Facebook’s Risk Factors: Mobile, Gov, Slowed Growth, Google+

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Facebook Still Growing Everywhere, Europe Leads At 229M, Asia Catching Up With 212M

Facebook’s $5 billion S-1 IPO filing includes a detailed assessment of business risks. These include: its lack of mobile monetization and the fact that it doesn’t own a mobile platform; government censorship and privacy scrutiny; inability to maintain its growth rate; and competition from Google+, Twitter and Microsoft.

Here’s a closer look at these risks, followed by the full text of the risk summary; you can see the entire Risk Factors section starting on page 10 of the S-1 filing to the SEC.

Growth And Engagement

Facebook explains that its biggest challenge may be that:

Our financial performance has been and will continue to be significantly determined by our success in adding, retaining and engaging active users. We anticipate that our active user growth rate will decline over time as the size of our active user base increases, and as we achieve higher market penetration rates.

As we’ve written about, Facebook has saturated some of its key first-world markets in terms of user count. Some specific threats to its growth and engagement include competing products, the failure to introduce well-received new products, the inability to balance the user experience with the presence of ads, content relevancy, reduced perception of the service’s usefulness, and concerns about sharing, safety and security.

Mobile

Facebook admits:

We do not currently directly generate any meaningful revenue from the use of Facebook mobile products. Accordingly, if users continue to increasingly access Facebook mobile products as a substitute for access through personal computers…our revenue and financial results may be negatively affected.

Simply put, Facebook’s mobile site and apps do not show ad sidebars or ads of any kind. Many suspect Facebook will soon start serving Sponsored Story ads in the mobile news feed, but it will have to limit their presence in order to not offend users.

In regards to its lack of a mobile device or OS, Facebook states:

We are dependent on the interoperability of Facebook with popular mobile operating systems that we do not control, such as Android and iOS, and any changes in such systems that degrade our products’ functionality or give preferential treatment to competitive products could adversely affect Facebook usage on mobile devices.

Google’s Android could give preference to Google+, and iOS already uses Twitter as its identity provider and native sharing option. Google and Apple could effectively box Facebook out of mobile if it doesn’t secure stronger relationships with them.

Additionally, Google and Apple control the native in-app payments systems on their mobile operating systems, preventing Facebook from earning its 30 percent tax on in-app purchases. Facebook has launched an HTML5 mobile app platform, but it has failed to gain significant traction. Facebook may need to develop its own mobile OS or wait until HTML5 becomes more powerful, and by then it could be too late to catch up to Apple and Google’s mobile app platforms.

Competition

Facebook says competitors are attacking from all directions, stating:

We face significant competition in almost every aspect of our business, including from companies such as Google, Microsoft and Twitter, which offer a variety of Internet products, services, content, and online advertising offerings, as well as from mobile companies and smaller Internet companies that offer products and services that may compete with specific Facebook features. We also face competition from traditional and online media businesses for advertising budgets.

This is one area where Facebook’s risk may not be as bad as it sounds. As I’ve detailed, the network effect of its interconnected user base protects it from disruption by similar services. Facebook has also been acquiring disruptive startups and talent. Through recent product launches like its asymmetrical Subscribe feature, Facebook has reduced Twitter’s threat.

Still, Google has enormous cash reserves and web presence to throw into the war with Facebook. Google knows identity as a layer that ties together activity on its various products is crucial to the future of its ad-targeting business. Google+ may never have the world’s most popular news feed, but its ability to serve highly targeted ads based on personal data and Google product usage could fracture social advertising demand.

Government Censorship and Privacy Regulation

Regarding the possibility of government censorship, Facebook notes:

It is possible that governments of one or more countries may seek to censor content available on Facebook in their country, restrict access to Facebook from their country entirely, or impose other restrictions that may affect the accessibility of Facebook in their country for an extended period of time or indefinitely. For example, access to Facebook has been or is currently restricted in whole or in part in China, Iran, North Korea, and Syria.

Facebook’s censorship in China is possibly the biggest barrier to its sustained growth. If it could gain entry there, it would quickly surge past 1 billion users. If more countries shut it out, it will have to squeeze a higher average revenue per user from its existing base. Facebook needs to build a crack team of international policy specialists and lobbyists to make sure there’s still a supply of fresh users to sign up.

Beyond censorship, Facebook is also subject to regulation:

Our business is subject to complex and evolving U.S. and foreign laws and regulations regarding privacy, data protection, and other matters. Many of these laws and regulations are subject to change and uncertain interpretation, and could result in claims, changes to our business practices, increased cost of operations, or declines in user growth or engagement, or otherwise harm our business.

Facebook recently settled with the U.S. Federal Trade Commission and survived an audit from the European Union’s Office of the Irish Data Protection Commissioner. Through smart compromises and negotiations, it managed to avoid dire consequences for its business, but it might not be so lucky next time. Strong domestic and foreign lobbying presences will be necessary to avoid heavy scrutiny. Most importantly, Facebook needs to carefully consider any change or product launch that influences privacy to avoid stumbles like Beacon, the transition of interests into public Likes, and the opt-out launch of facial recognition.

Additional risk factors include the fact that Zynga makes up 12 percent of Facebook’s revenue, the company’s dedication to user engagement over short-term financial results, privacy and security leaks, patent lawsuits, and hacker attacks.

Full Text of the “Summary Risk Factors”:

  • Our business is subject to numerous risks described in the section entitled “Risk Factors” and elsewhere in this prospectus. You should carefully consider these risks before making an investment. Some of these risks include:
  • If we fail to retain existing users or add new users, or if our users decrease their level of engagement with Facebook, our revenue, financial results, and business may be significantly harmed;
  • We generate a substantial majority of our revenue from advertising. The loss of advertisers, or reduction in spending by advertisers with Facebook, could seriously harm our business;
  • Growth in use of Facebook through our mobile products, where we do not currently display ads, as a substitute for use on personal computers may negatively affect our revenue and financial results;
  • Facebook user growth and engagement on mobile devices depend upon effective operation with mobile operating systems, networks, and standards that we do not control;
  • We may not be successful in our efforts to grow and further monetize the Facebook Platform;
  • Our business is highly competitive, and competition presents an ongoing threat to the success of our business;
  • Improper access to or disclosure of our users’ information could harm our reputation and adversely affect our business;
  • Our business is subject to complex and evolving U.S. and foreign laws and regulations regarding privacy, data protection, and other matters. Many of these laws and regulations are subject to change and uncertain interpretation, and could harm our business;
  • Our CEO has control over key decision making as a result of his control of a majority of our voting stock;
  • The loss of Mark Zuckerberg, Sheryl K. Sandberg, or other key personnel could harm our business;
  • We anticipate that we will expend substantial funds in connection with tax withholding and remittance obligations related to the initial settlement of our restricted stock units (RSUs) approximately six months following our initial public offering;
  • The market price of our Class A common stock may be volatile or may decline, and you may not be able to resell your shares at or above the initial public offering price; and
  • Substantial blocks of our total outstanding shares may be sold into the market as “lock-up” periods end, as further described in “Shares Eligible for Future Sale.” If there are substantial sales of shares of our common stock, the price of our Class A common stock could decline.