Google, Facebook, and Plaxo join DataPortability.  What does it mean for your startup?  Is the playing field even?

I keep hearing that we are in the midst of another tech bubble.  The question is simply,  is the current level of activity sustainable?  I firmly believe that we are in a bubble, however I do think that the rate of current startups will decline.  Most of the early stage companies I work with are bootstrapped and don’t need millions of dollars to execute upon their ideas.  Companies that do need VC level of funding will have a harder time getting access to $2 to 5 or even 10 million.

Check out this hilarious take on the bubble.  Maybe a little close to the truth for comfort.
[youtube=http://www.youtube.com/watch?v=fi4fzvQ6I-o&rel=1]

With all the recent coverage about the Microsoft investment of $240 Million in Facebook.  I have a few quick questions for everyone.  What do you think Microsoft if buying with this investment?  Just equity?  If that were the case, then I think you could argue that at least a few companies (people) value Facebook at ~$15 Billion.

1. Is there a larger advertising deal at work here?
   1. What is the amount of money that MSFT expects to recoup from this relationship?
2. What is the value to MSFT to keep Google from securing a relationship with Facebook?
3. Is $$ such a non-issue for MSFT that they can invest $240 Million without batting an eye?

YES, YES, NO.

Since MSFT is engaging in a larger advertising deal with Facebook.  Why does everyone assume that the money is solely for equity?  I don’t have any hard numbers (obviously, since I am such a huge Valley Insider, sic), but MSFT expects to get some type of return from the advertising deal.  This on it’s own shows that the 1.6% was just a portion of the deal.

As for Google…  It is my assumption that MSFT would do a lot to keep Google from developing a deeper relationship with Facebook.  The Facebook platform is getting lots of attention, but I would say that at this point it is still unproven as a business model.  One with a lot of potential certainly, but it is not quite there.

MSFT is betting on this relationship returning significant gains both in terms of a strategic relationship as well as in helping to extend its advertising network.  MSFT is in third place behind Google and Yahoo and is essentially buying access to gain traction.  It would be interesting to see the ROI calculations for MSFT in regards to the advertising component to determine the dollar value in proportion to the larger deal.

$18.88 Billion on hand…  Microsoft has enough money to buy most publicly trade companies outright.  The money they invested in Facebook represents a little over 1.2% of the money they have in cash.  Obviously a minor detail, but still significant.  I might be wrong here, but something with this many zeros HAS GOT TO MEAN SOMETHING.

My point is not that Facebook isn’t worth $15 Billion, my point is that the public data that is available doesn’t necessarily mean that they are worth that much.

In a recent article titled “In Facebook, Investing in a Theory” at the NYT has some interesting insights into Facebook App arena. Here are just a few nuggets:

Yet there are questions about the ability of these Facebook-inspired businesses to create sustainable revenues. Developers are restricted to placing advertising on their “canvas page” — the portion of the site through which users install and interact with an application. Facebook does not allow developers to advertise on users’ profile pages, where the applications themselves are imbedded.

I wrote a post earlier about the viability of Facebook apps and whether a developer should actually build one… The above is an interesting requirement, especially when you take into account the number of people that actually will ever land on a “canvas page”. The numbers are not large and then you have to determine what the CTR will be for adds on the page… It isn’t looking good for advertising as a way to support Facebook apps.

Several companies have created networks to funnel advertisements to canvas pages, and Facebook itself has indicated it will soon introduce its own ad system for developers.

All of these ad networks suffer the same problems, which is simply not enough exposure. As long as developers are limited in their ability to generate revenue then Facebook Apps as a standalone business will be hampered. Some companies, such as iLike, which have an affiliate type model can work, but again that is only if the users are able to click from the application to purchase directly and don’t have to land on the canvas page.

Andrew Chen, an advertising executive and adviser to the Silicon Valley investment firm Mohr Davidow Ventures, “…Facebook users click on ads significantly less frequently than elsewhere on the Web. And Facebook members who add applications to their pages can just as easily remove or ignore them“

This is another problem… Because the site is a content and communication platform, the propensity for people to click on advertising is lower than it would be on a search results page (obviously). The key question is simply, will the CTR create enough advertising revenue to compensate for hosting and bandwidth costs and support sustainable businesses?

The answer is YES, if you happen to be Facebook although they aren’t there yet at least in terms of profitability (disclaimer, this is my assumption). They are offloading development, hosting and bandwidth costs to the app developers and not having to pay a single penny! Brilliant actually. They reap all of the rewards without any of the associated costs.

Obviously, they are also feeding the hype. Without any proven success cases investment funds are being created and launched targeting Facebook app developers. Nothing like a few hundred grand to get people to sit up and take notice.

Nevertheless, Silicon Valley venture capitalists are creating funds devoted entirely to investing in Facebook tools. Internet entrepreneurs are shifting their businesses to focus on the social networking site. Some of the most popular applications are being sold, sometimes for hundreds of thousands of dollars — but only when buyers’ and sellers’ ideas about the potential of Facebook are similar.

Is this sustainable, I don’t know, but I don’t really think so. I definitely think a number of app developers can survive and thrive, but they will need to find new an innovative ways to monetize their app distribution/adoption/utilization. I don’t think advertising will generate enough revenue to build a sustainable business around.

And finally, this is simply scary! Bubble 2.0 anyone? Reminds me of the good ole days when companies would take mutual investments in one another and each would count that as revenue, or when they would purchase the SuperBowl adds…

Several companies have created networks to funnel advertisements to canvas pages, and Facebook itself has indicated it will soon introduce its own ad system for developers. So far, most of the ads on canvas pages promote other applications whose creators are seeking exposure.

That last sentence is of course not sustainable. I look forward to seeing the sustainable models that emerge and hopefully there will be more than a few!

It was a brilliant idea, one that with hindsight becomes even more so. Facebook decides to open up their service to outside developers. What others have done with an API to extend their content and data to other sites, Facebook did for its own site. There are now legions of developers creating new and innovative applications for Facebook members. They have created a system that allows others, on their own dime and computing power, to launch a staggering array of additional services. In the process making Facebook a much more enriching customer experience at minimal cost to themselves.

The coolness of being able to build an app that is used by tens of thousands if not millions of people is unquestionable. Facebook provides a much more direct path to scalability than could otherwise be accomplished through standard marketing techniques.

Although, it is by no means a certainty. It is becoming even less so, with the sheer quantity of apps available on Facebook. With the numbers exploding as they are, a new app has to compete just as directly for awareness of Facebook users as a site would need to with the larger Internet community. The one benefit is that Facebook has millions of users and very clear viral marketing mechanisms that aren’t available quite so easily on the web as a whole.

Once an app has reached a significant users, in this case lets say >100,000 users, is there an opportunity to monetize the application to reward the developer for their time, effort, and computing resources (for hosting the app)? However, before we answer that question, what are the options for generating revenue with a Facebook app?

Advertising - whether a Google Adwords CTR campaign for a CPM banner approach
Fee - can a developer charge users for using the app
Marketplace - is it possible to create liquidity for products or services (or even apps for that matter)

Advertising is allowed within the apps as per the Facebook App Guidelines with certain limitations of course. Based upon a rough calculation, I would assume that a CPC campaign would get between 0.3% and 0.5% as the advertising would be a minimal component of the app, would be one of many links on the site, and the psycho-graphic of the user base would not lead to a propensity to click on advertising as a whole. Social networking sites also have notoriously low ad rates, as the user base is quite generic.

Freemium (fee) models have a lot of potential as well, with one major drawback. How to get people to purchase? Also, I wasn’t able to find any guidelines / limitations on fee based services within the Facebook developer’s Terms & Conditions.

The benefit of advertising and fee based models is that they could potentially support an app only company. As long as the user base is large enough in both cases.

An interesting idea, is in creating liquidity in products and services and in essence hosting a marketplace for Facebook users. One example is ZuckerBucks. Disclaimer, I know the creator of Zuckerbucks. It is a fascinating idea, and one with a lot of potential to create a viable marketplace for products and services with a unique measure of worth, the ZuckerBuck. Creating a marketplace is a unique way to monetize a Facebook app, but I feel that advertising and fee based services will inherently support far more apps than anything else.

Say a developer is able to monetize their Facebook app, what are the potential costs for them to continue to host the app? Currently (09/19/07) they must only pay for the hosting of said app on their own servers. However, Facebook reserves the right to charge fees in the future, and may do so at any time:

Section 3. Fees

We reserve the right to charge a fee for using Facebook Platform and/or any individual features thereof at any time in our sole discretion. If we do charge a fee for using Facebook Platform or any feature thereof you do not have any obligation to continue to use Facebook Platform or the applicable feature. However, if you do: (i) we reserve the right to specify the manner in which the fee will be calculated, the terms on which you will be invoiced and charged and the terms of payment; and (ii) any and all fees payable by you pursuant to this Agreement are expressed exclusive of all taxes and duties, including Value Added Tax (”VAT”) or any similar applicable sales tax. In addition to such fees payable, you will pay any sales, use, value-added or import taxes, customs duties or similar taxes that may be assessed by any state and/or jurisdiction (collectively, “Taxes”) that Facebook is legally required to charge on the applicable fees under this Agreement. If requested to do so by Facebook, or as otherwise required by applicable law, you will supply your VAT identification number to Facebook. We may also change the fees or fee structure for Facebook Platform or any feature thereof at any time in our sole discretion, and in such event your continued use of Facebook Platform or such feature constitutes your agreement to such change (provided, that you will not have any obligation to continue to use Facebook Platform or such feature).

If they do begin charging a fee then the question becomes, can an app generate enough revenue to cover the hosting costs and what I would call “access fees” that Facebook may charge? It depends on the type of fee; whether it be a flat fee, a proportional fee, based on the number of users, etc. I do not think that Facebook will begin charging for access as it may hurt the growth opportunities. However, they may charge apps that present advertising, charge a fee to users, or monetize in some other way. When an app developer begins making money on their app, a strong case can be made that Facebook could be losing that revenue…

If they do begin to charge, then will we see the ego motive continue to drive companies to develop applications? If so, how will that affect the types of services as a whole?

Another key issue with developing a Facebook app is who owns the user. A number of sites have been very successful in having their apps utilized by millions of Facebook users. iLike is one example. Their issue is that the app is a standalone service and doesn’t integrate with their site. They do not own the users and have created no long term relationship (as far as I am concerned). If a developer is going to create an app, I would highly suggest that they build it in such a way that it integrates, adds to, and builds on services and features that they offer on their own site. You want your entire community to benefit when you grow your user base. I encourage developers to see Facebook as an extension of their current community / projects.

Before any startup decides to build a Facebook app, they need to run the numbers on potential users, revenue potential, resources required to build and host, and what type of integration will it have for their current site and with their current user base to determine if it makes sense for them. These numbers won’t be accurate, but the process of thinking through the ramifications and potential opportunity will help you understand if this is your biggest priority, or lower on your list.

(images included in this post are owned by Facebook)

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Nathan Kaiser, is the CEO and Co-Founder of nPost, a site devoted to promoting tech startups. nPost features tech startup jobs, interviews with entrepreneurs, and tech networking events.