Facebook Drives Value For Their Real Customer

| About: Facebook (FB)


Facebook’s customers are the people that give them money, not the users of the site.

Facebook is working to deliver a better product to marketers. Tracking customers proves their model.

Users are often quoted in the aggregate, but the real value comes from those that buy from advertisers.

Facebook (NASDAQ:FB) is taking advertisers seriously. In a move to prove that their advertisements are driving sales for customers, Facebook will let advertisers know when a promotion was first viewed and track users across devices. It may seem like an invasion of privacy to many activists, but Facebook isn't selling the advertising services to the privacy activists. For Facebook, the customer is the advertiser, not the person with an account on Facebook. This is a critical distinction for the company. Facebook is acquiring new users to expand the pool of users they can provide to the advertisers.

Users as a commodity

From Facebook's vantage point, users are a commodity. Facebook is the best company at acquiring that commodity and monetizing it. Yes, there are people behind most accounts, but calling the user on Facebook the customer is like considering a piece of gold ore to be the customer of a mining operation. Granted, Facebook's operations are different from mining, but there are some useful similarities.

Mining operations involve digging through enormous amounts of dirt to find a few very valuable pieces. From the perspective of that single mining company, the goal is to find and extract precious materials at a reasonable cost. The dirt around the materials is not driving value. For Facebook, not all users are created equally. I'm not talking about mobile vs. desktop. I'm talking about people that actually purchase products that were advertised to them.

Envision yourself as a customer

Imagine yourself buying advertisements on Facebook. Imagine actually giving Facebook the money acquired in your business over the previous year. To Facebook, this is the real source of money. It isn't the users; the money is coming from the advertisers. So when you're hypothetically contemplating paying Facebook, what you really want to know is what Facebook can provide for you. As a potential customer for Facebook's services, you really want some data to help you project the impact of your advertising budget. As this hypothetical buyer of Facebook's services, do you care about the privacy activists? No, you care about marketing expense and the resulting increase or decrease in your company's income.

Most users on Facebook won't follow the advertisement, but as a business owner, you are only concerned about your increase in sales. Going back to the mining analogy, this is the gold. These are the only people you really wanted to advertise to. The rest of the audience is irrelevant. Your cost benefit analysis, as an advertiser on Facebook, is just projecting your ability to acquire these individuals. You don't really care if Facebook shows your advertisement to ten thousand people or a hundred thousand. You want to know how many will walk in the door of your shop to make a purchase. If you know how many consumers will come into your business, you can figure out how much money you should expect to make. That is the only relevant piece of information in deciding if you should purchase advertising on Facebook.

Facebook understands their customer. Facebook understands their role in the creation of value for that customer. We frequently talk about MAUs and DAUs and how those users are split up by geography or by device, but really these numbers are all at least one off from the critical values. How much revenue can Facebook drive to advertisers and how effectively can they prove to advertisers that it was Facebook that did the work? Given the enormous number of users in Facebook, it makes sense to look at users as being a heavily diversified sample. However, talking about users in the aggregate is like talking about the amount of raw material available in a mine. Clearly, you'd rather have gold than dirt. You'd rather have copper, you'd rather have silver, but the dirt remains.

Driving value

Facebook needs to use the user's data to target which ads go to each person. By ensuring the right ad goes to the right customer, Facebook is ensuring it makes the most of the operations. Facebook has practices that ignite privacy concerns; but the concerns aren't coming from the customers.

What if Facebook lost a third of their monthly users, but kept absolutely all of the people that would purchase products and services seen on Facebook? Put yourself back in that role of a local business owner. Does it impact your decision to buy advertising? If Facebook can prove that showing your ad to the remaining two thirds will generate the exact same amount of sales for your business, then it shouldn't concern you when you are contemplating advertising.

Users that don't purchase do still provide value as brand ambassadors, but that value could be compared to a pyramid scheme. If the user does not purchase, the value comes from the other people they refer into the pyramid. In the aggregate, it is easy to think about users as having an average value. But the more Facebook refines their marketing, the more value they can create.

By tracking users between devices and sharing that information with marketers, Facebook is offering a better product to their ultimate customer. By tracking and sharing that information, Facebook is leveraging two advantages. The first is that they can target ads better. The second is that Facebook is providing very clear feedback to their customers about what worked. Risk demands return, and Facebook is pushing to reduce the risk in advertising. If Facebook can prove they are driving customers to businesses, they have a better product. This is the ultimate justification for driving up revenues per advertisement. As a person, I'm saddened by the loss of privacy. As an analyst, I'm impressed with the business model.

Disclosure: The author has no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.