Editor’s note: Sunil Gupta is the Edward W. Carter Professor of Business Administration and Head of the Marketing Department at Harvard Business School.
After months of speculations and hype, Facebook filed its S-1 yesterday as it prepares to go public. This public offering could value the company at almost $100 billion, more than the GDP of Iceland, Cyprus, Jordan and Kenya combined; and almost five times the initial market value of Google when it went public in 2004.
There are many indications that Facebook is likely to live up to its promise. Here are a few of them:
- Growth: Facebook has become the dominant social network in the world with 845 million users. At the same time it still has a significant potential for growth. In emerging markets such as Brazil and India, it has just begun with only 37 million and 46 million users respectively. The strong network effects give Facebook a significant competitive advantage over new players like Google+.
- User Engagement: One of the most interesting things that the recent S-1 reveals is the level of engagement of Facebook users. Of the 845 million monthly active users (MAU), more than half or 450 million are daily active users (DAU). This ratio of more than 50% shows remarkable stickiness and engagement to the site. Recent data also shows that messages through Facebook have now surpassed emails.
- Revenues and Profits: Facebook showed impressive growth in revenue from $2b in 2010 to $3.7b in 2011. More importantly the company is highly profitable with $1b in net income, or more than 25% of revenue. Compare that to Amazon, whose operating margin fell to 1.5% recently, yet its market cap stands at almost $81 billion.
- Future Revenue Potential: Facebook makes most of its money from display advertising and it is already a leader in this field ahead of Google and Yahoo. Display ad market has been slow to take off, but with the rise of rich media and development of new metrics the display ads market is likely to grow in the future and Facebook is well positioned to benefit from it. In addition, Facebook makes over half a billion of its revenues from payments and other fees as a platform provider. In other words, Zynga and other developers can use the Facebook platform to reach its 845 million users and Facebook collects “rents” from these companies. This platform revenue has a very large upside potential and it has already increased from 1% of Facebook’s revenue in March 2010 to almost 17% in December 2011.
- Limited investment: Facebook’s marketing cost is only 12% of its revenue. In contrast, Groupon’s marketing cost ballooned to almost 54% of its revenues in 2011. After almost 7 years of operation, Facebook employs only 3,000 people since it business is scalable. Compare this to Groupon and Zynga that already have more than 3,000 employees in 3-4 years of their history.
- Quality of management: Many startups implode as they grow and become big since the entrepreneurs do not have the leadership and management skills to run a large public company. Google was shrewd enough to hire Eric Schmidt as its CEO and Facebook has Sheryl Sandberg as the mature captain of the ship.
All this is not to say that Facebook won’t have challenges or there are no risks. History tells us that large successful companies are not immune to failure. Facebook faces challenges in the advertising market. Its over dependence on Zynga for platform revenue is also a matter of concern. Nonetheless, in my view Facebook is well poised to meet its high expectations.
Why should we care?
A successful public offering will certainly make Mark Zuckerberg and many of Facebook employees very rich, but what does mean for us and why should we care?
Facebook is one of the darlings of the tech industry and its IPO is clearly one of the largest and the most talked about event in tech industry. Given the mixed performance of recent tech IPOs such as Groupon and Zynga, many experts have been predicting that the Web 2.0 bubble is about to burst. If Facebook IPO underperforms this may indeed become a self-fulfilling prophecy, as the future tech companies would find it much harder to garner the interest of investors.
Tech industry has been a shining light in an otherwise gloomy US economy – it is where US still excels and no amount of outsourcing or cheap labor has taken away the American advantage. US is still considered the hub of technology and innovation and Apple, Google and FB are symbolic of this. A lukewarm reception for Facebook IPO could dampen this enthusiasm among investors and VCs that can have a negative ripple effect on the future Zuckerbergs and potentially on a thriving part of the economy.
Mark Zuckerberg dropped out of Harvard to create this thriving company, following in the footsteps of Bill Gates. Perhaps we at Harvard should encourage our best students to leave us!