Graphic via Facebook
Facebook makes the vast majority of its revenue from advertising sold on its site. But the company’s recent S-1 filing for its initial public offering showed that a substantial portion comes from Credits, the virtual currency used in Facebook games and other applications. If Facebook is going to develop and diversify its revenue streams — which it must — Credits is the natural place to begin.
In 2011, Facebook earned $557 million from payments made through Credits and other fees, 15 percent of the company’s total revenue. Facebook takes a 30 percent cut of all payments processed through credits, and that $557 million represents only that 30 percent, since Facebook doesn’t consider itself the principal in the transaction, just an intermediary.
So, give or take whatever special arrangments or alternate fees may be in play — the S-1 says that “in 2011, other fees revenue was immaterial” — Facebook users spent roughly $1.85 billion on virtual goods within the site last year.
However, that $1.85 billion and Facebook’s $557 million share itself isn’t very diversified: “Apps built by developers of social games, particularly Zynga, are currently responsible for substantially all of our revenue derived from Payments,” according to the S-1. Zynga accounts for 12 percent of Facebook’s total revenue. Some of that income comes from advertising for Zynga games, but most of it (AllFacebook.com estimates about $375 million) is from Zynga’s payments through Credits.
So not only does Facebook have to build up Credits in order to be less dependent on advertising, but it has to expand the scope of Credits in order to be less dependent on Zynga.
It’s a double imperative. But it’s also a market opportunity.
Three models for Facebook Credits: iTunes, PayPal, Square
There are some relatively elaborate things Facebook could do with Credits, like building or acquiring in-house rivals to eBay or Kickstarter or [pick your favorite site on the internet that involves forking over money]. And Facebook may do that, or it may allow third-party versions to set up shop inside Facebook in exchange for a cut.
But really, there are three straightforward revenue and retail models for virtual currency. And each of the three allows Facebook to be very competitive with other major internet companies who could use payment platforms to gather more user preference and social recommendation data, either to build Facebook alternatives or simply to keep it out of Facebook’s hands.
Again, it’s a double imperative, and also a market opportunity. Here’s how I see this potentially playing out:
1. The iTunes Model. It’s no accident that the 30 percent cut Facebook asks for through Credits is identical to the percentage Apple asks for apps sold and in-app purchases made through its App Store. Facebook could easily expand in the same direction for its Open Graph applications — first by extending Facebook credits as an option for in-app purchases and perhaps eventually requiring it, as it currently does with games.
Now media companies, as well as other app developers, have developed ways to route around making in-app payments to Apple. They could do the same for Facebook. But given the investment that companies like the Washington Post, the Wall Street Journal and others have made in Facebook’s social reader — and the power that Facebook’s platform offers to share and popularize news or other apps — companies may be willing to pay that price.
They could see it not as a toll — which, for all intents and purposes, Apple’s 30 percent cut really is — but through the social networking and recommendation services that Facebook offers, as a genuine value addition to their product. After all, strong placement on Facebook functions both as payment and advertising in a way that placement in the App Store can’t quite match. How many people check in to the App Store every day?
2. The PayPal Model. Just as Facebook identity authentication has spread throughout the web for comments and application — and the company’s advertising platform really ought to spread throughout the web — Facebook credits could be used as a general digital payment platform.
Some users, believe it or not, trust Facebook to handle their personal information, including their credit cards and bank accounts, more than other services. Logging in to Facebook is simple and straightforward, particularly if they have no allegiance already to PayPal or any other digital payment service. One secure account, concentrating a user’s entire identity. Frictionless (if frightening).
PayPal’s fees for such transactions are much, much lower than the 30 percent App Store rate Facebook is charging for games played on its own site, but the infrastructure required would be much smaller.
Also, Facebook could easily forgo some of the profits involved in exchange for the information it would be able to gather about how users actually spend their money throughout the web. That helps Facebook’s advertising business. It helps their in-app purchasing of virtual and physical goods. It helps their targeting of news and other information. It’s gold.
3. The Square Model. The last and perhaps most difficult piece would then be taking Facebook Credits out into the real world, to compete with Jack Dorsey’s Square, Google Wallet, and others as a mobile micropayment service.
Google has the advantage here, because it can build Google Wallet directly into Android and the near-field communications capability of newer smartphones. But with Card Case, Square has shown that thanks to geofencing, digital payments can work through a third-party app on a smartphone, just through proximity.
Facebook could adopt a similar approach, or make a deeper dive depending on how far it wants to extend its reach into mobile — whether through platform partners like Microsoft and Apple, or even its own long-rumored mobile operating system and handset.
Facebook’s trump card over Google? Believe it or not, it may turn out to be privacy. Whether or not it’s true, Facebook could argue that at least its personalized ads and aggregated information don’t change what you and your contacts see when they search for something on the open web.
Instead, all of that information stays within the secure confines of Facebook — even as Facebook itself metastasizes into not just the rest of the web, but any and all digital interactions.
It’s far from easy. But if Facebook can pull any of this off, its pre-IPO stock won’t be the only funny money converted into cool cash after the company goes public.
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