These were genuinely social applications—they successfully brought offline behavior into this new online world. It’s just that it was the kind of behavior that reflected the penchants of the people who still were the overwhelming majority of Facebook’s users—teenagers and college kids.
A few weeks before f8, Morin had coffee with Mark Pincus, the erstwhile founder of Tribe.net, co-owner of the sixdegrees social networking patent, and early investor in Facebook. Pincus told Morin excitedly that he intended to build a poker application for the new platform. “It won’t work,” Morin asserted dourly. “Games aren’t viral.” Pincus went ahead and launched Texas HoldEm Poker on Facebook, starting a company called Zynga, which was headed for huge success. Zuckerberg himself was disappointed at the silliness of many of these apps. He wanted his company to help people communicate things that mattered, not make it easier to play around.
Then came the phenomenon called Scrabulous. Two brothers from Kolkata, India, Rajat and Jayant Agarwalla, built a blatant imitation of the classic board game Scrabble for Facebook. You could play multiple games with as many friends as you wanted, taking a turn whenever it was convenient. Scrabulous was a sensation. The magazine PC World rated Scrabulous number fifteen on its list of “The 100 Best Products of 2008,” just behind Craigslist and ahead of the Nintendo Wii. (Facebook itself was number three.) Some days as many as 342,000 people played.
Scrabulous got even Mark Zuckerberg’s attention. He had never succeeded in convincing his grandparents to join Facebook, but now they finally agreed—so they could play Scrabulous with him there. His antipathy toward games on Facebook began to crack. It was apparent to him that you were interacting with people you cared about when you played Scrabulous. And after all, Scrabble was a game of words and the intellect—the kind of game played by people who went to Harvard.
All this excitement did not go over well with the owners of Scrabble, however. Shortly after Scrabulous launched, Hasbro, which owns the rights in the United States and Canada, tried to buy the online game, reportedly for as much as $10 million. The Agarwalla brothers refused to sell, then Hasbro sued them. The game was shut down. Meanwhile, Mattel, which sells Scrabble in the rest of the world, launched its own Facebook version for use outside North America. Eventually Hasbro launched a legal U.S. Scrabble for Facebook, and the Agarwallas reworked their game to resemble Scrabble less and renamed it Lexulous. It remains popular.
Pincus’s Texas HoldEm was the next game to take off. Morin was right in a sense—games didn’t spread virally as quickly as some kinds of applications. But they engendered extraordinary loyalty—once a user starts playing, they frequently come back. Zynga later added other games, including Farmville and Mafia Wars, both of which now have millions of users. Pincus raised money from venture capitalists and invested aggressively. Zynga is now the largest application company on Facebook, with about 250 employees and over $200 million in annual revenues. And Pincus says Zynga is profitable. Texas HoldEm had 20.3 million active users on Facebook in December 2009, making it by far the most popular poker site anywhere on the Internet. But even more impressive is the game called Farmville, also created by Zynga. On Farmville, a player manages and grows a farm, tending crops and feeding animals, etc. You trade with your neighbors and join in a community of farmers all trying to build the biggest and most productive farm. It has about 80 million total users. Overall Zynga has 241 million total active users for all its games as of February 2010, according to the research firm Inside Network.
Games are now the most successful type of application on Facebook, drawing in phenomenal numbers of players. It makes sense, since gaming is a fundamentally social activity. Facebook enables you to play any game with any of your friends on the service. As of February 2010 there were twelve games on Facebook with more than 20 million players, according to the company. The highly complex World of Warcraft for years dominated online multiplayer gaming, with at most 11.5 million players. But gaming on Facebook is a more casual activity. “We now have tens of millions of people playing games who don’t identify themselves as gamers,” says Gareth Davis, who oversees the gaming portion of the Facebook platform. “They play games here because they want to have fun with their friends.”
Davis is working with every major console game manufacturer to enable classic video games to connect with Facebook and incorporate a social element. “In three years every game will be social,” he predicts. “Every single device—whether it’s a console or a phone or a TV—will connect with Facebook and be able to incorporate and share your Facebook data.” One game by a company called Social Gaming Network enables people to play tennis. For a racket they swing an iPhone that is connected to Facebook. Their adversary on Facebook can be anywhere else in the world, swinging his or her own iPhone.
Games and silly applications continued to surge throughout the Facebook platform’s first year, but the company was finding it wasn’t simple to manage and police its ecosystem of partners. Since anyone could create an app, the platform attracted quite a few players who were less idealistic than Zuckerberg and more interested in making a quick buck.
A competition ensued among applications for users at all costs. Applications were designed as much to get new users as to be fun or valuable. The key was to figure out how to manipulate Facebook’s software so that messages would go into people’s News Feed inviting them to download an app. Applications became very clever about generating stories that would flood everyone’s home pages. One called Funwall let you create little animations or download video onto your profile. That was fine and good. But it had an insidious interface that used ambiguous language to trick many users into sending invitations to every single friend. Even tech industry sophisticates fell for it.
Facebook kept trying to weed out spammers and encourage more reputable applications. But changes intended to punish malfeasance often impaired legitimate apps. Says Morin: “We had to learn a lot about developer relations and policy setting and things that we just didn’t understand. We sort of stumbled our way through becoming good at dealing with developers.”
The company implemented a variety of new rules to try to police applications and make them behave. It urged users to complain about spam. It changed the software to reduce the number of application stories flowing into a user’s News Feed. And it hired an industry veteran to head up the platform. Ben Ling, a slender and flamboyant Chinese-American, had been running the payment system called Google Checkout. He was the highest-level employee Facebook had ever lured away from Google. Executives called him a “rock star.”
By the summer of 2008 the problems had gotten completely out of hand. Facebook’s platform was like the Wild West. So at a second f8 that July, Facebook announced a variety of refinements and rule changes, including a rating system. Now Facebook could weed out apps by “verifying” the good ones. Facebook wanted to encourage the apps that were the most fun or useful. Despite all the fluff, a fair number of substantial and useful applications did get traction. A popular one called Visual Bookshelf let you list books you’ve read, rate them, and write short reviews.
But Zuckerberg’s favorite Facebook application was the Parker-and-Green–created Causes. It was driven by high motives—to help nonprofits raise money. Facebook users who make a donation create a story in their friends’ News Feeds. Ideally that inspires friends to make their own donations. Explains Joe Green: “Social recognition matters in charity, too. People who make big donations like to get their names on hospital buildings. So we at Causes allow you to show what you care about on your Facebook profile.” He says it’s like wearing a yellow rubber Livestrong bracelet. Users responded strongly. Causes has remained among the largest applications on Facebook.
Now the platform ecosystem has become substantial. There are more than 500,000 applications operating on Facebook, created by over 1 million registered developers from 180 countries. More than 250 of these applications have at least one million active users every month. Investors have h
igh hopes for this new type of software company. The top five Facebook applications companies alone—Zynga, Playfish, Rock You!, CrowdStar, and Causes—have raised approximately $359 million in investment capital between them. That includes a giant $180 million infusion into Zynga in late 2009 by private investors led by the Russian firm Digital Sky Technologies. Justin Smith, who runs Inside Facebook, which is devoted to the Facebook developer community, estimates that there are about fifty venture-funded software companies with substantial revenues whose primary business is building and operating applications on Facebook. Zynga is the largest. About 200 smaller companies, comprised of two to four developers each, have annual revenues of several hundred thousand dollars. At least another 300 solo operators have written a Facebook application that earns enough to support them.
Facebook application companies are doing so well that their estimated aggregate revenue in 2009 was roughly the same amount as Facebook’s itself—slightly over $500 million. These applications generate revenue in several ways. Selling advertising generates $200 million for applications companies. Apps often host ads promoting other Facebook apps, and get paid about fifty cents on average each time a user clicks through and installs another app.
Transactions inside applications create even more revenue. Justin Smith of Inside Facebook estimates there were $300 million in such transactions in 2009. Much of this is spent to buy an upgrade to a more advanced level of a game, or to buy virtual goods, like a fancier shoe to kick your friend in KickMania. Playfish’s Pet Society game, where users set up houses to display their pets, releases new virtual items every Monday. On Valentine’s Day in 2009 the company sold five million images of roses that players could give to their friends. Each one cost about two dollars. In Zynga’s Texas HoldEm, players who want more chips than they’re allocated each day pay real money to get them, even though there is no way to remove winnings from Facebook. Numerous Facebook games have revenue exceeding $3 million per month.
Savvy marketers have also realized that Facebook applications are a free way to get in front of consumers. That’s why the Washington Post Company did its Political Compass. When Bob Dylan released a new album in 2008, his record label created an application that used old footage of him as a young man holding a series of signs. Facebook users could put their own message on the signs and then host the film on their profile.
In turning its network into a platform for whatever any outside developer wants to build, Facebook has created many new capabilities but also a new set of risks. For all their usefulness and entertainment value, applications on Facebook are often cavalier about how they treat user data. Frequently when users install an app they give it essentially blanket permission to extract data from their profile. But once that data is in the hands of the developer the user loses all control of what happens to it. Facebook has just begun to take steps to deal with this problem. The limits for what is and isn’t acceptable remain unclear, and predatory applications continue to arise that take unnecessary liberties, often in order to make personal data available to outside marketers who pay for access to it. It’s another piece in the complicated puzzle of Facebook privacy. Says Marc Rotenberg of the Electronic Privacy Information Center: “Facebook and its business partners learn lots about us, but we know very little about them or about what information of ours is collected and how it’s used.”
As more and more software companies embrace the platform and as Facebook’s dominance of social network computing spreads around the globe, the company’s platform strategy is rapidly evolving. Its long-term plan is that fewer and fewer applications will operate inside Facebook’s own walls. Now a service called Facebook Connect enables any website to tap into users’ information and network of friends, and send reports of user activity back into News Feeds on Facebook. The company increasingly is encouraging partners to tap into Facebook that way. So far more than 80,000 websites already do, including about half of the largest ones worldwide. Zuckerberg’s long-desired platform strategy has been paying off.
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$15 Billion
“A trusted referral is the holy grail of advertising.”
Opening Facebook up to everybody had been a huge success. By the fall of 2007 more than half the site’s users were outside the United States. The explosive international growth was a powerful sign of Facebook’s growing universal appeal, since the company had done nothing to make it easy for non-Americans to join. All the text remained completely in English, for one thing.
But the growth also presented a serious business problem. Facebook had to start figuring out how to make money—providing service to people all over the world was expensive. All the ads were aimed solely at Americans, which meant that Facebook was not generating any appreciable revenue from more than half its users. The advertising deal Facebook had signed with Microsoft a year earlier only applied inside the United States. If Facebook was going to take advantage of its newfound global presence, it needed a partner to help it sell display advertising internationally. Microsoft had made it plain it would love to be that partner, extending its U.S. deal to a global one.
Zuckerberg had always been blasé about advertising . But Facebook now had 50 million active users and the platform had transformed it into an industry darling. The company had to find a way to pay for it all. Hundreds of thousands of new users were joining every week. And Facebook continued to build its infrastructure based on the assumption it would be much, much larger in the future. That meant spending millions of dollars for new servers. If he had to have ads, Zuckerberg hoped to develop a new kind that would work uniquely well on Facebook, ads that wouldn’t interfere with a user’s experience. The last thing Zuckerberg wanted was for it to feel like watching network television, where the show is routinely interrupted by irrelevant and inane advertising.
The U.S. ad deal gave Microsoft the exclusive right to sell banner advertising on Facebook. That had to change. Relying primarily on Microsoft for the lion’s share of revenue was precarious. Facebook needed its own self-managed streams of revenue.
Separately, Zuckerberg and Facebook’s board decided it was time to raise more money. Peter Thiel in particular wanted to do it that fall. Thiel has a refined nose for the twists and turns of the financial markets. Stocks were at levels not seen since the dot-com bubble and investors were feeling buoyant. Facebook’s reputation and growth had been transformed by f8 and the platform launch, and it was time to take advantage of enthusiasm among investors. But Thiel also knew that if they went out asking investors for money, someone might try to buy the entire company. To Thiel and Jim Breyer that was an appealing idea, but it horrified Zuckerberg (whose two unfilled seats on the board of directors remained in his control as a form of horror insurance).
The CEO asked Van Natta and his newly hired chief financial officer, Gideon Yu (who had been CFO at YouTube), to see what kind of interest they could drum up for a small stake in the company. Yu now says he thought Facebook might be able to get investors to buy stock at a valuation of about $4 billion. That would have been a huge leap. A little more than a year earlier, its third round of financing (called Series C) had raised $27.5 million, valuing Facebook at $525 million.
But this company, as usual, didn’t conform to the usual expectations. Several venture capital and private equity firms were willing to buy a chunk of Facebook at a $10 billion valuation. That was eye-opening to Yu. He’d clearly been thinking too small. But Zuckerberg wasn’t satisfied. He thought the company was worth $20 billion, says another confidant. He and Van Natta decided to try for $15 billion. Sure enough, they found interest from several parties, but not enthusiasm. Nobody would invest at this level without doing some serious negotiating on the terms. “We found where the market was,” says Yu. “We were going to be able to get a deal done at $15 billion.”
This was right about the same time that talks with Microsoft about an international ad deal began in earnest. The software giant also wanted to hold on to its U.S. deal with Facebook, b
ut Microsoft executives felt they couldn’t let it stay the same. It needed to renegotiate the deal as much as Facebook did. Microsoft was losing about $3 million a month on the U.S. ads. It was putting the lion’s share of its banner ads on Facebook pages that displayed photos, but people just didn’t much notice ads in that environment. The price Microsoft thus could charge advertisers was low. Yet it had agreed to pay Facebook a guaranteed minimum amount—around 30 cents for every thousand page views, regardless of what it was getting from advertisers.
Everything Microsoft was doing in online advertising was fundamentally a response to Google’s growing power. Google search ads were garnering over half of all online advertising dollars, even as the increasingly profitable search giant was starting to toy with other sorts of software that directly competed with Microsoft’s core PC products. To fight back and defend its turf, Microsoft was now going head to head with Google across the board in online advertising. As part of this effort, it was investing billions of dollars to improve its own online search software. Separately, it had in May made its biggest purchase ever—paying $6 billion for aQuantive, which distributed advertising across the Internet. Now that it owned this distribution engine, it badly needed additional inventory to sell through it.
Microsoft CEO Steve Ballmer was fed up with losing deals to Google. He had recently lost both of the industry’s two biggest partnership opportunities after coming exquisitely close to agreement. Each time, Google swooped in at the last minute and stole the deal away. Ballmer had flown to New York in December 2005 to negotiate a major ad partnership with Time Warner’s AOL. He left town thinking he had a deal. Google unleashed its ad team headed by Tim Armstrong and came in with a better offer in days and sealed a contract with a $1 billion investment in AOL that valued it at $20 billion. Then in August 2006, Microsoft had a deal with News Corp.’s MySpace and was poised to guarantee $1.15 billion, according to one of the deal negotiators. Google pounced at the final hour and won with a three-year guarantee to News Corp. totaling about $900 million. News Corp. apparently wanted the status of partnering with Google so much it was willing to give up revenue to do it. Microsoft had been further galled when Google swept up Internet banner advertising network DoubleClick for $3.1 billion in early 2007. This time, Ballmer was resolved it would not happen again.
The Facebook Effect Page 27