- Primary Products
- How Facebook earns?
- Financial Performance
- Drivers of growth in advertising revenue
- Cost of revenue & operating expenses
- User trends
- Risks and challenges in the business model of Facebook.
Facebook, the leading social media network of the world has more than 2 billion monthly active users. Apart from being the most favorite social media channel of millenial users, it is also the favorite marketing channel for marketers. The brand has seen very fast growth in its revenue and user base in the recent years. Growth of the internet technology worldwide and seevral other factors too have supported the rapid growth of this social media channel. The product mix of Facebook also includes Instagram, Messenger, Whatsapp and Oculus. In the recent years, the number of challenges the social media network is facing has grown. Apart from privacy concerns and the data scandal, more challenges have emerged. Even in the face of these challenges the popularity of Facebook has continued to grow. The social media network allows people from around the world to connect with others and form communities. While Facebook is already enjoying immense popularity, Instagram has also seen a lot of success and has acquired a very large customer base. The main drivers of Facebook and Instagram’s success are technological advancement and innovation. Around the world, technological changes are happening fast and competitive pressure in the industry is also high. Regulatory challenges can also limit the prospects of growth. However, Facebook is expecting more growth in the near future.
Let’s have a look at how Facebook’s business model works, its revenue model, what are the reasons behind its success and its risks as well as challenges.
Facebook is headquartered in Menlo Park, California. Apart from Facebook, the other products it owns include Instagram, Whatsapp, Oculus and Messenger. The mission of Facebook is to give the people the power to build community and bring them close together. The main focus of the business to create useful and engaging products that help people connect and share with their friends, families and communities.
Facebook is mainly a social media platform that enables people to connect, share and communicate through a number of devices including smartphones, tablets, PCS and other internet enabled surfaces. Apart from that it offers an optimized news feed and serves personalized ads. There are several ways in which people can connect and engage with each other through Facebook including connecting and sharing and writing on others’ timeline.
Instagram is also a popular social media network mainly for sharing images, videos and messages. It also helps people find and follow their interests. The platform has grown highly popular as a marketing platform. There are fashion, fun and food brands flocking to Insta in larger numbers than ever before to reach a large crowd of fans. Celebrity accounts are especially among the most followed ones on Instagram.
Messenger is a simple messaging tool with a simple and easy to use user interface but equipped with powerful features. It makes it easy and convenient for the send private and personal messages to their friends and family. Because of its simple and easy to use interface the messenger has grown highly popular and is being used widely.
Whatsapp is also a simple and powerful messaging tool which has grown highly popular worldwide because of its simply city, convenience and the powerful messaging and sharing features it offers. You can message and share with security and privacy to individuals as well as groups. These features have made it a popular application even in the business circles. Its simplicity and convenience have helped it find organic growth faster.
Apart from virtual reality products including hardware/software, Oculus offers special products/tools for the developers.
How Facebook Earns? Revenue Model of Facebook
The main source of revenue for Facebook is advertising. The company generates substantially all of its revenue by selling advertising to marketers. The advertising model of Facebook is similar in various aspects to that of Google. Marketers can reach a large audience through Facebook ads and use its segmentation features to segment the customers on the basis of age, sex, location, interest or behavior. Marketers can purchase ads that will appear on Facebook, Instagram, Messenger and on third party websites and apps. The marketers can pay for the advertising directly or through resellers and advertising agencies. Charges for ad placements are based on the number of impressions or specific actions like clicks.
The objective of the marketer may be impression or click or both. When an ad is displayed to the user impression is considered delivered. However, in case of action-based ads, the ad is considered delivered when the specific action is taken. Facebook has continued to improve its ad business and the structure of ads and so the number of ads shown is subject to methodological changes. The total ad revenue is divided by the number of ads delivered to know the price per ad. The price per ad reflects the effective price the marketer paid per impression irrespective of whether he paid for impressions or actions. In case of the advertising arrangements made through resellers or advertising agencies, the revenue is recognized on a net basis. While advertising is the source of substantial part of its revenue the company also derives a smaller part of its revenue from payments and other fees. The net fee that Facebook receives from the developers using its payment infrastructure comprises the payments fee. The ‘other fees revenue’ of Facebook includes the revenue it earned from hardware as well as various other services.
The revenue of Facebook has increased fast during the last five years. It has more than doubled between 2016 and 2018. The revenue of Facebook in 2016 was 27.6 Billion dollars which grew by 47% in 2017 to 40.6 Billion dollars. Again from 2017 to 2018, the revenue of the company rose by around 37% reaching 55.8 Billion dollars. The company has experienced growth in revenue mainly due to rising advertising revenue. Apart from the user base the ad business of Facebook has also experienced fast growth in the recent years.
A substantial part of the entire revenue of Facebook is generated from advertising. Out of the total 55.8 Billion, 55 Billion were generated from advertising in 2018. Growth in the use of mobile devices globally was the main driver of growth in advertising revenue. Around 92% of the total advertising revenue Facebook earned was generated from advertising on mobile devices. Apart from the number of ads delivered, the average price per ad was also higher in the year 2018. The number of ads delivered in 2018 was around 22% higher in 2018 as compared to 2017. The average price per ad also grew by around 13%.
Major drivers of growth in advertisement revenue:
Apart from the number of users, the overall engagement level also grew across the entire platform leading to a rise in revenue from ads. The number and frequency of ad delivery also grew across the Facebook products in 2018. Growth in demand for Facebook’s ad inventory led to growth in the average price per ad. The rise in demand for Facebook’s ad inventory was caused by several factors. Apart from increased ad spending in the existing markets, the number of marketers advertising actively on Facebook as well as the relevance, quality and performance of Facebook ads has also continued to improve. These factors have led to growth in demand for Facebook ad inventory. However, advertising revenue of Facebook is also affected by seasonality. Traditionally, advertising revenue of Facebook has remained the strongest in the fourth quarter which is because of the higher advertising in the holiday season. Fiscal year at Facebook ends in December. This is the time when ad spending is at its highest across all the major platforms including google. After that it falls again in the next quarter.
Cost of Revenue and operating expenses:
Cost of Revenue:
The cost of revenue at Facebook is mainly comprised of the costs associated with the delivery and distribution of Facebook’s products/services. It mainly includes the costs associated with operating the Facebook data centers. Facebook has built its own data centers through which it serves its products and also plans to expand the size of its technological infrastructure mainly by investing in data centers and other projects. Apart from United States, it also has several more data centers located internationally. The company has offices and data centers in more than 30 different countries. The cost of revenue at Facebook also includes the costs related to the partner arrangements including the costs related with acquisition of traffic and content as well as transaction processing fees and the costs of consumer hardware inventory sold.
The cost of revenue increased 72% in 2018 compared to the previous year rising from around 5.5 Billion dollars and reaching around 9.4 billion dollars. The increase could be attributed mainly to the growth in the operating expenses for the data centers and other technological infrastructure as well as higher content and traffic acquisition costs.
Research and development costs:
Research and development at Facebook includes the development of new as well as improvement of the existing products. The R&D expenses of Facebook mainly include the share based compensation, salaries and benefits for the employees in its engineering and technical teams who are involved in Research and development. The R&D expenses grew by 32% from 2017 to 2018 rising from 7.8 billion dollars to 10.3 billion dollars. It happened mainly because of increase in the number of people involved in R&D as well as to a small extent growth in expenses on professional services.
Marketing and sales costs:
Marketing and sales costs are related to sales, sales support, marketing, business development and customer service functions. Expenses mainly include the salaries, share-based compensation, and benefits for employees working in these areas. The marketing and sales expenses of Facebook grew from 2017 to 2018 by 66% which happened mainly because of the rise in the number of people working in the sales and marketing functions leading to rise in the payroll and benefits expenses. Apart from that expenses related to marketing and community operations also increased. Marketing and sales expenses increased from 4.7 to 7.8 Billion dollars.
General and administrative expenses:
The G&A expenses mainly include the share-based compensation, salaries and benefits of the employees in legal, finance, human resources, corporate communications and policy, and other administrative functions. Apart from that it includes expenses on legal related costs and professional services. There was a 32% increase in the number of employees in the general and administrative functions causing an increase in the payroll and benefits expenses. The General and administrative expenses of Facebook grew from 2.5 to around 3.5 Billion dollars from 2017 to 2018.
Facebook is an innovative technology company and spends a large sum each year on research and development every year. The key metrics that Facebook uses to measure user activity and revenue include DAU, MAU ad ARPU. DAU is the metrics for Daily Active Users, MAU for Monthly Active Users and ARPU for Average Revenue per User.
DAU and MAU measure the number of users only on the Facebook platform excluding the Instagram, Whatsapp and Oculus users. Changes in the user trends affect the revenue and profits of Facebook by affecting the number of advertisements it is able to show as well as their value to the marketers. A substantial part of the entire Facebook user audience accesses Facebook and messenger on mobile devices.
A daily active user is a user who accessed Facebook or messenger on a given day through its website or on a mobile device. DAUs and DAUs as a percentage of MAUs are the measures of user engagement. There was a rise of 9% in DAUs from December 2017 to December 2018 rising from 1.4 Billion to 1.52 Billion. The rise was mainly affected by the rising number of users in India, Indonesia and Philippines.
A Monthly active user is a user who accessed Facebook through its website or a mobile device during 30 days of the day of measurement. MAU is a measure of the size of Facebook’s global active user community. Number of MAU’s rose by 9% from December 2017 to December 2018 reaching 2.32 Billion.
The company calculates its ARPU based on the user geography and its estimate of the geography in which impressions were delivered or other goods and services were sold. ARPU is obtained by dividing the total revenue of Facebook in a quarter from a given geography divided by the average of the number of MAUs at the beginning and end of the quarter. The geography is the user affects the financial results of Facebook since the company monetizes the users in different geographies at different rates. US and Canada are somewhat matured and larger online and mobile advertising markets due to which the average rates are higher in these markets. In 2018, the ARPU of Facebook in the US and Canada markets was around ten times higher than that in Asia Pacific. However, each of the geographic regions saw significant increases in their ARPU in the 2017-18 period. ARPU increases in the respective geographies were as follows:
US and Canada: 33%
Asia Pacific: 20%
Rest of the World: 21%
Risks & Challenges:
With the growth and proliferation of the internet technology and its increased availability and speed throughout the globe, the internet-based services and social media websites have enjoyed immense growth during the recent years. Facebook is a leading social media platform that has seen its user base and popularity grow very fast in the recent years. Apart from growth of internet, its focus upon innovation is also a key reason behind its growth. However, the number of risks and challenges before Facebook have also kept growing. Apart from increased government pressure since the recent data scandal, the company is also facing higher pressure in the form of increased competition from numerous internet companies and online sources of entertainment. There are more challenges before Facebook, many of which are discussed below:
Competition in the web world has grown fast and Facebook has numerous competitors. Several of them compete for advertising revenue with Facebook including Google, Amazon and Microsoft. Apart from them there are other internet companies as well as like Tencent that are competing with the product offerings of Facebook including its social media platforms and the messenger. Moreover, there are regional social media companies plus the YouTube, Twitter and other social media channels which are competing for user base and market share with Facebook. The internet industry is marked by rapid innovation and technological disruption. There is always the fear of the competitors using new and advanced technologies to disrupt Facebook’s business. This has also led to Facebook spending a substantial part of its revenue on Research and development.
Overdependence on advertising for revenue
Facebook generates a substantial part of its revenue from advertising and especially mobile advertising. Substantial part of its user base is accessing Facebook on mobile devices. While the competition for every penny from online advertising has grown, Facebook’s business model relies nearly completely on its advertising revenue. While its revenue model is profitable there are also some major hurdles and risks like the rise of adblocking technologies which are already eating into a substantial part of advertising revenue.
User attraction and retention:
The success of Facebook and its revenue and profitability to a large extent depends upon the size of its user base and its ability to engage the users. Attracting and retaining users is a key challenge before Facebook which has to introduce new features and continuously focus upon innovation to make its platform all the more engaging. This has also led to higher expenditure on things like R&D as well as marketing.
User engagement on mobile devices:
Substantially all of the Facebook users are accessing the platform through mobile devices The user base accessing the site on desktop and laptop devices has shrunk. As such making the platform more mobile ready and its features engaging for the mobile users is a key challenge before Facebook. It has focused upon making its features engaging as well as adding new features that make it more convenient for mobile users to message and share. Since a substantially large part of the advertising revenue is being generated from mobile devices, the company has made mobile a central focus. However, this has also led to growth in operating expenses. The higher operational costs are eating into profit margins. However, operational costs have also grown due to increased headcount and increased investment in marketing as well as research and development.
There are a number of areas including data security and user privacy in which regulatory pressure on Facebook and other social media sites as well as internet companies has grown, the recent data scandal led to more controversy and debate. Internet companies like Facebook are facing higher scrutiny as well as legal oversight. This can limit growth prospects as well as lead to reduce revenue and profitability. User privacy, managing user generated content as well as data security are some key areas where regulatory pressures might be expected to rise further.
Facebook being the leading and most famous social media channel also enjoys very high degree of media exposure. While on the one hand, this is good, on the other any form of negative publicity affects its reputation and cause loss of revenue and user base. Managing reputation is a key challenge before the internet and social media companies. It already received a lot of negative publicity following the recent data scandal and continues to be subject to higher media scrutiny since then. In this way, there are several risks and challenges before Facebook and its business model. Apart from competition and higher operational costs as well as user engagement challenges, the company is also facing many more challenges related to data security and user privacy. Overall the number of risks and challenges before Facebook is quite large and the company needs to focus upon several important things on a priority basis.
Facebook is a leading social media platform that has enjoyed immense growth in popularity and user base in the recent years. Apart from growth in the number of Daily Active Users and Monthly Active users, the Average Revenue Per User as well as total advertising revenue. Simultaneously the number of users accessing Facebook through mobile devices has also grown very large. A substantial part of advertising revenue of Facebook is being generated from mobile devices. While the company has enjoyed profitable growth due to sharp growth in its user base, it is also spending a lot more on innovation as well as marketing. Operational costs have grown since a substantial part of the revenue is being invested in research and development and the headcount in various functions has also grown. Other challenges like higher regulation of the internet industry in US and Europe will also make the situation difficult for Facebook. Oculus has not seen any substantial growth or success either and advertising being the only major source of revenue, Facebook may want to find out newer channels for revenue and growth.
Other Sources: Facebook Annual Report 2018