Facebook Home Is A Disaster, But Is It A Catastrophe?

| About: Facebook (FB)

After its tumultuous IPO exactly one year ago, the reviews of Facebook's (NASDAQ:FB) latest imbroglio, Facebook Home, are rolling in. And they don't sound encouraging. Among tech bloggers, they trend all the way from John Gruber's opinion that it was a bad idea from the beginning all the way to Marco Arment's that it "was flat-out badly designed" in the end. A bad idea coupled with bad execution for a strategy that is potentially critical to Facebook's long term viability should leave investors wondering where this company is headed.

But don't just listen to the geek elite: what about all the regular smart phone-toting, sharing-obsessed folks that comprise Facebook's target audience? It's hard to say. Thousands of one star reviews have accumulated in the Google Play store, and download volume has been low. Disgruntled users complain of Home's limited functionality, intrusive design, battery-draining behavior, and the general lack of utility of having Facebook front and center on your phone (and photos of your friend's drunken escapades slideshowing uncontrollably athwart your lock screen). On top of that, sales of the HTC First handset, with Facebook Home built-in, have been so lackluster that AT&T has dropped the price from $99 to 99 cents with some analysts speculating this is in advance of the carrier discontinuing it entirely.

Surely, the software will improve as the monthly updates add features and the company responds to feedback. And Home is not yet compatible with most Android devices, so these are early days to be reading into Home's failure to immediately catch on. But while I think it's easy to ridicule the recent media coverage of Home-as-flop as short-sighted and sensationalistic--news about Apple (NASDAQ:AAPL) suffers from this, as well--I think potential investors need to seriously consider what the failure of Home could mean for the company if events continue to trend in that direction. In other words, how much future earnings potential has Facebook staked on Home, and to that end, is Home a great product that people will actually use?

According to their most recent quarterly report, 68% of Facebook users in the quarter ending March 31, 2013 accessed the site via mobile, up from 64% the previous quarter, 54% the same quarter a year ago, and 42% a year before that. The transition of Facebook's users to mobile has been extremely rapid and will likely continue as mobile platforms themselves take over from traditional PCs, particularly for "social" apps like Facebook. Also reported was that 85% of Facebook's revenues in the last quarter came from advertising with the rest made up by payments and fees. Since payments and fees don't appear to be going anywhere, advertising is the company's sole source of significant revenue and the source they'll be depending on going forward. The calculus here is simple, and Facebook hasn't kept it a secret: their future prospects depend on mobile. They state it explicitly in the report:

While most of our mobile users also access Facebook through personal computers, we anticipate that the rate of growth in mobile usage will exceed the growth in usage through personal computers for the foreseeable future, and that the usage through personal computers may be flat or continue to decline in certain markets, including key developed markets such as the United States, in part due to our focus on developing mobile products to encourage mobile usage of Facebook.

That's four uses of "mobile" in a single sentence! They clearly intend to jump from dominant web application to dominant mobile app--but these are completely different ecosystems that play by completely different rules. The web is like a public, open forum compared to the private, walled gardens of the "app" world. As for their progress so far, Facebook has been generating significant revenue from ads with 30% coming from mobile for the first quarter of 2013. Considering the sharp uptick in mobile usage of the social network and a history of revenues that looks like the "interval training" option on an elliptical machine, however, it is clear they're a long way yet from cracking the mobile market. What they need is for their mobile users to treat Facebook as the same sort of portal it gets treated as on the web.

I myself know many people who go directly to Facebook by default when they fire up their browsers. This is one of the reasons it's the most-visited website in the world. On their phones, however, they have to consciously make that choice, and they may not be doing so as often as Facebook needs them to. Hence Home--Facebook's play for the mobile equivalent of the portal. On this basis, I think it's quite likely that Facebook is betting big on Home to capture the usage they need to serve their data-hungry marketing partners. I think it's also probable that Home could turn out like Google+, another lingering technology that has not and likely will not see widespread adoption but which seems important enough to Google (NASDAQ:GOOG) that they will continue developing and pushing it ad nauseam.

Facebook has many smart and talented employees and a singular focus on figuring out mobile. There's no question that they will continue to innovate and iterate their way toward both technological superiority and financial stability. But inasmuch as there are challenges for Facebook, there are risks for investors. The most obvious risk is that Facebook doesn't own the Android platform that Home is built on top of. Although Google likes to use mealy-mouthed rhetoric to make everyone feel warm and fuzzy, they consistently invade and attempt to dominate every market they can (and why shouldn't they?).

The company started by conquering search, moved on to take over maps and email, decided to challenge Apple in mobile, and ultimately made a major bid for social networking. But Facebook, as an advertising company, is a direct threat to Google's underlying business model, and that threat could have dire consequences for Facebook as long as they're dependent on Android. Google has already blocked the ability of developers to update their apps automatically, a crucial part of Home's technology, without going through the Play store. Coincidence?

Talent retention is another problem. As even Zuckerberg has acknowledged, Silicon Valley is not exactly a bastion of loyalty. If Home turns out to be the failure that many have been calling it, nobody should be surprised if their best people start jumping ship. The superstar developers are always looking for new projects, and they hardly want to be stuck working on a dud. Facebook is still a wealthy and prestigious company, so this may not be a problem yet, but it's likelier than not to become one eventually, particularly as its culture evolves from dynamic startup into legacy corporate. Seen in this light, their purchase of Instagram and recent move to acquire Waze are less brilliant strategic moves than desperation plays: if you can't hire it or build it yourself, you have to buy it.

The other significant threat is more like a threat by omission. Facebook Home is not available for iOS and probably never will be. Despite all the hoopla surrounding Android's rise, iOS is still extremely popular, particularly in the crucial North American market, and may actually be regaining market share there. Furthermore, there is data that suggests iOS users spend more time and money on the Internet than Android users, which means the size of the installed base itself is less significant than its quality (i.e. its usefulness to advertisers). Harry McCracken recently collated these numbers: around half of Facebook's revenue comes from the US and Canada; according to Strategy Analytics, Apple shipped 34% of all mobile phones (not just smart phones) in Q4 2012, slightly higher than Samsung; more significantly, iOS users overall are generating 74% of all app download revenue and 61.4% of mobile OS usage belongs to iOS versus 24.9% for Android (StatCounter claims that Android has higher OS usage, however, so take these numbers with the usual skepticism).

Whatever the true breakdown, iOS remains a major presence in the global smart phone market. If Facebook is betting on Home to drive future growth (and that remains an if), they need it to be available on iOS. Will that ever happen? Note the evasive response of Cory Ondrejka, Facebook's director of mobile engineering, to recent questions about the possibility that Apple will allow Home on iOS. Fast forward to the end of the video for the uncomfortable, awkward silence.

To the issue of Facebook Home's quality as a product (beyond what the download numbers and user reviews already indicate), I think Ben Thompson sums it up succinctly in his insistence that Facebook is an app, not a platform:

An app can afford to be prescriptive about the user experience and means of interaction; in fact, the best apps have a point of view on how the user ought to use their service.

Platforms, on the other hand, are just that: a stage for actors (i.e. apps) of the user's choosing to create a wholly unique experience that is particular for every individual user.

It follows, of course, that no successful platform can be built on advertising. Advertising demands eyeballs; platform success demands the ability to fade into the background as said unique experiences take center stage.

I'm not sure an app is worth $64 billion.

Whatever their claims to the contrary, Facebook is no longer, in the final analysis, about providing high quality services to its users--their much-touted "people-oriented" computing experience. As a publicly-traded company, their sights have by necessity become fixed on generating revenue, a goal that is only tangentially aligned with winning over the hearts and minds of the madding, data-generating crowd. It may appear to be good news that Facebook has begun to operate more like a conventional business, but it could ironically turn out that doing so will lead them to alienate their users, thus threatening their business' very viability.

I can't say for sure what's going to happen, of course, but I am skeptical that Facebook will be able to find some balance between generating revenue from advertising while continuing to deliver a superior product to the users on whose visits and data Facebook depends. Fads without ads have always had the most appeal on the Internet, and the more Facebook grows, the more it will depend on increasing ad-based revenue, and the more therefore those ads will creep into their users's daily experience.

At some point, new apps will arise that don't fill your news feed with unsolicited marketing clutter, and both SV and the VC will stampede away to greener pastures. In the meantime, those who go long on Facebook don't have much history to guide them, only the hope that Facebook must know what it's doing and just will, just has to, find some way to monetize its billion-plus users--if not with Home, then with something else. But they should keep in mind that Internet users are fickle and all that lays between success and failure for the social networking leviathan are a few clicks of a button or gestures with a finger.

Disclosure: I am long AAPL. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.