Is Facebook building an iTunes/Google Play competitor?

While Amazon and Apple have huge leads, Facebook has enough users, personalization, technology, and convenience to gain a foothold selling movies, music, and other digital goods.

Facebook isn't pressing the panic button as its stock price dipped below $30 this week , but investors are not showing much love for the company.

They want to know soon whether the honeymooning Mark Zuckerberg can turn Facebook's massive pool of personal data, and billions of user interactions per day, into a super-profitable business, like Google or Apple.

Zuckerberg seems to have a different near-term agenda, following Jeff Bezos' Amazon school of management -- attain dominant market share before profits. The formula is to focus on creating an extraordinary customer experience and sign up a few billion users, constructing a moat that competitors can't easily cross.

As Zuckerberg wrote in his letter to prospective shareholders about his company's culture, "Simply put: we don't build services to make money; we make money to build better services."

Facebook has the moat, given its lead in audience and time spent on the site versus competitors. With more than 900 million members, and nearly 60 percent visiting at least once a day, Facebook is the Internet's megalopolis. The planetary colonization continues, with accelerating growth in India, Brazil, Indonesia and other countries.

But achieving Google-like revenue and growing into a $100 billion or $200 billion valuation won't be easy. Facebook's advertising efforts and paid services, mostly in the form of credits used to buy virtual goods on social games from Zynga and others, yielded $3.7 billion in revenue and $1 billion in profit in 2011. Those are nice numbers for an 8-year-old Web company but not great in comparison with the 14-year-old leader in search.

Google, which has the advantage of user intent in selling its core search results, had $37.9 billion in revenue and $9.7 billion in net income for the same year, and grew revenue at 29 percent year-over-year.

So far, Facebook has focused on unobtrusive, small display ads and Sponsored Stories, which display a user's name, photo, and a tagline asserting that the person "likes" an advertiser. The more splashy, high-priced ads that take over substantial real estate on the pages of most sites are not part of the Facebook playbook. GM reportedly pulled its $10 million ad buy because Facebook wouldn't allow the car maker to run a full-page takeover ad on the site.

The rise in mobile usage of Facebook is proving more difficult to monetize than the desktop, despite the increase in time spent on mobile apps. Facebook warned potential investors in its IPO prospectus that the more people who access its mobile version instead of the Web, the worse its business performs.

So how does Facebook grow its revenue and profit at clip that will elevate the stock even to its IPO price of $38 per share? Certainly, Facebook can make improvements to its display advertising, with more precision targeted units sold at higher prices based on mining the 100 petabytes of data it has gathered about its users.

But even at larger scale, with 2 billion users if Facebook's growth in emerging countries continues at pace, Facebook's basic ad model won't result in a higher revenue per user. In fact, users outside the U.S. are worth far less monetarily to Facebook, and it costs the same to serve them a page. (See Frederic Filloux's on Facebook's advertising future in Monday Note.)

Facebook does have a Trojan horse, though it's not clear if the company is going to exploit it any time soon. Facebook Payment and its currency, Facebook credit, generated about 15 percent of company revenue in 2011 -- $557 million. Facebook takes a 30 percent cut of each transaction. Only about 15 million users gave Facebook a credit card and bought virtual goods with Facebook payments last year, which leaves a lot of runway. That's less than two percent of Facebook's current addressable audience.

Just prior to the IPO, Facebook introduced its own app store, Facebook App Center . Facebook can take a fee for apps sold through its store as well as for digital goods and upgrades once an app is installed. App Center is more open than other app stores, routing Facebook users to Apple's App Store and Google Play, while collecting data for its social graph. In May 2012, Facebook routed an estimated 90 million users to Apple's store. That kind of lead generation could be a source of revenue.

A next step would be to unite Facebook Payments and the App Center, creating a full-blown store of digital goods, from movies and books to music and apps, that caters to the growing base of Facebook addicted and media consuming users.

Facebook will take a cut from apps sold in its forthcoming App Center, similar to how iTunes and Google Play operate their stores

The rumored Facebook phone could also play into this digital department store strategy, in the same way that the iPhone, Google phone and a rumored Amazon phone play into a branded one-stop shopping device for everything digital.

Apple's iTunes store generated $1.9 billion in revenue in the second quarter of this year. It will be hard for Facebook to resist getting into competition with Apple, Google, Microsoft Samsung, Sony and others seeking to become the hub of everything digital.

While Amazon and Apple especially have a huge lead on the competition, and offer a high level of convenience and personalization -- which is a kind of ambient lock-in -- Facebook has enough users, personalization, technology, and convenience to gain a foothold. Competing with partners who offer music, videos and other digital goods that integrate with Facebook's platform would prove tricky, but it's part of what every giant company does as its hunger for usage and profit grows.

In response to a query about building a store similar to iTunes, a Facebook spokesperson said, "We have no plans for that at this time."

It's not clear whether "at this time" means never or maybe sometime. Part of Facebook's mission, as drafted by Zuckerberg , is to build products that are "social by design" and to "build the services that give people the power to share and help them once again transform many of our core institutions and industries." It's hard to imagine that Zuckerberg isn't considering weaving a digital department store more deeply into the fabric of Facebook.

 

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