Facebook's (NASDAQ:FB) business model isn't just social networking; it's advertising. Social networking is just how Facebook acquires traffic for the sake of that advertising. Advertising is where the monetization is.
Because of this, if Facebook begins to undermine the value of Facebook advertisements, then it's undermining its entire business model. Unfortunately, Facebook is doing just that.
They've recently ramped up their so-called "Edgerank" formula, which essentially makes choices for the users of the site, in order to control what content they do and don't see -- rather than allowing them to make that choice for themselves.
This undermines the automatic value of fan pages, makes advertising less attractive, and is leading to some advertisers to advertise less on the network.
What Is Edgerank?
Edgerank is the algorithm that Facebook uses to decide which updates you'll see from pages that you "like", and even which updates you'll see from your friends.
This means if you ever get a sneaking suspicion that Facebook is "hiding" some stories from you that you would usually see, then you're probably right.
The algorithm has been getting "stronger", lately. Last month, Facebook rolled out some changes that kicked some fan pages in the teeth, by filtering their updates from many, and sometimes even most, of their fans.
This happened even though many those pages had, originally, a thriving community with discussions, viral image sharing, and everything you'd expect that would be welcomed by Facebook.
Considering many fan page administrators are advertisers, this had led to anger from many people who are the main source of income for Facebook. There's been public protest from small and big businesses alike, including powerful marketing agencies like Ogilvy and the firm that manages Ford's online brand.
So why is Facebook doing this bizarre change? Short-term profits. And no, that's not a good thing for investors.
Why Facebook Is Increasing Edgerank
The general theory by Facebook is that this will make sure that "low-quality" updates won't bother users. This, of course, misses the point. If people don't want to see updates, then they can just filter it out themselves. People defriend other people all the time, and people unlike pages all of the time.
The real reason for Facebook's change has nothing to do with making users happy. I have yet to see anyone gush over the changes -- most are ticked off. The real reason is that Facebook is trying to artificially boost short-term profits.
The profits come from frustrated users and page administrators who have the ability to "promote" their posts. I run a page with 13,000 fans, and I have the ability to post something for them all to see for $50.
This might sound like not too much money, but for non-profits and "hobby" pages, it's absurd. And for many marketers, the problem isn't with the requirement to spend a little money -- it's with the fact that Facebook fans aren't as sure of an investment as they used to be, in terms of advertising.
Earlier, it was simple to calculate how much a fan was worth. If a fan would pretty much always see your new content you'd post, that was a type of automatic value.
But now, advertisers have much less of an incentive to spend hundreds or even thousands of dollars if they're not sure those new fans will even see content posted on the page.
The Backlash: Lots of Justified Anger
The changes are essentially made to push page admins to spend a little extra money on Facebook. That's the entire point of the change. It's a "gotcha" moment. It's also backfiring.
High profile social media experts like the manager of Ford's account, as well as the VP of Ogilvy's digital strategy team, have bashed the change, with Jeff Doak stating plainly:
"This change is more than just a minor tweak. This is Facebook doubling down and admitting that they really don't have any interest in brands having a real relationship with the fans they've accumulated... I know the analysts and strategists I talk to think Facebook has finally crossed a line that puts their entire value proposition in question."
As someone who is an advertiser on Facebook, I couldn't agree more. Let me make this as perfectly clear as possible: when Facebook begins to make it difficult to see everything you've signed up to see -- which is the point of the entire website -- it's cutting off its own economic head.
It's just absurd, and almost everyone seems to see it for what it is: short-sighted profit-seeking without considering the long-term profit consequences.
Of course, Facebook should monetize. But Facebook should monetize by using the exact opposite strategy.
Facebook should make fan pages more valuable if they want to increase income. Not less valuable. That defeats the entire point, especially when there are other ways to engage with fans that don't involve risky "now you have an audience, and now you don't" gimmicks.
Why Users Should Decide
I won't analyze this from a "be nice" perspective. This is purely about business and the future of Facebook's monetization. If Facebook wants to ensure loyalty, and actually make more money, then they shouldn't do it with infuriating short-sighted gimmicks. They should increase revenue by increasing value.
Remember, 70% of Facebook ads point to on-site locations, like fan pages. If Facebook wants to guarantee happy advertisers, then they need to make those fan page fans worth more.
The opposite of this is to make it uncertain whether fans will even see content when money is spent to acquire them. Facebook is shooting themselves in the foot, leading some to cut back on advertising.
Earlier this year, far before the fiasco currently unfolding, GM made some waves by saying FB ads didn't work. Just a few months later, in September, Google (NASDAQ:GOOG) continued to grow ad revenue faster than Facebook.
In the incredibly competitive world of online search, Facebook can't afford to mess around with the value of Facebook fans. If the company wishes to grow ad revenue, then it needs to increase the value per fan per page.
The way to do this is a complete about face: let the users see the content, and let them filter their feeds as they see fit. Do this and users will be happy, marketers will be happy, and the profits will be there in the long-term.
Facebook should immediately make the default setting one where users can manually change their feeds, and possibly give them an option in their settings to turn Edgerank on. I doubt many will use that feature, but make it a choice, at least.
What This Means For Investors
Short-tem speculating aside, this is troubling for those looking for long-term trends to invest in. A company like Facebook should be incredibly careful when it comes to their advertising platform and their users. Undermining loyalty could greatly encourage alternatives to keep springing up, could flat-out lose money, and show short-term focus rather than long-term vision.
This doesn't mean Facebook is going to self-destruct in the next couple of years, because they have incredible amounts of potential, already have substantial profits, and many viable new traffic/income streams like with the Facebook search engine, and the alternative potential of working with Bing.
Still, my money is cautious and long-term oriented, and until Facebook can show that they can make wonderful money without ticking off their users, my money will find alternatives for growth. That means I won't touch Facebook with a ten-foot poll right now.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. 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.