Facebook – Smart or Stupid?

As we all know, one of the biggest stories in 2006 was about a deal that never happened. Despite multiple rumors of buyout offers from various suitors, Facebook rejected them all and decided to stay independent. Now, whether that was a smart decision, or a stupid one, is likely to be one of the big stories of 2007. In either case, the key-determining factor will rest on how well Facebook monetizes this year.

But before we get to the profit and loss statement, allow me to make a few observations about Facebook, and its relative position within the overall social networking space. Firstly, I thought Facebook made a very smart strategic decision last year when they opened up their network beyond the college (dot edu) market. From what I hear, their increased signup and overall traffic numbers are bearing that decision out.

Secondly, their approach to product planning and feature enhancements has always made certain of one thing… for Facebook users, it’s all about communications, and any new feature must enhance that core functionality and not distract from it. Too many competing social networks are moving away from that core, and those that continue to do so will end up suffering when the novelty factor of such “enhancements” inevitably wears off.

Lastly, the loyalty and usage stats (e.g. stickiness) of Facebook remain extraordinarily high, particularly for their original student users. The correlation between the last point and the second should not be lost, and as I often like to say, it’s what makes social media (and its reliance on user-based peer-to-peer production and consumption) somewhat like an Internet version of the hypothetical “perpetual motion machine.”

So given such positives, one might conclude that Facebook did in fact make the right decision not to sell… as momentum and value creation certainly seems to be in their favor. Unfortunately, that’s not the end of the story… let’s now get to the bad news.

On the surface, the bad news is simple. Like most social networks, Facebook is facing the monetization challenge. All their direct sales efforts and third-party alliances (e.g. deals with Microsoft and IPG) to sell advertising are yielding far less than expectations.

Word on the street, Madison Avenue that is, is that advertisers who have experimented and bought ads on Facebook are universally disappointed with the results. Consequently, getting these big brands to come back to the table and pony up again with significant ad-buys is going to be very difficult. In other words, Facebook is looking at a foggy fiscal future, and needs to make some tough decisions.

It seems its an opportune moment for potential suitors to take another look. Yahoo, how about making that call?