaviors within an offline community.

This makes for an interesting lesson learned: it’s easier to piggyback off a pre-existing community with offline behaviors that drive online service usage. Restrict user registration (and other behaviors) to build desired online service Facebook made important product decisions that ensured harmony and trust between the offline community and the online service created. Facebook originally limited membership to those users who could verify they had a

“. edu” e-mail address for the college they attend. Facebook also placed limits on the ability to search or browse users to the college that the user attends.

These measures aim to make users feel that the site is exclusive and limited to members in their offline community (colleges and universities). In the early days of Facebook, something like 30% of users actually posted their cell phone number on their profile. I’m not sure whether this statistic is still valid, but it supports the notion that users trust who is viewing their profile. Facebook has recently opened its doors to users outside the . edu networks. To accomplish this, they have created “networks”. High schools, employers and geographic areas are, essentially, what colleges were to the original Facebook.

When you join one of these “networks,” you can only view others in the self-designated network. Additionally,Facebook has implemented a number of privacy controls that allow users to control exactly who gets to see the information they provide. Aggregation of a series of deeply penetrated micro communities Facebook is a more compelling advertising opportunity than other social networking sites because of deep penetration within a series of micro communities (college campuses). If a local advertiser wants to target a particular college campus, Facebook is the best way to get the advertiser’s message to that audience.

CPM rates for local advertising command a significant premium from advertisers because of their more targeted nature. With 65% of users logging in daily and 85% weekly, advertisers can run time-oriented campaigns very effectively. The large, branded advertisers, who value reach, can advertise to nearly every student in the 18-22 demographic in the US with

one campaign. Facebook will have ample opportunity to diversify its revenue streams beyond traditional banner advertising due to its deep penetration in these micro communities.

Having the attention of 90% of students attending a university lends itself to online classifieds, event listings, e-commerce, and lead generation. Facebook should be well-positioned to be a major player in online classifieds given the usage patterns of its user base. Built strong brand recognition amongst user base and advertisers The key to an online advertising business targeting branded advertisers (advertisers looking for branding, not just clicks) is having a strong brand that advertisers want to be associated with. A perceived hot brand is what drives premium CPM rates.

Two sites having similar demographics and user usage patterns may have drastically different CPM rates based solely on the perceived brand recognition and image factor. While some people I spoke with disagreed, I believe that Facebook did a masterful PR job - highlighting the impact that Facebook has made on the lives of college students and their online media consumption in nearly every story written. How often do you hear that 90% of Facebook users login to the site once per week? Clearly the PR coverage came as a result of the tremendous viral growth, but capitalizing on that PR to help build brand was a key success factor.

Founder(s) credibility with college audience The “face” of Facebook is Mark Zuckerberg. Back in February 2004, whenFacebook was founded, he was a student at Harvard. Two other students, Dustin Moskovitz and Chris Hughes were the second and third employees of the company. This added a level of credibility to the site in the minds of

the student users. It was something one of them had created, not something fed to them by a “company” in the traditional sense. It was a place that they could trust because one of their own had made it.

Adding to the underground feel of Facebook was the viral spread of the site. It fanned out throughout Boston, and then the Ivy League. Students at other schools had to wait in line until Mark and friends could find time to add their school. This created even more buzz around the product. Launch strategy Prior to launching Facebook, Mark Zuckerberg had experimented with a number of different web products. In fact, his first attempt targeted at the Harvard student body was called FaceMash, which drew criticism from the University and some students, prompting Mark to drop the service.

Mark launched Facebook (at the time called thefacebook. com) in February 2004. Once the site was ready for users, the Facebook founders blasted e-mails to Harvard students to let people know about the site. The team had access to the e-mail addresses of Harvard students at each dorm. Thus e-mail marketing, viral feature sets, and word of mouth was how Facebook was launched. Given the immediate positive reaction that Facebook received at Harvard, Facebook began rolling out the service to other universities.

Facebook did not use a targeted geographic roll-out strategy in the early days, they received registration requests from students at other schools, and then prioritized which schools to open based on the number of these requests. Interesting to note that this is how Craigslist rolls out to new cities – based on user requests. From what I understood, Facebook

did not receive any help from the schools themselves to promote the Facebook site to the student body. If anyone has evidence to the contrary, please leave a comment below. Exit analysis

There has been much speculation in the blogosphere and mainstream press regarding who will buy Facebook and for what acquisition price. I have heard from reliable sources that Facebook did indeed turn down acquisition offers for ~$750M earlier this year. Recent reports have claimed Facebook is in acquisition talks with both Yahoo and Microsoft for ~$1B. Is such a lofty valuation for Facebook justified? It all depends on an evaluation of future growth prospects, but I think that there is a misconception in the blogosphere that Facebook is not generating much revenue.

On the contrary, Facebook was generating almost $1M per week in advertising revenue in Q1 2006. It is likely that Facebook will generate ~$50M in revenue in 2006, up from ~$10M in 2005. Some reliable sources believe that Facebook will do ~$200M in revenue in 2007. Given that Facebook has been guaranteed $200M in revenue over three years by the Microsoft advertising deal, the 2006 and 2007 revenue numbers seem attainable. If the 2007 revenue goal of $200M is reasonable, a 5X forward revenue multiple does not seem to be an excessive valuation multiple.

Many people also point to the fact that Facebook is considerably smaller than MySpace from a site traffic perspective and hence should have a lower valuation than the ~$500M that MySpace was purchased for. This type of comparison based on unique visitors and page views is clearly flawed because not all page views are created equal. There are several good

reasons why Facebook’s page views are more valuable than those of MySpace: 1) Facebook’s core user base (college students) is more desirable than MySpace’s core user base (teenagers).

Because college students have more disposable income and are more likely to have credit cards than teenagers, they are more desirable from an advertiser perspective. 2) Facebook represents a more compelling local advertising opportunity than MySpace because Facebook can guarantee deep penetration of college campuses, whereas MySpace cannot show the same types of local market usage patterns. The CPM rates for local advertising campaigns are typically substantially higher than national campaigns because of their more targeted nature. )

Facebook is viewed as a safer option than MySpace for branded advertisers, as Facebook has a less racy image than MySpace. In a market where advertisers are still hesitant regarding user generated content sites, Facebook has done a better job of brand positioning. Another noteworthy part of the Facebook story is how they masterfully handled the VC financing process, limiting the amount of equity dilution to the founders. When Facebook raised its first VC round of financing in April 2005, they negotiated a pre-money valuation of ~$85M at a time when they were generating less than $500K per month in revenue.

Facebook was able to command such a high valuation by courting both VCs and potential acquirers simultaneously. With term sheets in hand to be acquired for $85M, Facebook was able to drive up the pricing on the VC round. I remember discussing with VCs who participated in the bidding for that first round how the price, which originally started at a $20M pre-money valuation, just kept climbing week after week until

Accel Partners finally won the deal at ~$100M post-money. Hats off to Accel Partners for accurately assessing the potential of Facebook in those early days.

The prevailing wisdom from other VCs was that Facebook would probably be capped at a $200-300M exit, and hence a 2-3X return was not high enough to justify the risk, given the youth and inexperience of the Facebook founders. Accel is likely to make a 8-10X return on its initial $13M investment in just 2 years. Facebook’s most recent $25M round was rumored to have taken place at a $550M valuation after turning downing a $750M acquisition offer. Once again, the Facebook management did a great job of creating a competitive environment for their second VC round.

The one piece of information I would be curious to know is how Facebook’s $500K seed round of financing was structured. That investment was done at the end of 2004 by ex-PayPal exec Peter Thiel (when Facebook was available on ~30 campuses). I’m guessing that $500K bought 5-10% if it was structured as equity, but would have bought considerably less if it was structured as convertible debt. If anyone can shed some light on the seed round, please leave a comment below.