Google Inc : How Facebook Makes Money Could Change

By Benjamin Pimentel, MarketWatch

SAN FRANCISCO (MarketWatch)--Facebook Inc.'s initial public offering filing paints a clearer picture of how the social networking giant makes money--though experts say that picture could change in the months and years ahead.

A big chunk, about 85%, comes from online advertising, pitting Facebook against such industry leader Google Inc. (>> Google Inc) as well as Yahoo Inc.(>> Yahoo! Inc.) and Microsoft (>> Microsoft Corporation), which together run the Bing search engine.

But increasingly, some of Facebook's dollars are coming from payments and fees, mainly from the cut the company gets other firm's transaction on the site. The bulk of that flow--about 12%--currently comes from Zynga Inc. (>> Zynga Inc), shares of which soared Thursday as investors realized how big a role the social gaming firm plays in Facebook's business.

But some analysts see Facebook pushing to find other revenue streams. One argues that it's part of the company grand ambition to become the site where most Web users hang out--and hopefully spend their money.

"Think of Facebook City," said analyst Tim Bajarin of Creative Strategies Inc. "Ultimately, while they would never create a walled garden, they could create a community where once you come in, you pretty much have all you need there."

Facebook's goal, he said, is have more users making purchases, do their banking or even making dinner reservations in the site.

"Initially, everyone just figured that he would tie advertising to everybody's front page," Bajarin said, referring to Facebook Chief Executive Mark Zuckerberg. "When Zuckerberg got up and started creating a platform, that's when we began to realize that he was going beyond the traditional advertising model."

Bajarin added that "it's very clear that, to Zuckerberg and his team, this could be a platform for delivering applications."

Payments and other fees made up only 1% of Facebook's total revenue of $345 million in the March quarter of 2010, while 99% came from advertising, according to the filing with the Securities and Exchange Commission. By the end of 2011, 17% of Facebook's revenue came from payments and fees, while 83% flowed from advertising.

A new kind of advertising

The company has spawned new kinds of online advertising, based on the interactions of Facebook's 845 million users.

Through sponsored stories ads, a business or group can pay to highlight certain posts from a user's friend network or other Facebook pages. Fan ads lets users to become a fan for product or brand by clicking "become a fan."

IDC analyst Karsten Weide said advertising will probably remain Facebook's main revenue source, saying, "The low hanging fruit is really advertising."

And Facebook certainly has momentum in that space due largely the site's growing attraction to brand advertisers and also small and medium-sized businesses, Weide said. In fact, Facebook overtook Yahoo in the No. 2 spot in display ad revenues in the third quarter of 2011, according to IDC data. Google was No. 1.

"It's growing pretty fast," Weide said. "Brand advertisers are moving a lot money into Facebook."

And that's mainly because of the potential that every ad will go viral through Facebook's user networks. "That's what they think is happening," he said, referring to brand advertisers. "It's hot and it's sexy."

The catch, Weide said, is that the effectiveness of Facebook ads is still hard to measure. "Right now, it's an article of faith for many brand marketers," he added.

Finding other models

Which could be a reason why it really makes sense for Facebook to look for other revenue sources, including those beyond advertising. There's been speculation that the company could move into the search business, a market dominated by Google.

"It would be the obvious step," Weide said. "It would hurt Google a lot."

Giving users the ability to more easily purchase products or services on Facebook could also open up another robust stream of revenue, said Wedbush analyst Michael Pachter.

"As soon as they give users a reason to register a credit card, we're going to see a dramatic increase in impulse purchases," he said.

Crawford Del Prete, also of IDC, said Facebook "has an unbelievably wide view in terms of the ways they think they can make money." But that's where some of the risks come in, he added.

"Between here and when those other revenue streams are a significant percentage of revenue, it could be a very unpredictable business model," he said.

In other words, Facebook City's viability isn't assured.

"Their experimenting with trying to figure out how to engage people online beyond advertising is admirable and could be cool," Del Prete said. "But they could spend a lot of money and, you know what, people don't engage. Those are expensive lessons to learn."

Still, Bajarin of Creative Strategies stressed that for now, "their platform is paying off nicely."

"And by the way, they're just getting started," he added.

-Benjamin Pimentel; 415-439-6400; AskNewswires@dowjones.com