Is Facebook Overrated?

By Anita Hamilton

Whether you realize it or not, social networking is something you do every day. Each time you tell a friend about a good movie, bore a neighbor with pictures from your kid's birthday party or catch up on gossip at work, you are reaching out to people you know to share ideas, experiences and information. The genius of social-networking websites such as MySpace and Facebook lies in their ability to capture the essence of these informal exchanges and distill them online into an expanding matrix of searchable, linked Web pages.

Nearly half the people who went online in the U.S. in October--83 million, according to the research firm comScore Media Metrix--visited MySpace or Facebook, making social networking one of the most popular activities on the Web. MySpace has the clear lead, with a U.S. audience of 72 million--more than twice that of Facebook's--and 2007 profits estimated at $200 million.

Although Facebook is expected to earn just $30 million, the three-year-old site is getting all the buzz. One reason: Microsoft recently bought a mere 1.6% of the company for $240 million, an investment that values Facebook at $15 billion, which is in the ballpark of Gap and Xerox. That's far smaller than Google, valued at about $200 billion, but both Facebook and MySpace think they are made of the same game-changing stuff. Like Google, they want to change the way you live and work online. And like Google and practically everyone else on the Internet, they are betting that advertising will make them, and their investors, unimaginably wealthy along the way.

Founded by Harvard dropout Mark Zuckerberg, now 23, Facebook was originally a way for college students to keep tabs on who was dating whom. It's evolved since then into a social network: an open book on its members' lives, welcoming just about anyone.

Facebook's inclusiveness has broadened its popular appeal, but the alchemy of the Web is converting eyeballs to dollars via the "click-throughs" that advertisers crave--and the social nets are still searching for the magic formula. Members of both Facebook and its chief rival, MySpace, spend on average about 3 1/2 hours a month clicking around on each site, but they get so caught up in checking out their friends' pages and updating their own that they are less likely to click through to the ads. What's more, Facebook may not be able to keep up the momentum of its rapid-fire growth because social-networking aficionados are notoriously fickle. Remember Friendster?

Social networks are a lot like nightclubs, and Friendster was the place to be in 2004 and '05, before MySpace came along and stole its mojo. In short, Friendster got boring. "It's like a high school dance," says Max Levchin, CEO of Slide, a top maker of image-based applications for social networks. "Everyone shows up and nobody does anything, because there's nothing to do."

So Facebook and MySpace are trying to morph from the high school gym--a place for flirting and gossip--into one-stop entertainment destinations. "MySpace is your starting point to the Internet," says CEO Chris DeWolfe, who recently rolled out features that let MySpace members play casual games like online poker and watch mini-videos of '80s TV shows like Fantasy Island and Diff'rent Strokes. Facebook has gone even further. In August it sent out an open invitation to software developers to devise new widgets. Three months later, Facebook has some 7,000 free add-on applications that let members do everything from monitor their stock portfolios to map anyplace they've ever visited to text friends' phones via the site.

Every one of those applications represents one more aspect of your life that can live on Facebook, and the more you can do there, the more important and valuable the site becomes. (And, as MySpace recently discovered, the more tempting it is to hackers.) Search engines help you find things, but everything they cull from is public. A social network affords something more: access to the personal lives and tastes of the people in your circle, or at least as much as they're willing to share. For that reason, explains Chamath Palihapitiya, Facebook's vice president of product marketing, "I see Facebook as becoming more essential than search."

Will advertisers see it that way too? In early November, both Facebook and MySpace announced new schemes that would allow advertisers to more closely target messages. The idea is that if ads are made more relevant, more people will click on them, which in turn will boost the fees the sites can charge for them. MySpace's new "hypertargeting" strategy scans profile pages for keywords and sells ads against them. If you say you love burritos, for example, a banner ad for Taco Bell might appear at the top of your page. Facebook, on the other hand, involves its members more intimately in the process. The site gives members the option of sending an update to their friends with every purchase they make online--an extension of the news feed that tracks all the other things Facebook members do. If you choose to tell your friends about the Seinfeld DVD box set you just bought from Amazon, for example, your friends will also get a small ad right beneath that update. Advertisers can specify, on the basis of demographic data culled from a user's profile, exactly which members they want to view the ad.

It has the creepy prospect of turning your life into one big direct-mail campaign. But Facebook's Zuckerberg sees the new model as just another form of word-of-mouth. "Nothing influences people more than a recommendation from a friend," he says. To allay privacy concerns, Facebook makes sharing your shopping habits optional, but it's betting that for the bare-it-all generation growing up on social networks, broadcasting what you buy will seem as natural as posting the details of a bitter breakup--or what you ate for breakfast.

While Facebook has the momentum, its battle with MySpace is just heating up. "I don't think there is going to be one winner or loser," says Michael Morris, a media analyst with UBS. "Both MySpace and Facebook can flourish, just like there's more than one television network." Other big players are casting their lots with one or the other. Microsoft beat Google and Yahoo! in the bidding for Facebook. News Corp. bought MySpace for $580 million in 2005, and Google hosts MySpace's ads, guaranteeing at least $900 million in revenue through 2009.

There is no guarantee, however, that people will embrace the advertising models that Facebook and MySpace are pushing. "How do you serve up ads in such a fashion that your young, hip audiences aren't turned off by it?" asks venture capitalist Jim Timmins of Pagemill Partners. Google faced these same worries in 2004 when it launched context-sensitive ads inside its e-mail program Gmail. When the company went public later that year, skeptics voiced similar concerns about the viability of an ad-supported model for its search engine. Google now trades at more than $600 a share and could earn $4 billion this year.

Which brings us back to the real question: Is Facebook worth $15 billion? If it goes public sometime next year, as is widely expected, potential investors need to ask, "How big can Facebook grow?" says Internet analyst Bob Peck of Bear Stearns, who pegged Facebook's value at $6 billion in August. "You want to buy low expectations," says David Trainer, president of the business-valuation firm New Constructs. Google went public amid widespread skepticism, but Facebook has been anointed by its boosters as the next Google, despite MySpace's bigger audience and deeper pockets. As is always the case with the Web, some investors are going to make epic amounts of money. Others won't.