Facebook’s biggest barrier to enormous wealth? Trust

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Why Facebook will find it hard to monetize the social graph

This is first of a three-part series on Facebook as an investment. Coming up:
• Facebook will remain king, but social pure plays will fade
• Brands: How to cut your exposure to Facebook business risk

If Facebook’s stock price were based on the number of blog posts about its IPO, the company would be in great shape, but too few posts have addressed Facebook’s real barrier to monetizing its business, so we will rectify that here. 

Although Facebook is a fantastic social venue and platform, I did not buy into Facebook and do not plan to invest in its stock. (The stock price is down 30 percent from its debut on May 18.) Facebook‘s Achilles heel is a significant trust gap with its users, and now, its investors. Its trust gap will make it difficult for Facebook management to fully monetize its most unique asset, its users’ social graph data. Moreover, the management team has not shown the insight or willingness to address this barrier.

Why lack of trust is Facebook’s Achilles heel

That Facebook has a spotty trust profile with users is an understatement. Its management has a history of being cavalier with users’ data. Although many have argued this point, I’ve observed that Facebook’s policies have been mostly legal, but trust is independent of legality. Facebook’s management has gotten better about “considering” users during the past year or so, but such consideration has felt compliant and not entirely voluntary.

This matters. Although I have no inside information about Facebook’s technology or strategy, my knowledge of user social data and its value in developing relationships leads me to deduce that Facebook’s gold mine is its unique knowledge of users’ social graphs. Just play around with Facebook ads. Only Facebook knows what California physics undergrads prefer in music, movies and running shoes. Who their friends and hobbies are, and when they post their running updates. And what moms with 3.2 kids who went to Berkeley think about whales or global warming or Republican budget proposals.

The problem is, although I’m sure Facebook has employed some of the best attorneys for a long time, and user agreements give Facebook the “right” to use social data however they want, we have all witnessed that users themselves revolt when they perceive that they have been duped. And when they discover how Facebook intends to use their personal information (that they have willingly, if ignorantly, surrendered, by the way), they will undoubtedly see red. This is Facebook’s biggest risk. It’s not a legal issue, it’s a trust and relationship issue.

There is a significant chance that Facebook management has been intentionally keeping the implications and value of social graph data under wraps because a significant portion of its users would not agree with letting Facebook use their social information in the way that would monetize it best.

This is Facebook’s biggest, darkest secret, its deepest, broadest vein of gold. It’s Facebook’s biggest problem, and its IPO will force the issue in an unfortunate way.

Compounding interest: Facebook’s IPO trust snafu

By now, Facebook’s IPO has taken the trust gap into another realm. Whether the mismanagement of the IPO is ultimately Facebook’s “fault” or Morgan Stanley’s, it will raise stakeholders’ suspicions of the company. It would not have mattered so much if Facebook had not allowed a legacy of mistrust to form around the company.

I am assuming that Facebook management did not commit any crimes (from the analyses I’ve read, I have no reason to believe they did), but there is a risk that there was some impropriety.

Also IPO-related, Facebook management has done a subpar job managing investor expectations. Yes, dumb money rules the market because few analysts or investors have any idea about how to “value” social technologies, and the market’s ignorance is not Facebook’s fault. That said, management has not helped themselves by pumping up expectations of large advertising revenues and the claim that they will monetize on mobile. Regarding the latter, I predict that increasing network speeds will help mobile incrementally, but small screen size will persist.

Adverts on mobile will continue to disappoint. They will never deliver — for Facebook or anyone else — because online advertising in general has underperformed expectations. People do not like invasive ads in any form, and that will not change.

Wrapping up: Profound attitude change needed at Facebook

Facebook’s dilemma is that it won’t monetize enough to fulfill investor expectations through advertisements. It will probably continue to make money, but expectations are so high, it will disappoint. Facebook management has not been forthcoming with its biggest asset. This may be because:

• They want to collect more data while users are still ignorant and build out the information architecture to prepare to monetize it.
• Management really thinks they can fulfill investor expectations with advertising and ancillary businesses such as Facebook Payments.
• They want more time to experiment with ads; Timeline is built to increase advertising on Facebook, and they will learn much from users’ and Pages’ behaviors with it.
• If #1 or #2 is true, Facebook is in trouble.

Facebook management has to fix the trust gap, right away. This won’t be easy, but Facebook needs to appreciate the difference between being legally right and earning the trust of its community. This means a profound attitude change.

• Probably Facebook management thought like a startup — it created a high-tech cloud app. The problem is, although that’s true, Facebook has become a community, and to develop trust, Facebook has to submit to the community. Management has to accept that, although it has legal principle on its side, the community will feel that it doesn’t have ethics on its side.
• I don’t know any of Facebook’s management personally, but my impression is that this would be a profound attitude change. But it’s the only way Facebook will be able to fully monetize its gold.
• Facebook doesn’t have much time. As I’ll point out in Part 2, I estimate it has 2-5 years to optimize a return on its social data.
• The community has to feel that Facebook wants to serve it. Facebook talks the talk but has not walked the walk. There’s no faking here.
• It may be useful to compare Facebook with LinkedIn, where management is far more experienced, astute and careful. LinkedIn has been extremely conservative with how it collects and uses members’ data. True, its data is more “business-oriented,” less “intimate”; LinkedIn has a completely different social profile.
• I’ll close with this disruptive thought. Facebook, like most other Web 2.0/3.0 startups, has bought into “monetizing” by selling data [and access/adverts] to brands. Medium- to long-term, a big portion of the  money will come from users, reversing the Web 1.0 pattern (“everything online is free”).
• Imagine putting users’ data in their service, which would align Facebook with users. For example:

• Parents would pay for a roommate finding service, according to very specific criteria.
• Educate recruiters about “cultural fit” and help users leverage their personal activities into culture fit at jobs or consulting contracts; ditto for undergraduate school (“where do I go to college”?).
• Dating/romance according to unique data; if done at the same time as other suggestions, Facebook could avoid the perception that it’s a “dating site.”
• Help users find support for difficult life situations.
• Help very specific user types tackle difficult use cases through collaboration (bookish people who like to splurge help each other save money; Facebook has unique insights about how they splurge).

Christopher S. Rollyson is a partner in Socialmedia.biz and managing director of CSRA, a management consultancy that advises enterprises and startups on social business strategy and execution. Contact Christopher by email, follow him on Twitter and Google Plus or leave a comment below.