Facebook woes remain tangled web

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(DALE CUMMINGS)

Facebook Inc., the Menlo Park, Calif., social media service, may be approaching the limits of its commercial growth. The company last week produced its first quarterly report as a publicly traded company, in the face of growing investor skepticism about its prospects. The stock price promptly dropped to new lows because it was clear that making money off the Internet is not as easy as it used to be for the company.

Throughout the publishing world, writers, artists, distributors and readers are wondering how creation and circulation of ideas will be financed in a digital world, since Internet access is free to anyone with a computer and an Internet connection.

Facebook appeared to have found part of the answer in a delightful and entertaining system that lets users form virtual communities of like-minded people through the friends of their friends. The activity is so amusing users will put up with a certain amount of advertising, which up to now has paid the costs of the service.

Facebook's July 26 quarterly statement showed, however, its operating margin -- the excess of operating income over operating expense -- narrowed to 43 per cent in the second quarter of this year from 53 per cent a year earlier. In most lines of business, 43 per cent would be considered a generous operating margin, but in any business, a 10-point decline in operating margin is a warning signal big trouble might lie ahead.

The company's revenues have grown in the last year, but its expenses have grown far more. Its user base is still growing, but the sales and marketing costs to attract new users appear to exceed the extra ad revenue the service garners from the additional users. The company aims to connect everyone on Earth to everyone else. It now has 955 million users, which is a most impressive number, but the latest ones were hard to recruit and the next ones may be harder still.

The appeal of Facebook is that all your friends are on it. But at its present size, a great many of your friends are not on it and the likelihood they will join is small and getting smaller. A loss of growth momentum may be fatal to the appeal of the service. The July report showed the user base is still growing, but the cost of acquiring new users is now too great to be sustainable.

Facebook got off to a bad start with investors when they bought its newly issued shares at $38 in May and then watched them drop quickly to $28. Those who sought reassurance in the July quarterly report learned more and more Facebook users get the service through their smartphones, missing much of the advertising that is designed for the larger screens of home computers. The management declined to offer any sign it had a way of dealing with these difficulties. The stock price dropped to the low 20s. Publishers resumed the search for ways to cover the costs of creation and distribution in the Internet age. Facebook founder Mark Zuckerberg had a great idea, but he has not yet solved the revenue problem of Internet communication.

Republished from the Winnipeg Free Press print edition August 1, 2012 A6