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Facebook in Frantic Mode

Facebook’s acquisition of Instagram — for one billion dollars — tells a lot about Mark Zuckerberg’s state of mind. Which is at least as interesting as other business considerations and was best captured by cartoonist Ingram Pinn in last week’s Financial Times comic. To illustrate John Gapper’s excellent Facebook is scared of the Internet column, Ingram Pinn draws an agitated Mark Zuckerberg frantically walking through a hatchery, collecting just hatched startup-chicks as fast as he can, while, in the background, AOL and Yahoo collect older chickens in larger carts.

In last week’s Monday Note, I hinted that I’d never put my savings in Facebook’s stock. (For that matter, I see writing on business and owning stocks as incompatible). When I read the news of the Instagram acquisition, I wondered: Imagine Facebook already trading on the Nasdaq; how would the market react? Would analysts and pundits send the stock upward, praising Zuckerberg’s swiftness at securing FB’s position? Or, to the contrary, would someone loudly complain: What? Did Facebook just burn the entire 2011 free cash-flow to buy an app with no revenue in sight, and manned by a dozen of geeks? Is this a red-flag symptom of Zuckerberg’s mental state?

Four things come to mind.

1/ Because he retains 57% of Facebook voting rights, Zuckerberg rules its board and can make any decision in a blink of an eye, no debate allowed. This can be a great asset in Silicon Valley’s high speed tempo, or it can stir up shoot-from-the-hip impulsiveness.

2/ Facebook’s founder attitude reminds one of Bill Gates during Microsoft’s heydays: no crack allowed in the wall of its dominance. The smallest threat must be eliminated at any cost. Where Microsoft used legally dubious tactics, Facebook unsheathes its wallet and fires a billion dollars round. In the startup world, this will have two side effects: For one, Facebook is likely to become the exit of choice Google once was. Two, the size of the Instagram transaction (some of it in stock) is likely to act as a beacon for any startup harvesting users by the millions. It sets an inflationary precedent.

3/ By opting for such a deal, Facebook’s management reveals its own feelings of insecurity. It might sounds crazy for a company approaching the billion users mark and providing an array of services that became a substitute to the internet’s basic functions. But, with this transaction, the ultra-dominant social network acted like an elephant scared of a mice. Instagram has 35 million users? Fine. But how many are using the service more than occasionally? Half of it? How many are likely to switch overnight to a better app? Most likely many will. Especially since Instagram is not a community per se, but a gateway to larger ones such as Twitter and Facebook.

4/ From a feature-set perspective, Facebook might find itself in a quandary. Kevin Systrom and Mike Krieger designed the ultimate stripped-down application: a bunch of filters and a few basic sharing features. That’s it. It is both Instagram strength and main weakness. Such simplicity is easy to replicate. At the same time, if Facebook-Instagram wants to raise the feature-set bar, it might lose some of its users base and find itself competing with much better photo-sharing applications already populating Apple or Android app stores.
To put it differently, Facebook photo-sharing model had been leaking for a while. Zuckerberg just put  a serious plug on it, but other holes will appear. A couple of questions in passing: Will Facebook continue to accept and encourage loads of third parties photo-sharing apps that connect to its network? Some are excellent — starting with Apple’s iPhoto, especially the iDevice version that will always benefit of an optimized hardware/software integration. How does Facebook plan to deal with that? And if it chooses to grant some level of exclusivity to the Instagram app, how will the audience react (especially when you read comments saying “We liked IG because it wasn’t FB”)?

Lastly, the bubble question. Again, three things.

First, let’s be fair. If indeed there is a new internet bubble, Facebook isn’t the only player to fuel it; investors who lined up at Instagram’s doorstep did it too. A few days before the deal, IG raised $50 million at a half billion valuation; Zuckerberg snatched the company by simply doubling the bet.

Two, comparing the FB/IG deal to Google’s in 2006 acquisition of YouTube for $1.65 billion doesn’t fly either. From the outset, everyone knew internet video was destined to be huge; it was a medium of choice to carry advertising. Therefore, the takeover by Google’s fantastic ad-machine was likely to yield great results. YouTube became a natural extension of Google services — just look at how competing services such as DailyMotion in France, or Vimeo are doing without the ad rocket-engine.

Three, the metrics used in an attempt to relativize the deal are dubious at best. Instagram had no monetization strategy–other that a lottery-like exit. This says applying any kind of cost per user ($33 for the theory in vogue) is bogus. Being unable to project any sustainable revenue mechanism makes such a valuation process completely pointless. In Instagram’s case, the only way to come up with a price tag was guessing the amount of money a small group of suitors–Facebook, Google and Twitter–might be willing to cough up for Instagram’s eyeballs.

If this deal shows one thing, it is the frenzied, cutthroat competition these three players are now locked in. Mark Zuckerberg is not through with collecting hatching eggs. He won’t be alone either.

frederic.filloux@mondaynote.com

iTunes’ Windows Problem

The best thing that happened to Apple in the last two decades was Steve Jobs’ 1997 return to power after he reversed-acquired the company he’d co-founded 20 years before.
And the best thing that has happened in the Apple 2.0 era is iTunes.

Without iTunes’ innovative micropayment system and its new way of selling songs one at a time, the iPod would have been just another commodity MP3 player. Instead, the iPod became Apple’s “halo product” and the genre’s king, with a lasting dominant market share (70% or more) and, in 2006, surpassing the Macintosh in revenues: $7.7B vs. $7.4B.

The iTunes-powered iPod rescued the company’s image. Then teetering on the edge of insignificance, Apple came to be perceived as a serious contender.

This was nothing compared to the contribution iTunes was about to make to the iPhone. A song is simply a string of zeroes and ones, so is an app; the only difference is the destination directory (I am, of course, simplifying a bit, here). The well-debugged iTunes infrastructure turned out to be a godsend for the new Jesus Phone: The smartphone became an “app phone” and the rest of the industry followed suit. iTunes App Store downloads now surpass music traffic:

But…

Today, the toxic waste of success cripples iTunes. There are times when I feel that iTunes has reached Windows Vista bloatware proportions: Increasingly non-sensical complexity, inconsistencies, layers of patches over layers of patches ending up in a structure so labyrinthine no individual can internalize it any longer. (Just like the Tax Code.)

iTunes’ metastasis happened naturally as it tried to incorporate new packaging and delivery systems. The media — music, videos, apps — is no longer the message. iTunes gives you TV seasons, college courses, audiobooks, podcasts; it passes files between Macs and iPads, syncs devices, uploading and downloading everything through the Cloud…and should we mention Ping, the unfortunate attempt at “social”?

iTunes has turned into an operating system — kludgier and uglier than many — a role it was never meant to fill.

This criticism might sound excessive. Apple is doing obscenely well, Mac and iDevices show impressive growth, the stock keeps climbing. Why worry about iTunes? Business is great!

That’s the line RIM and Nokia execs once took.

On the music side, do we like looking for music, managing it, fixing inexplicably broken playlists? Do we care for bizarre recommendations from the Genius? (No connection with the really helpful ones in Apple Stores.) Buying music from Amazon is easier, more informative, more pleasant — and downloads drop right into my iTunes library.

Admittedly, managing apps has become much easier…if you use WiFi sync to a Mac or PC where the larger screen helps when you’re sorting through dozens of programs (I’ll confess that I hoard a mere 170 apps…). But it still feels like it falls short of what an independent module, with its own tools and UI, should be able to do.

Things take a turn for the worse when it comes to transferring files between, say, an iPad and a Mac. The It Just Works motto doesn’t apply. While Keynote documents sync automagically between an iPad and an iPhone, there’s no such love between the iPad and the Mac. iTunes offers a kludgy solution, semi-hidden at the bottom of the Apps section, although I doubt anyone uses this method. E-mail and DropBox are faster.

The rumors of a new iTunes version (perhaps called 11, a versioning number increment that signals a major update) have rekindled criticism of the aging giant and invited suggestions for fixes or more radical structural changes. For a sampling, see iTunes: Time to right the syncing shipErica Sadun’s TUAW post, and a counterpoint by Scott P. Hall who thinks ‘iTunes is well structured, and easy to use’. Most of us agree with pointed put-downs such as these (from Jason Snell):

Apple has packed almost everything involving media (and app) management, purchase, and playback into this single app. It’s bursting at the seams. It’s a complete mess. And it’s time for an overhaul.

….

And let’s be honest: iTunes is at its worst when it comes to app management. The app-management interface in iTunes is ridiculously slow. iTunes can fill up your hard drive with tens of gigabytes of iOS apps that can easily be downloaded from Apple. Syncing apps frequently destroys folders and makes apps disappear. The interface that shows where the app icons will appear on your iOS device is unstable, unreliable, and inefficient.

…and from Erica Sadun (emphasis added):

iTunes is an unwieldy behemoth, slowly suffocating from its own size and age.

….

Forget about launching iTunes: music browsing and playlist selection (not to mention creation) needs to migrate into Spotlight (or some similar always-on feature). Tunes should be part of the computing experience, not a separate app.

Let’s hope that “iTunes 11” does more than move furniture around and add another layer of patches. Personally, I’d vote for breaking it down into separate modules such as Music, Video, and Apps. This wouldn’t rub against the Apple grain: There’s the everything-in-one-app Outlook philosophy, and then there’s the Apple practice of separating Mail, Address Book, and iCal. Also, breaking up the iTunes “monopoly” would make fixes and upgrades more manageable.

But there are two possible flaws in this line of thinking.

First, it assumes that the iTunes problem is confined to the client app, to the software we run on our desktops and devices. This isn’t likely to be the case. We’re no longer in the era of PC desktop software where patiently redoing the Mac OS foundation got us OS X. It’s almost certain that many of the iTunes problems we experience in the client actually come from poorly designed applications in Apple’s Cloud, running on noble but out-of-date architectures such as WebObjects.

A possibly more significant impediment is Apple’s “Windows problem”. As Allen Pike explains on his blog (pointed to by John Gruber), Windows is iTunes’ ball and chain (emphasis added):

[…] they can’t split iTunes into multiple apps because many, if not most iOS users are on Windows. iTunes is Apple’s one and only foothold on Windows, so it needs to support everything an iOS device owner could need to do with their device. Can you imagine the support hurricane it would cause if Windows users suddenly needed to download, install, and use 3-4 different apps to sync and manage their media on their iPhone? It’s completely out of the question.

I remember my surprise when I bought my first iPod mini and saw iTunes software running on Windows. Imagine, Apple writing Windows software! Good UI, runs well, doesn’t feel like a dragging-one’s-feet port. But there’s a price: Some of the iTunes problems might stem from its use of cross-platform development tools, an approach that encourages (and sometimes insists on) a least common denominator experience. (I just checked, iTunes on Windows is very close to the Mac version.)

Allen Pike is right: iTunes, or its successor, must run on Windows. But I don’t see how that’s an unbearable burden on Apple, especially in light of the economics involved. If cross-platform tools are too limiting, Apple could develop “separate but equal’’ versions of iTunes as a way to keep selling iDevices to Windows users. (On this topic, the iPhone/iPad maker has done a much better job catering to Windows users than what RIM/Blackberry and Nokia have done for Mac users.)

Let’s hope Apple doesn’t become complacent, that they aren’t blinded by iTunes’ spectacular numbers. Let’s hope they deliver a really Apple-like iTunes experience. Paraphrasing a grand departed French politician, I like iTunes so much I want five of them.

JLG@mondaynote.com

Facebook’s Bet on Privacy

Would you buy Facebook shares? A few weeks ahead of its mammoth IPO, millions of people probably dream of getting a slice of it. Spreadsheet jockeys have done their job and demonstrated with unanimous conclusiveness that, indeed, Facebook deserves its expected $100 billion valuation — or that gravity’s law will inevitably apply.

Facebook numbers are both fascinating and frightening. The social network will pass the 1 billion members mark this year and the capillarity of its services is creating an alternate internet before our very eyes. It has already become a credible substitute for email; it soon will be the dominant news channel for millions. At the same time, it is hugely profitable: Facebook’s margin reaches 62% and its $3.5 billion cash pile will allow occasional mistakes or, if you prefer, bold experiments.

Then, what could go wrong for the ultra-dominant digital rhizome? Two things: its contempt of privacy and Wall Street frothy expectations.

Two years ago, I interviewed David Kirkpatrick for Le Monde Magazine. He’s the author of the Facebook Effect, a book that remains a must-read if you want to understand the company and its founder. In our conversation, he described a Mark Zuckerberg perfectly aware of the sensitivity of privacy issues, but at the same time deeply convinced social norms would evolve towards nearly-total transparency. According to Kirkpatrick, Zuckerberg felt that, as long as users where given the proper tools to control it, privacy should not be an issue for his empire’s future. Put another way, Zuckerberg deeply believes in Facebook’s Grand Bargain: its core followers will accept full openness as a default setting and trade personal data in exchange of its features-rich service. He actually lived by this belief. And monetized it brilliantly.

Facebook’s most valuable currency is not the “Credits” used in its games, but its huge trove of consumer data.

The efficiency of this system comes form the “platform effect”, from Facebook’s federation of millions of sites that embed the “Like” button or allow their own users to register with their Facebook ID. Trying to protect one’s privacy while using Facebook is a hard Protean task as the company constantly changes its rules. Applications hosted by Facebook only make things worse as user personal data are allowed to leak to third party developers in a sneaky and overly abundant ways.

Last week, as a part of its remarkable What They Know series, the Wall Street Journal published a compelling story titled Selling You on Facebook:

A Wall Street Journal examination of 100 of the most popular Facebook apps found that some seek the email addresses, current location and sexual preference, among other details, not only of app users but also of their Facebook friends. One Yahoo service powered by Facebook requests access to a person’s religious and political leanings as a condition for using it. The popular Skype service for making online phone calls seeks the Facebook photos and birthdays of its users and their friends.

You might ask: What’s the connection between these privacy concerns and the upcoming IPO? Well, Facebook derives most of its revenue from advertising. And said advertising revenue stems from its ability to profile its users like no one else in the business. Still, in spite of its ability to serve an ad targeted to a South Texas single mother who likes Bob Dylan and Taco Bell, Facebook yields little revenue per capita. Where Yahoo makes $7 per user and per year and Google $30, Facebook’s ARPU actually amounts to a mere $4.39.

A further problem: Facebook does so after saturating its most solvent markets.

Now, let’s turn to Wall Street expectations. A $100 billion valuation would mean Facebook being traded at 27 times its 2011 revenue. For comparison, Google, Apple and Microsoft, all highly profitable, are valued between 4 or 5 times their respective revenue for their last fiscal year.

Hence the math: In a recent story published in Fast Company, Farhad Manjoo quotes a Dartmouth finance professor who said “[to justify Wall Street expectations] Facebook will need to see $70 billion in annual revenue by 2021, up from just $3.7 billion in 2011″, which translates into a 25% to 30% growth over the next decade… in the context of an advertising market growing at 4% per year, as Manjoo points out.

To meet these goals–even by going way beyond the one billion members mark–Facebook will have to extract more bucks from each one of its users. This means making an even better use of the data users traded for services.

This brings us to the biggest risk for the Facebook economics. If Facebook doesn’t play the privacy game well, two things are likely to happen. One, members will pressure the social network to limit its use (meaning the sale) of user data. Two, legislators will enter the fray. We already see early signs of political challenges with movements such as the Do Not Track initiative, one that is laying the ground work for legislations all over the world. This concern was reflected in the Risk Factor section of Facebook’s S-1 filing :

Our business is subject to complex and evolving U.S. and foreign laws and regulations regarding privacy, data protection, and other matters. Many of these laws and regulations are subject to change and uncertain interpretation, and could result in claims, changes to our business practices, increased cost of operations, or declines in user growth or engagement, or otherwise harm our business.

Facebook’s future relies in great part on its ability to wisely adjust the privacy dials. Even at the expense of its shareholders’ dreams.

frederic.filloux@mondaynote.com

The “Sharing” Mirage

This week’s most stunning statistic: In February, Facebook drove more traffic to the Guardian web site than Google did. This fact was proffered (I couldn’t bring myself to write shared) at the Changing Medias Summit Conference by Tanya Corduroy, Guardian’s director for digital development (full text of her speech):

Eighteen months ago, search represented 40% of the Guardian’s traffic and social represented just 2%. Six months ago – before the launch of our Facebook app – these figures had barely moved.

A recent Pew report echoed these figures, revealing that just 9% of digital news consumers follow news recommendations from Facebook or from Twitter. That compares with 32% who get news from search.

But last month, we felt a seismic shift in our referral traffic. For the first time in our history, Facebook drove more traffic to guardian.co.uk than Google for a number of days, accounting for more than 30% of our referrer traffic. This is a dramatic result from a standing start five months ago.

She made her point with a graph showing the crossing of the two traffic lines, even though the Facebook referrals now appear to be receding:

This is obviously a great achievement for the team who created the FB app. Overall, The Guardian’s relentless pursuit of digital innovation is paying off. Its last month traffic stats are staggering: more than 4 million unique browsers (+64% vs. Feb 2011) and almost 70 million unique browser monthly (+76% vs. Feb 2011). As for its mobile site, it is growing at a year-to-year rate of… 182%, with 640,000 unique browsers a month.

The Guardian Facebook App played a critical role in this rise in traffic. Over the last five months, 8 million people downloaded it and 40,000 are signing up every day, again according to Tanya Cordrey.

While it is the most documented, the Guardian’s case is far from being an isolated one. Scores of online news organizations are now betting on Facebook to boost their traffic. So far no one regrets the move. Not even the reader who can now enjoy for free what s/he is otherwise expected to pay. Take the Wall Street Journal: Against my objections, by forcing me to buy the mobile version, it abusively charged me €307 to renew my yearly subscription (which translate into a 100% price hike!) — this while most of it content is available on Facebook for free. And here in France, I know of one of the most viewed newspaper site about to go on Facebook with the following rationale: ‘We know we are not going to make a dime from this move, but we have to be there. We know our FB app will be a hit, and we’ll decide later what to do next…’ Once hooked on that eyeballs fix —even non-paying ones— it is safe to assume this company’s marketing people will be reluctant to lose their valuable new audience.

There are plenty of good reasons for large news organizations to be on Facebook. But the current frenzy also raises questions. Here is a sample:

#1: Demographics. As the Guardian example shows in the graph below, FB’s demographics are attractive: most of its social users are among the 18-24 group which, for this newspaper, is otherwise harder to reach:

(I found this graph on Currybetdotnet, a blog maintained by Martin Belam, the Lead User Experience and Information Architect at the Guardian. Martin wrote this great piece about the Guardian Facebook app).

#2: Control. Facebook apps are usually Canvas Apps. The pages are hosted and served by the publishers within a Facebook iFrame. This is the equivalent of an embedded mini site on the brand’s Facebook page. One of the key advantage is you retain control of all the relevant analytics (unlike working with Apple or Amazon). It can be quite helpful to see what kind of content the 18-24 group is interested in.

#3: Audience quality. In theory, being able to tap into Facebook’s 845 million users is attractive. But reaching readers in a remote African country, thanks to Facebook’s growing penetration in the region, makes very little economic sense from an advertising standpoint. More broadly, the web already suffers from of a loss of audience quality as publishers are pursuing eyeballs or unique visitors just for the sake numbers. A Facebook page (or app) doesn’t carry any stickiness: 8 out of 10 readers look at a single page and go elsewhere —and every marketer knows it. Being big on Facebook won’t translate into big money.

#4: Dependence. To me, that’s the main issue. Media should be very careful with their level of reliance on other content distributors such as Facebook, Google, Apple or Amazon. This can be summed up to a simple question: can we trust them?

The short answer is no.

It has nothing to do with any evil intent from these people. I’m just stating a mere fact: these companies act primarily in their own best interest. Everything they do is aimed at supporting their core business: building a global social rhizome for Facebook; extending its grasp on search and, as a result, on the related ad dollars for Google; selling more iPads, iPhones, and Macs for Apple; and up-selling high margin products and retaining the customer for Amazon. Everything else is secondary. If, at any given moment, distributing media content through deals attractive to publishers serves these goals, fine. But conditions might change and pragmatism always wins the day.

Facebook might decide to charge for hosting a media site, or require the use of its Credits currency for the transaction it carries. Amazon might alter its revenue sharing scheme without warning. Apple can decide overnight that some application features are no longer accepted in the AppStore, etc. Shift happens, you know.

Don’t expect any support from the legal side: all contracts are under US jurisdiction. You can challenge the big ones only if you seek seven figures damages. But let’s face it: for a media group form Sweden, or for a regional paper from the Midwest, it is completely unrealistic to consider suing a Silicon Valley player.

Of course, that doesn’t mean a media company shouldn’t work with large American tech companies. All have products or distribution vectors that result in fantastic boosters for the media business. But, updating the old saying: When you dine with one of these high-tech giants, bring a long ladle.
Naïveté is not an option.

frederic.filloux@mondaynote.com

Ebooks: Defending the Agency Model

(Last of a series — for a while.)

Launching an antitrust probe against books publishers, as the US Department of Justice might do, can’t come at a weirdest time. In the two previous Monday Notes, we explained how Amazon is maneuvering itself into a position to dominate the entire book industry. The Seattle giant keeps moving up the food chain, from controlling ebooks distribution (in addition to selling print books), to competing against publishers and even agents by luring best selling-authors. No one would bet a dime on the printed book as it reaches its peak while ebooks sales keep exceeding expectations.

Then, why does the DOJ waves the threat of an antitrust action?

Five publishers –and one distributor, Apple– are in the the US administration’s crosshairs:  Hachette Book Group (a division of Lagardère Group), Simon & Schuster (CBS Corp),  MacMillan (Holtzbrinck GmbH), Penguin (Pearson PLC), and HarpersCollins (News Corp). All are said to be suspected of ebooks prices collusion. (The Wall Street Journal broke the story on March 9th).

First, some background. There are two competing distribution models for printed books, electronic books and electronic newspapers as well: the wholesale model and the agency model. Using the wholesale model, the publisher sells its goods to the distributor for a fixed price — say half of the suggested street price — and the distributor is free to decide the actual price to the public. In the agency model, the publishers set the retail price, the distributor gets a fee (30% or so) and that’s it.

Amazon is fond of the wholesale model. But, in order to effectively enter a new market, the company had to make concessions. For example, in the newspaper business Amazon reluctantly yielded to the demands of European publishers who preferred the agency model. French publishers went for this arrangement last year (but they priced their publications too high, forgetting that a real e-paper format has nothing to do with PDF facsimile or a digital edition loaded with features). In the UK, British newspapers went for the wholesale model, much cheaper for the customer: they are doing well with lower margins and much higher volumes. (Price elasticity is a proven concept for digital publishing).

In the US market, Amazon offers nothing but the wholesale model. You end up with absurdly low prices:

…While the French weekly Paris Match won’t accept any discount:

… At least on Amazon. On the Relay.com digital kiosk, the magazine is sold for €1.59 ($2.08) per copy.

When it comes to selling newspapers or books, the wholesale model doesn’t seem to favor the publisher, this for three main reasons:

The wholesale model’s primary goal is to serve the retailer’s overall strategy. Let’s assume Amazon wants to strengthen its general e-distribution market share and to increase sales of its Kindle product line. Then, the price of the primary product becomes secondary: it is in the company’s best interest to price-dump ebooks top-sellers in order to stimulate the sale of other products, or to up-sell high-margin items through its incredible recommendation engine –something Amazon is extremely good at. The entire retail sector strategy is based on a similar combination of moves.

– This makes the wholesale model is a deflationary one. Once it has acquired the rights to distribute a book (print or digital), the retailer is free to lower its margin as it sees fit, even going into negative territory (provided there is no law, such as in France, that prevents dumping practices). As a side effect, consumers gets used to low prices, ignoring the fact such prices may or may not reflect the item’s true economic value: a bestseller acquired for $14 by Amazon will be sold for a discounted $9.99. Once the the consumer bites, the retailer catches up by selling other higher margin products and/or hooking the customer into its system.

That’s why, when Apple launched its iBooks Store, publishers stuck inside Amazon’s wholesale system were willing to take their chances. They asked Steve Jobs for the agency model: price set by them and Apple taking its 30% cut. Jobs obliged, he wanted to boost iPad sales and, to do that, needed to attack Amazon’s domination of the ebook market. (Kindle formats currently accounts today for 60% of total sales). Jobs’ move put publishers in a position to go back to Amazon and ask for the same conditions.

Coming back to the DOJ’s looming antitrust action, did the book publishing industry collude in trying to pressure Amazon to change its practices? I don’t know if they acted in concert (people talk, you know) but they moved in accordance to their best interest by taking advantage of the newcomer, Apple. Now it seems the dispute over pricing has resumed: last month, Amazon pulled out 4,000 ebooks from one of the biggest books distributors in the US, the Independent Publishers Group (story in the New York Times here).

Pricing an item should be left to the one who produces it. The case of the book publishing industry is not as simple as, say, an appliance maker looking for the most potent retail channel for its hair-dryers or its toasters. The book sector is entering a painful transition: First, it needs to respond to consumers who want a large catalog of inexpensive ebooks; two, there is a plateauing but still strong print market ($73 billion worldwide). Managing a smooth decline for this segment is key to the industry’s health, especially as the ebook market yields thinner margins. Legacy publishers are culturally ill-equipped for such a difficult transition: they now find themselves competing with the agile, cash-rich, data and technology-driven players of the digital world.

frederic.filloux@mondaynote.com

Carriers Whine: We Wuz Robbed!

[First: No (new) iPad report, yet. In the meantime you can feast your eyes, or nurse your dyspepsia, by googling “iPad 3” or “new iPad”. This will tell you almost everything (minus the Fingerspitzengefhül, the all-important gut-feel) about the product, and definitely everything about the kommentariat. If we thought we’d plumbed the nadir with the iPhone 4S…]

Dictionary.com unfolds the historical and linguistic links to We Wuz Robbed, and translates: We were cheated out of a victory; we were tricked or outsmarted.

The gist of the carriers’ lament is this: We do the hard work and someone else is making all the money. And by someone else they mean a certain interloping personal computer company that has, without the slightest experience in the technical (and deal-making) intricacies of the mobile phone industry, inexplicably lucked into the smartphone business and pocketed an unfair share of the cash.

The PR flacks go to work and give us this “rich” WSJ article, “How the iPhone Zapped Carriers”, from which I extract a few of its many gems:

Americans are glued to their mobile devices, obsessively calling, texting, emailing and downloading applications. So why is the U.S. wireless industry in such straits, as shown by AT&T Inc.’s crucial but failed plan to buy T-Mobile USA?
A big reason is that carriers are losing power to the device and software makers riding the smartphone boom.
…..
For the most part, it’s really been a wealth transfer from AT&T shareholders to Apple shareholders…
…..
Device makers and app developers are having the fun, while the carriers are doing the grunt work.

Nowhere does the churnalist entertain anything other than the carrier party line. Not a word from users, from Google, from the device makers and software freeloaders who are “riding” the boom and having all the fun.

The article’s bias is clear, in its language and innumeracy. First, AT&T’s “crucial but failed” attempt to buy T-Mobile was a bid to restrict competition and raise prices. Had the merger gone through, customers would be the ones crying “We wuz robbed.”

Second, the article mentions a decrease in the sacrosanct monthly ARPU (Average Revenue Per User) to $46.09, down $2 from the previous year. Behold once more the lack of respect for the reader exhibited by the fake four-digit precision. But beyond the attempted intimidation, what is the meaning of the $46.09 average, what ingredients does it mix together?

Curious, I ask the oracle a simple question: ATT ARPU. The first hit is a happy — triumphant almost — AT&T press release for Q4, 2010:

AT&T Reports Record 2.8 Million Wireless Net Adds, Strong U-verse Sales, Continued Revenue Gains in the Fourth Quarter
…This marked the eighth consecutive quarter AT&T has posted a year-over-year increase in postpaid ARPU.

And the news gets better. The Q4 2011 investor presentation (download it here) yields these morsels:

…and…

The average ARPU for smartphones on AT&T’s network is 1.9 times that of the company’s non-smartphone devices.

The $64 ARPU is for all wireless devices, smart (with their 1.9x revenue premium) and dumb. Two years ago, AT&T CEO Randall Stephenson pronounced himself happy with the “over $100” ARPU from iPhone subscribers. So how much does AT&T get for its iPhones today?

From Apple’s latest earnings release, we know the iPhone ASP (Average Selling Price) is about $660. AT&T subscribers pay $200, plus $20 or more in accessories, directly to Apple. This leaves $440 to be fronted by AT&T. Subtract that $440 number from $2880 (the customary 24 month x $120 agreement), and there’s $2440 left — or about $100 per month of “real” iPhone ARPU.

But there’s a problem with my back-of-the-envelope calculations. Data consumption makes up 40% of AT&T’s service revenue; I can’t prove it, but I suspect that iPhone subscribers are more ‘‘generous”, they consume more data, than AT&T’s other customers. In Q4 2011, that probably worked out to a nice ARPU of about $120 per iPhone.– and users will pay even more now that the “unlimited’’ plans are no longer offered.

What about Verizon? Are they being “zapped,” too? The oracle obligingly responds to “Verizon ARPU” with a few good links, such as this one, trumpeting Verizon’s robust health:

US carrier landscape in Q3: Verizon records biggest ARPU

Jumping to Verizon’s Q4 2011 numbers and to the January 24th earnings call transcript (courtesy of Seeking Alpha), we needn’t shed tears. The company’s smartphone business is doing well:

Ever since the iPhone barged in, we’ve heard carriers cry extortion; they complain that Apple’s prices — to them — are too high. But they took the iPhone and its prices for two simple reasons: higher ARPUs and fear of losing subscribers to a competitor, the cost of watching your most “productive” subscribers — the ones who contribute to the 1.9x ARPU factor — go elsewhere. It’s better to bet the company on the iPhone than on not having it.

Sprint agrees. According to our WSJ story, Sprint has committed $15B to the purchase of iPhones for a period ending in 2014. (Another WSJ story says $20B, but what’s $5B these days?) As obverse evidence, we have T-Mobile’s simple explanation for its subscriber losses: No iPhone.

Carriers subsidize smartphones because it’s what their customers want, and they put up with the iPhone’s higher price because it’s what their customers want most. Just last week, a T-Mobile exec called for an end to smartphone subsidies — but refused to go first. When/if the iPhone becomes less desired, the carrier subsidies will subside.

I introduce this thought by way of providing context for another statement in the WSJ article:

‘’… subsidizing a customer buying an iPhone would cost 40%, or about $200, more than another kind of phone, on average.”

(Let’s see: $200 divided by 24 months, that’s about $8 a month. Will an iPhone customer yield the extra $8 in monthly ARPU? The carriers’ accountants seem to think so.)

Still on subsidies, try this thought experiment: You walk into an AT&T or Verizon store with a fully-paid unlocked phone. Will you get a lower monthly deal? I asked and, in both cases, the answer is a polite no. See this on-line chat with a Verizon person:

No deal on an unsubsidized phone. The logic is impeccable: We complain about subsidies while using them to tie customers up.

Carriers want to imagine a world in which the ‘‘excess’’ $200-per-iPhone subsidy moves back to its rightful home: the carriers’ coffers. With 180 million iPhones sold so far, that’s $36B of pure carrier profit…and Apple would still enjoy an ASP of more than $400 for its iPhone. Cosmic order would be restored.

Back in this reality, carriers complain about excessive subsidies and threats of disintermediation, of attempts to make them ‘‘dumb pipes’’. But nowhere do we see a discussion of the ratio between the cost of an additional cell tower and the new revenue it generates. We can be sure carriers know this number, but they’re not sharing. It must be a good one: We now see carriers eager to offer their new LTE infrastructure as data pipes for the (unsubsidized) new iPad.

As a final offering, regard this handy chart from Fierce Wireless:

Some observations and a little math, in no particular order.

  • The first four carriers, Verizon, AR&T, Sprint, and T-Mobile, have 295M subscribers, 90% of the total US market.
  • If we multiply each carrier’s ARPU by its number of subs, sum the results, and divide by the 295M, the overall ARPU works out to about $50 (our journalist would write $49.69).
  • For the two leading carriers, the churn rate (people leaving) is quite low, about 1%. Compare this to the iPhone-less competitors: Before Sprint got the iPhone 4S, Sprint’s churn was about twice AT&T’s; T-Mobile’s is close to three times that of Verizon’s.
  • AT&T continues to benefit from its early bet on the iPhone and, in Q3, added more subs than Verizon.
  • Both Verizon and AT&T get about 40% of their service revenue from data.

JLG@mondaynote.com

Ebooks: The Giant Disruption

(Part of a series)

In the last twelve months, I’ve never bought fewer printed books — and I’ve never read so many books. I have switched to ebooks. My personal library is with me at all times, in my iPad and my iPhone (and in the cloud), allowing me to switch reading devices as conditions dictate. I also own a Kindle, I use it mostly during Summer, to read in broad daylight: an iPad won’t work on a sunny café terrace.

I don’t care about the device itself, I let the market decide, but I do care about a few key features. Screen quality is essential: in that respect the iPhone’s Retina Display is unbeatable in the LED backlit word, and Kindle e-ink is just perfect with natural light. Because I often devour at least two books in parallel, I don’t want to struggle to land on the page I was reading when I switch devices. They must sync seamlessly, period, even with the imperfect cellular network. (And most of the time, they do.)

I’m an ebook convert. Not by ideology (I love dead-tree books, and I enjoy giving those to friends and family), just pragmatism. Ebooks are great for impulse buying. Let’s say I read a story in a magazine and find the author particularly brilliant, or want to drill further down into the subject thanks to a pointer to nicely rated book, I cut and paste the reference in the Amazon Kindle store or in the Apple’s iBooks store and, one-click™ later, the book is mine. Most of the time, it’s much cheaper than the print version (especially in the case of imported books).

This leads to this thought about the coming ebook disruption: We’ve seen nothing yet. Eighteen months ago, I was asked to run an ebooks roundtable for the Forum d’Avignon (an ultra-elitist cultural gathering judiciously set in the Palais des Papes). Preparing for the event, I visited most of the French publishers and came to realize how blind they were to the looming earthquake. They viewed their ability to line-up great authors as a seawall against the digital tsunami. In their minds, they might, at some point, have to make a deal with Amazon or Apple in order to channel digital distribution of their oeuvres to geeks like me. But the bulk of their production would sagely remain stacked on bookstores shelves. Too many publishing industry professionals still hope for a soft transition.

How wrong.

In less than a year, the ground has shifted in ways the players didn’t foresee. This caused the unraveling of the book publishing industry, disrupting key components of the food chain such as deal structures and distribution arrangements.

Let’s just consider what’s going on in self-publishing.

“Vanity publishing” was often seen as the lousiest way to land on a book store shelf. In a country such as France, with a strong history of magisterial publishing houses, confessing to being published “à compte d’auteur” (at the writer’s expense) results in social banishment. In the United Kingdom or the US, this is no longer the case. Trade blogs and publications are filled with tales of out-of-nowhere self-publishing hits, or of prominent authors switching to DIY mode, at once cutting-off both agent and publisher.

And guess who is this trend’s grand accelerator? Amazon is. To get the idea, read these two articles: last October’s piece in the New York Times Amazon Signs Up Authors, Writing Publishers Out of Deal, and a recent Bloomberg BusinessWeek cover story on Amazon’s Hit Man. The villain of those tales is former übber-literary agent Larry Kirshbaum, hired last May by the e-retailer giant to corral famous writers using six-figures advances. (By the way, BBW’s piece is subtitled “A tale of books, betrayal, and the (alleged) secret plot to destroy literature”, a hard-sell come-on…). Of course you can also read the successful self-publishing poster-child tale in this excellent profile of Amanda Hocking in the Guardian.

Here is what’s going on:

– Amazon is intent on taking over the bulk of the publishing business by capturing key layers of intermediation. At some point, for the market’s upper-crust, by deploying agents under the leadership of Mr. Kirshbaum and of its regional surrogates, Amazon will “own” the entire talent-scouting food chain. For the bottom-end, a tech company like Amazon is well-positioned for real-time monitoring and early detection of an author gaining traction in e-sales, agitating on the blogosphere or buzzing on social networks. (Pitching such scheme to French éditeurs is like speaking Urdu to them.)

– For authors, the growth of e-publishing makes the business model increasingly attractive. Despite a dizzying price deflation (with ebooks selling for $2.99), higher volumes and higher royalty percentages change the game. In the too-good-to-be-an-example Amanda Hocking story, here is the math as told in the Guardian piece:

Though [a $2.99 price is] cheap compared with the $10 and upwards charged for printed books, [Hocking] gained a much greater proportion of the royalties. Amazon would give her 30% of all royalties for the 99-cent books, rising to 70% for the $2.99 editions – a much greater proportion than the traditional 10 or 15% that publishing houses award their authors. You don’t have to be much of a mathematician to see the attraction of those figures: 70% of $2.99 is $2.09; 10% of a paperback priced at $9.99 is 99 cents. Multiply that by a million – last November Hocking entered the hallowed halls of the Kindle Million Club, with more than 1m copies sold – and you are talking megabucks.

Again, aspiring (or proven) authors need to cool-down when looking at such numbers. The Kindle Million Club mentioned above counts only 11 members to date — and most were best-sellers authors in the physical world beforehand.

– But at some point, the iceberg will capsize and the eBook will become the publishing market’s primary engine. Authors will go digital-first and the most successful will land a traditional book deal with legacy publishers.

Shift happens, brutally sometimes.

frederic.filloux@mondaynote.com

Next week: the editing equation and how the rise e-publishing will segment the craftsmanship of book-making.

Apple’s Grand User Experience Unification

Apple just announced Mountain Lion, the 10.8 version of the Mac operating system, scheduled for delivery in late summer of this year. I dutifully installed the developer preview; it works, mostly (see here for PCMag’s list of notable features, and here for a quick video tour.). More important is that less than a year after the introduction of OS X 10.7, we now have two data points and can draw a line…and the slope confirms our expectations: Mac OS X begat iOS but, now, iOS fathers Apple’s Unified User Experience.

iOS leadership came about for two reasons.

First, the numbers. You’ve probably seen this “viral” Asymco graph, compliments of Horace Dediu, that compares the installed base growth for various Apple products, alive and historic:

Quoting Horace:

The iOS platform overtook the OS X platform in under four years, and more iOS devices were sold in 2011 (156 million) than all the Macs ever sold (122 million).

No one, Apple execs included, expected such an explosion. But here we are: The son of OS X is now the Big Daddy and everything else must line up behind it. Imagine an alternate universe in which Scott Forstall, Apple’s iOS czar, hadn’t won the decision to pick a version of Mac OS X as the software engine for the iPhone. (Scott is also the “father” of Siri. He convinced Jobs to buy the company and to put substantial resources behind it after the acquisition.)

Just as important, iOS provides a fresh (or “fresh-ish”) start. iOS is a rebirth, rid of (many) sins of the past. Because it must run on less of everything — RAM, MIPS, screen, power –engineers were “forced” to shed the layers of software silt that accumulate inside any OS. This gave iOS designers and coders the opportunity to rethink the User Experience (UX), and to pass these ideas back to the Mac.

As examples: The multi-finger trackpad gestures, inherited from iOS, are welcome additions to OS X, they help us find our way in a maze of application windows. So are the full-screen apps with their felicitous and subtly size-conscious ways of hiding and revealing menubars and the Dock. The animation may differ between the smallest 11.6” MacBook Air and a large 27” screen, but physically it feels the same.

Under the hood, we discern an iOS-inspired ways of installing and uninstalling applications. In another trick learned from iOS, Lion manages application state from fully on to fully off and, more interestingly, various levels of readiness in between.

[For an in-depth and opinionated discussion of the technical aspects of OS X Lion -- including glimpses into the Mac’s possible future -- you can spend $4.99 on Mac OS X 10.7 Lion: the Ars Technica Review. It’s available in Kindle e-book form, but not as an Apple i-Book. You can also turn to Fraser Speiers’ lucid discussion of iOS multitasking here, with videos here.]

In 2007, while clearly coming from the same company, the Mac and the iPhone had markedly different UXs. The phone’s small screen was the biggest reason for the differences. When the iPad came out in 2010, some folks joked that the new device was simply a Brobdingnagian iPhone, perfect for the fat-fingered. But the size-appropriate translation of the iOS UX onto a much bigger screen hinted at things to come…and, indeed, later that year Apple announced its intention to further adapt iOS user interface ideas and fold them into the Mac.

If the Mac is a now-traditional personal computer, the iPad is a more personal one, and the iPhone is really personal. (This should please Messrs. Ballmer and Shaw at Microsoft. According to their hymnal, there is no shift to a post-PC era, it’s turtles, err… PCs all the way down to smartphones.)

For a company that prides itself on simplicity and elegance, it only makes sense that Apple would offer a consistent UX across all its devices, a GUUX, a Grand Unified User Experience. Apple customers should be able to move easily and naturally from one device to another, selecting the best tool for the task at hand. Add another unification, iCloud storage services, and Apple can offer more reasons to buy more of its products.

It’s a lovely, soothing theory.

In reality, the Grand Unification isn’t there yet. We still face antiquated limitations, bad bugs, aging applications, and capricious flourishes.

Let’s start with the menubar at the top of the OS X screen. It worked well on the original Mac with its small screen and lack of multitasking, but on today’s 21.5’’ or 27” displays and the many applications they contain, the menubar is bad ergonomics and leads to confusion. Novice and experienced users alike are often misled: If you unintentionally click outside the app window, the menubar at the top of the screen becomes associated with another app, or with the Finder:

On apps such as Pages, it gets worse: You have to deal with two menubars, the one inside the app window, and the one at the top of the screen. Why does Apple cling to this antiquity?

(Friends tell me that it would be difficult to move the top menubar into the app. Perhaps…but more difficult than moving from the undebuggable OS 9 to the Unix/NextStep-based OS X?)

In Microsoft’s Windows, each app window carries its own menubar, there’s no need to move to the top of the big screen to access the File menu, there’s no confusion about the context of your action. Furthermore, when you close an app’s last window, the app quits. Apple recently started doing something similar, but it’s apparently limited to a few utility programs; big apps don’t quit when their last window is closed.

Why not take a few good ideas from Windows?

Moving to bad bugs, the Mac’s Mail app is still an abomination, an app that was either poorly architected or poorly implemented or both. It keeps quitting or freezing on my machines. All on its own — meaning with no prodding by this user — Mail will spin the dreaded beachball for tens of seconds. Is it talking to itself?

Another of my favorite apps, Preview, will suddenly lose part of its mind:

With the Mountain Lion announcement, Apple execs tell us that OS X is now on a once-a-year release regimen. Great…but what about iWork apps? When will they be updated?

I have a long list of iWork bugs, and some are really embarrassing. Take a simple Numbers graph and copy it into Pages:

Works fine…but it loses its title and legend when copied into Word. It must be Microsoft’s fault, right? No, the same thing happens when the chart is moved to Apple’s own Preview:

(When I tried it again, just to make sure this wasn’t a “luser” error, Preview crashed on me.)

Speaking of Microsoft Word, the US version knows the punctuation rules for both US English and French. Not my version of Pages…which is why I have to keep Word around.

Some apps aren’t merely not improving, they seem to be going downhill. The Lion version of Address Book made it harder to manage multiple books, and the app ignores some of Apple’s own UI conventions, such as double-clicking at the top of the window to minimize it.

I’ll finish this litany with Apple’s skeuomorphic flourishes. This apparently is a new fashion: Make computer objects look more like the “real” thing in order to provide familiarity. Sometimes, as with the faux stitched leather and bits of torn paper in the iCal app, familiarity breeds contempt:

The Address Book is even worse, I won’t reproduce it here.

Sure, a good UX needs to extend a welcome mat, but we don’t need extraneous, functionally pointless simulacra of the physical world. Perhaps these details are just a case of brainstorm hysteria in Cupertino: “Idea: Put a rod and hoops at the top of each window, hang drapes on the side and give users a choice of styles!”

Apple must choose between its established Bauhaus elegance and 70‘s Rich Corinthian Leather:

Let’s end on more measured notes.

  • Bugs and brain flatulence aside, a Grand Unified UX is the right idea. Who will argue against making it easier to move from one Apple device to another? Especially when using fresh and successful iPhone/iPad constructs as the model.
  • Lion and Mountain Lion are transitional versions, and the awkwardness shows…but they’re moving in the right direction. Mountain Lion, even in its buggy preview form, shows a large number of nice improvements over Lion.
  • It’s been a very long time – three years — since the latest iWork release. But this lull is very likely due to Apple’s focus on the first set of iOS releases. Sooner or later, we’ll see a fresh iWork that cures the most glaring bugs — and that makes OS X and iOS file formats more compatible.

Lastly, having spent a little more time with Mountain Lion, I hope we’ll get the newer version of Safari ASAP. At the top of the list of neat improvements: we’ll be granted the ability to search directly from the URL bar. Yes, finally, just like Opera, Firefox, Chrome and Internet Explorer…

JLG@mondaynote.com

Twitter, Facebook and Apps Scams

Here is the latest Twitter scam I’ve heard this week. Consider two fictitious media, the Gazette and the Tribune operating on the same market, targeting the same demographics, competing fort the same online eyeballs (and the brains behind those). Our two online papers rely on four key traffic drivers:

  1. Their own editorial efforts, aimed at building the brand and establishing a trusted relationship with the readers. Essential but, by itself, insufficient to reach the critical mass needed to lure advertisers.
  2. Getting in bed with Google, with a two-strokes tactic: Search Engine Optimization (SEO), which helps climb to the top of search results page; and Search Engine Marketing (SEM), in which a brand buys keywords to position its ads in the best possible context.
  3. An audience acquisition strategy that will artificially grow page views as well as the unique visitors count. Some sites will aggregate audiences that are remotely related to their core product, but that will better dress them up for the advertising market (more on this in a forthcoming column).
  4. An intelligent use of social medias such Facebook, Twitter, LinkedIn and of the apps ecosystem as well.

Coming back to the Tribune vs. Gazette competition, let’s see how they deal with the latter item.

For both, Twitter is a reasonable source of audience, worth a few percentage points. More importantly, Twitter is a strong promotional vehicle. With 27,850 followers, the Tribune lags behind the Gazette and its 40,000 followers. Something must be done. The Tribune decides to work with a social media specialist. Over a couple of months, the firm gets to the Tribune to follow (in the Twitter sense) most of the individuals who already are Gazette followers. This mechanically translates into a “follow-back” effect powered by implicit flattery: ‘Wow, I’ve been spotted by the Tribune, I must have voice on some sort…’ In doing so, the Tribune will be able to vacuum up about a quarter or a third — that’s a credible rate of follow-back — of the Gazette followers. Later, the Tribune will “unfollow” the defectors to cover its tracks.

Compared to other more juvenile shenanigans, that’s a rather sophisticated scam. After all, in our example, one media is exploiting its competitor’s audience the way it would buy a database of prospects. It’s not ethical but it’s not illegal. And it’s effective: a significant part of the the followers so “converted” to the Tribune are likely stick to it as the two media do cover the same beat.

Sometimes, only size matters. Last December, the French blogger Cyroul (also a digital media consultant) uncovered a scam performed by Fred & Farid, one of the hippest advertising advertising agencies. In his post (in French) Cyroul explained how the ad agency got 5000 followers in a matter of five days. As in the previous example, the technique is based on the “mass following” technique but, this time, it has nothing to do with recruiting some form of “qualified” audience. Fred & Farid arranged to follow robots that, in turn, follow their account.  The result is a large number of new followers from Japan or China, all sharing the same characteristic: the ratio between following/followed is about one, which is, Cyroul say, the signature of bots-driven mass following. Pathetic indeed. His conclusion:

One day, your “influence” will be measured against real followers or fans as opposed to bots-induced accounts or artificial ones. Then, brands will weep as their fan pages will be worth nothing; ad agencies will cry as well when they realize that Twitter is worth nothing.

But wait, there are higher numbers on the crudeness scale: If you type “increase Facebook fans” in Google, you’ll get swamped with offers. Wading through the search results, I spotted one carrying a wide range of products: 10,000 views on YouTube for €189; 2000 Facebook “Likes” for €159; 10,000 followers on Twitter for €890, etc. You provide your URL, you pay on a secure server, it stays anonymous and the goods are delivered between 5 and 30 days.

The private sector is now allocating huge resources to fight the growing business of internet scams. Sometimes, it has to be done in a opaque way. One of the reasons why Google is not saying much about its ranking algorithm is — also — to prevent fraud.

As for Apple, its application ecosystem faces the same problem in. Over time, its ranking system became questionable as bots and download farms joined the fray. In a nutshell, as for the Facebook fans harvesting, the more you were willing to pay, the more notoriety you got thanks to inflated rankings and bogus reviews. Last week, Apple issued this warning to its developer community:

Adhering to Guidelines on Third-Party Marketing Services

Feb 6, 2012
Once you build a great app, you want everyone to know about it. However, when you promote your app, you should avoid using services that advertise or guarantee top placement in App Store charts. Even if you are not personally engaged in manipulating App Store chart rankings or user reviews, employing services that do so on your behalf may result in the loss of your Apple Developer Program membership.

Evidently, Apple has a reliability issue on how its half million apps are ranked and evaluated by users. Eventually, it could affect its business as the AppStore could become a bazaar in which the true value of a product gets lost in a quagmire of mediocre apps. This, by the way, is a push in favor of an Apple-curated guide described in the Monday Note by Jean-Louis (see Why Apple Should Follow Michelin). In the UK, several print publishers have detected the need for independent reviews; there, newsstands carry a dozen of app review magazines, not only covering Apple, but the Android market as well.

Obviously there is a market for that.

Because they depend heavily on advertising, preventing scams is critical for social networks such as Facebook or Twitter. In Facebook’s pre-IPO filing, I saw no mention of scams in the Risk Factors section, except in vaguest of terms. As for Twitter, all we know is the true audience is much smaller than the company says it is: Business Insider calculated that, out of the 175 million accounts claimed by Twitter, 90 million have zero followers.

For now, the system stills holds up. Brands remain convinced that their notoriety is directly tied to the number of fan/followers they claim — or their ad agency has been able to channel to them. But how truly efficient is this? How large is the proportion of bogus audiences? Today there appears to be no reliable metric to assess the value of a fan or a follower. And if there is, no one wants to know.

frederic.filloux@mondaynote.com

Strange Facebook Economics

Exactly three years ago, Charlie Rose interviewed Marc Andreessen, the creator of Netscape and Facebook board member. In his trademark rapid-fire talk, Marc shared his views on Facebook. (Keep the February 2009 context in mind: the social network had 175 million users and Microsoft had just made an investment setting Facebook’s valuation at $15 billion.)

About Mark Zuckerberg’s vision:

The big vision basically is — I mean the way I would articulate it is connect everybody on the planet, right? So I mean [there are] 175 million people on the thing now. Adding a huge number of users every day. 6 billion people on the planet. Probably 3 billion of them with modern electricity and maybe telephones. So maybe the total addressable market today is 3 billion people. 175 million to 3 billion is a big challenge. A big opportunity.

Indeed.
About monetization:

There’s a lot of confusion out there. Facebook is deliberately not taking the kind of normal brand advertising that a lot of Web sites will take. So you go to a company like Yahoo which is another fantastic business and they’ve got these banner ads and brand ads all over the place, Facebook has made a strategic decision not to take a lot of that business in favor of building its own sort of organic business model; and it’s still in the process of doing that and if they crack the code, which I think that thy will, then I think it will be very successful and will be very large. The fallback position is to just take normal advertising. And if Facebook just turned on the spigot for normal advertising today, it’d be doing over a billion dollars in revenue. So it’s much more a matter of long term (…)  It could sell out the homepage and it would start making just a gigantic amount of money. So there’s just tremendous potential and it’s just a question exactly how they choose to exploit it. What’s significant about that is that Mark [Zuckerberg] is very determined to build a long term company.

In another interview last year, commenting on Facebook’s generous cumulated funding ($1.3 billion as of January 2011), Andreessen said the whole amount actually was a shrewd investment as it translated into an acquisition cost of a “one or two dollars per user” ($1.53 to be precise), which sounded perfectly acceptable to him.

Now, take a look at last week’s pre-iPO filing: Marc Andreessen was right both in 2009 and in 2011.

Last year, each of the 845 million active members brought $4.39 in revenue and $1.18 in net income. Even better, based on the $3.9 billion in cash and marketable securities on FB’s balance sheet, each of these users generated a cosy cash input of $1.53 dollars.

How much is the market expected to value each user after the IPO? Based on the projected  $100 billion valuation, each Facebooker would carry a value of $118. Keep this number in mind.

How does it compare with other media and internet properties?

Take LinkedIn: The social network for professionals is fare less glamorous than Facebook, a fact reflected in its members’ valuation. Today, LinkedIn has about 145 millions users, for a $7.7 billion market cap; that’s a value of $57 per user, half a Facebooker. A bit strange considering LinkedIn demographics, in theory much more attractive than Facebook advertising wise. (See a detailed analysis here). Per user and per year, LindkedIn makes $3.5 in revenue and $0.78 in profit.

Let’s now switch to traditional medias. Some, like the New York Times, were put on “deathwatch” by Marc Andreessen three years ago.

Assessing the number of people who interact with NYT brands is quite difficult. For the company’s numerous websites, you have to deal with domestic and global reaches: 43 millions UVs for the Times globally, 60 millions for its guide site About.com, etc. Then, you must take into account print circulation for the NY Times and the Boston Globe, the numbers of readers per physical copy, audience overlaps between businesses, etc.

I’ll throw an approximate figure of 50 million people worldwide who, one way or the other, are in some form of regular contact with one of the NYT’s brands. Based on today’s $1.14 billion market cap, this yields a valuation of $23 per NYT customer, five times less than Facebook. That’s normal, many would say. Except for one fact: In 2011, each NYT customer brought $46 in revenue, almost ten times more than Facebook. As for the profit (a meager $56 million for the NYT), each customer brought a little more than a dollar.

I did the same math with various media companies operating in print, digital, broadcast and TV. Gannett Company, for instance, makes between $50 and $80 per year in revenue  per customer, and, depending on the way you count, the market values that customer at about $50.

Indeed, measured by trends (double digit growth), global reach and hype, Facebook or LinkedIn are flying high while traditional medias are struggling; when Facebook achieves a 47% profit margin, Gannett or News Corp are in the 10% range.

Still. If we pause at today’s snapshot, Facebook economics appear out of touch with reality: each customer brings then times less than legacy media, and the market values that customer up to five times more. And when News Corp gets a P/E of 17, Gannett a P/E of 8, Facebook is preparing to offer shares a multiple of 100 times its earnings and 25 times its revenue. Even by Silicon Valley ambitious standards, market expectation for Facebook seems excessive: Apple is worth 13 times its earnings and Google 20 times.

Facebook remains a stunning achievement: it combines long term vision, remarkable execution, and a ferociously focused founder. But, even with a potential of 3 billion internet-connected people in 2016 vs. 1.6 billion in 2010 (a Boston Consulting Group projection), it seems the market has put Facebook in a dangerous bubble of its own.

frederic.filloux@mondaynote.com