2009: The Year Facebook’s Platform Monetization Efforts Kicked In

As we’re on the cusp of entering 2010, the Facebook Platform is now over two and a half years old. While that time has gone by quickly, the Platform has come a long way, and is starting to show signs of maturity. After the “wild west” of 2007, Facebook primarily opted for Platform stability and growth instead of monetization in 2008. But while Facebook continued expanding by leaps and bounds this year, 2009 was also the year that Facebook’s platform monetization efforts really began to take shape – in somewhat unexpected ways.

It’s somewhat hard to remember now, but during much of the last couple years the tech press was heavily focused Facebook’s plans to build a “PayPal killing” payments service. The idea was basically that Facebook would monetize its platform by owning both the payments layer and the identity layer, eventually spreading its tentacles further throughout the web via Facebook Connect, which would serve as the underlying infrastructure for both an ad network and payments service in the future. Less attention was paid to the role Facebook would play in paid customer acquisition for developers, primarily due to the fact that for a long time developers were able to distribute their applications very widely and very cheaply through aggressive use of Facebook’s “viral” communication channels.

So, what actually happened in 2009? While Facebook has indeed been working on its payments service, it’s looked quite different than many expected – primarily focused on currency, instead of building out broader direct payments infrastructure and operations – while in the meantime, developers have been playing a leading role in Facebook “beating the shit” out of its advertising numbers (we believe as many as 7 out of Facebook’s top 10 performance advertisers are Platform application developers). Let’s take a closer look at what has played out in each area and why.

1) Facebook: Monetizing Virtual Goods Through Currency

Although Facebook is building a payment service for app developers, it’s focusing more on partnerships with other types of payment services rather than building out the payments layer itself. Facebook still requires users to purchase Facebook Credits (its universal virtual currency) using a credit card, and it has begun testing additional payments partnerships. For example, earlier this fall, Facebook began testing mobile payments with Zong, and we expect Facebook to start testing more payments integrations with other payment services (from mobile, prepaid, and regional providers) in 2010.

Ultimately, however, Facebook has shown so far that it wants to rely on payments partners to manage deposits, and we think that will continue next year, instead focusing mostly on its currency experience. Why? Basically, currency is a much higher margin business. While we believe identity is vital to payments, and Facebook is in an interesting position to expand its role as a more generic payments platform in the future, we don’t believe Facebook is likely to build up the global operations necessary to build out such a service soon.

However, Facebook is interested in playing a more meaningful role in creating a universal currency that could assist the expansion of the virtual goods market. Although a couple payments aggregators have tried to create a quasi-universal currency on the Facebook Platform, no one has really succeeded as of yet.

Facebook believes it can add significant value to the Platform virtual goods market through its currency, and has started experimenting with efforts in this direction with developers. If Facebook Credits can provide a better experience for users, who might trust Facebook with their data more than they do third parties, thereby increasing conversion rates for developers, Facebook could create the most valuable currency on the Platform, even without any mandatory Credit-use policies. At that point, it could reasonably charge 30% transaction fees and build a relatively substantial revenue stream.

How much money are we talking? To get our specific estimates for the size of the virtual goods economy on the Facebook Platform for 2009 and 2010, get our Inside Virtual Goods: The US Virtual Goods Market 2009-2010 report. But for the sake of comparison, let’s say developers on the Facebook Platform will do a) $250 million, b) $500 million, c) $750 million in virtual goods transactions next year.  If Facebook were to power the currency for, say, 25% of those transactions, it would see a) $19 million, b) $37.5 million, c) $56 million in currency related revenues next year (assuming a 30% fee). However, it’s important to remember that it’s still very early, and Credits doesn’t power very many transactions today.

Facebook’s ability to make money with currency on the Platform depends on its ability to get both the application integration and payments experiences right. The leading payment aggregators on the Platform have been doing this for years now, so we’re interested to see how much and how quickly Facebook finds success as it rolls out its currency more broadly in 2010.

2) Facebook Ads: Quietly Raking in Developer Spend

Although we’ve written extensively about this trend over the course of the year, many people are still surprised to discover just how much some developers are spending on Facebook Ads. While Facebook started to monetize the Platform directly through Credits this year, 2009 was really the year that developers started to meaningfully use Facebook’s advertising platform for paid customer acquisition.

Developers turned to Facebook to accelerate growth for a variety of reasons, including the competitive dynamics of the market, changes to Facebook’s communication channels, changes in the Facebook Platform ad market, and social gaming’s growth across a variety of interesting demographics (for details, see our Inside Virtual Goods report). But, unlike one year ago, as we enter 2010, developers now have enough data to start estimating the lifetime value (LTV) of different users, and they’re spending behind those calculations.

Because Facebook Ads are becoming an increasingly attractive way for developers to find more people in their target audience, developers are becoming increasingly sophisticated in their traffic buying. As you may expect, some are beginning to use proprietary tools that run on the new Facebook Ads API to automate and improve performance. We think this is a good sign, as it reflects that developers are finding valuable users with increasing efficiency, and we expect this to continue in 2010.

A side effect of increased developer ad spending is that some people are getting more concerned that this will create misaligned incentives that could lead to Facebook giving special treatment to big fish (i.e. Zynga, EA, etc.). The thinking here is that since large developers have gotten a lot more aggressive in aligning their interests with Facebook by spending a major piece of their marketing budgets on Facebook Ads, Facebook’s policy enforcement team might skip over some of their usual checks when reviewing their apps.

We think this is an important issue to keep watch on, but we also think that Facebook has a long term view and is unlikely to sacrifice the reputation of its platform for short term gains, somewhat akin to how Google hasn’t sacrificed the reputation of its search results for big AdWords spenders. It’s always possible Facebook could explore the gray area here more deeply, still offering sufficient incentive to all developers to keep them on the Platform, but we would be surprised if Facebook established the precedent that big spenders get significant policy privileges, especially at this point in the development of the ecosystem.

2010: Facebook Adds, Captures More Value

It cannot be understated how much the Facebook Platform has accomplished since it launched. Three years ago, it didn’t even exist. Today, the Platform is serving hundreds of millions of users per month with hundreds of thousands of applications, all for free. After the first wave of the gold rush subsided in 2008, and Facebook clamped down on early abusers of the Platform, a new wave of entrepreneurs building large virtual goods-based businesses has emerged. Today, Platform applications play a very important role both in keeping Facebook users engaged on the site and in growing Facebook’s user base – and the Platform is really just starting to generate revenue.

While it’s true that fundamentally Facebook is making money by “taxing” the moving parts of the Facebook Platform ecosystem, it’s important to remember that Facebook must continue to add sufficient value for developers if there are going to be any moving parts to tax in the future. Facebook must continue to offer a compelling value proposition to Platform developers and users, and there is no shortage of ways that Facebook could screw that up significantly – from policy blunders to privacy mishaps, from product problems to payments scares.

Ultimately, we think 2010 is going to be a year in which Facebook both adds and captures more value in both the currency and user acquisition components of the Facebook Platform ecosystem. Facebook’s currency and advertising tools are still very rudimentary, and a lot (if not all on the currency side) is still to be seen. It’s a good time to be building social games and apps monetizing through user payments for virtual goods, and Facebook will be increasingly getting in on the party next year.

To dig deeper into the virtual goods market, check out our new report: Inside Virtual Goods: The US Virtual Goods Market 2009 – 2010.