Facebook Faces Harsh Accusation

| About: Facebook (FB)

On Tuesday July 31st, a company called Limited Run brought a harsh accusation about Facebook's (NASDAQ:FB) advertisement program. The company claimed that about 80% of all clicks it receives through Facebook don't come from real people but from bots that are programmed to click on those ads and bring revenue to Facebook. At the moment, Facebook is studying the issue and the company will probably make an announcement regarding the matter once things get clearer. Here is Limited Run's announcement about the issue:

A couple months ago, when we were preparing to launch the new Limited Run, we started to experiment with Facebook ads. Unfortunately, while testing their ad system, we noticed some very strange things. Facebook was charging us for clicks, yet we could only verify about 20% of them actually showing up on our site. At first, we thought it was our analytics service. We tried signing up for a handful of other big name companies, and still, we couldn't verify more than 15-20 percent of clicks. So we did what any good developers would do. We built our own analytic software. Here's what we found: on about 80% of the clicks Facebook was charging us for, JavaScript wasn't on. And if the person clicking the ad doesn't have JavaScript, it's very difficult for an analytics service to verify the click. What's important here is that in all of our years of experience, only about 1-2 percent of people coming to us have JavaScript disabled, not 80% like these clicks coming from Facebook. So we did what any good developers would do. We built a page logger. Any time a page was loaded, we'd keep track of it. You know what we found? The 80 percent of clicks we were paying for were from bots. That's correct. Bots were loading pages and driving up our advertising costs.

The company also claimed that it contacted Facebook about the issue but did not receive a response. Currently Facebook receives 90% of its revenue from these clicks and any negative movement in this area can hurt the company's finances deeply. This is not even about whether accusations have a merit or not. Every time someone clicks on an ad on Facebook, the company receives money from it. If many large companies advertising on Facebook start believing that their money is not well-spent, they might take their business elsewhere.

Interestingly enough, Facebook didn't flatly deny the accusation but merely said that it would study the issue. This is enough to raise suspicion. I don't really believe that the company actually built bots to generate fake clicks so that it can generate profits; however, the issue is very suspicious. The bots could be created by anyone, however it is Facebook's responsibility to identify and clean this mess. In the business world, confidence is everything. Companies build credibility after being in business for many years without any major incidents. Facebook's struggle to earn credibility in the business world will be a very tough and long road. If incidents or accusations like this regarding the company continue on, this can be very dangerous for the company's very existence as it relies greatly on advertisement revenue.

In the same page where Limited Run posted its accusation, others have joined in. One commenter said "only 10 to 30 percent of Facebook PPC [pay-per clicks] are recording in analytics. (This is an) obvious problem with bots. Facebook should be clearly refunding a big chunk of this ad spending either through direct payment or a class action lawsuit." Another commenter agreed: "Facebook was a waste of money (for us). Although we didn't establish that hits were actually bots this would explain a lot. We withdrew and have no intention of revisiting, think shareholders should make paper airplanes with their (stock certifications)."

In addition, it is not known how many of Facebook's nearly 1 billion accounts actually belong to real people. Recently, Facebook admitted that as many as 83 million of the accounts in its website were "fake" accounts. There might be many more fake or duplicate accounts yet to be identified by the company. I suspect that many of Facebook's clients will now pay close attention to how their clicks are generated and Facebook might be losing a lot of business in the coming weeks and months. In order to increase its revenue from advertisements, Facebook will have to fight an uphill battle of proving its current and potential customers that its advertisements actually work and result in great return on investment. Facebook has failed to do this so far.

In comparison, Google (NASDAQ:GOOG) is pretty good at catching suspicious movements such as bots on the internet and keeping them out of the loop. Facebook still has a lot to learn from Google when it comes to generating revenue from its advertisement business and doing it effectively so.

At the moment, I would stay away from Facebook as an investor. The company's business model is not very clear and it is incredibly difficult to predict how much it will earn in the near future. The company's stock price will probably remain volatile in the short term with a lot of sharp movements in either direction and this is not a stock I would want to buy at the moment. On the other hand, I wouldn't short it either as the market has an incredible ability of pumping certain stocks beyond reason and keeping them expensive for a long time.

Disclosure: I am long GOOG.