Facebook Isn't Too Big to Fail

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You've heard this debate already: Facebook (NAS: FB) could die like MySpace and Friendster before it -- except that the new king of social networking has grown far too big to be so easily replaced.

I'm here to tell you that Facebook absolutely is not too big to fail. In fact, this moment right now could be the peak of Facebook's power. There's a better-than-ever chance that the only way is down.

Here's why.


Word on the Street
Ironfire Capital analyst Eric Jackson got the ball rolling in a recent CNBC interview: "In five to eight years they are going to disappear in the way that Yahoo! (NAS: YHOO) has disappeared," he said. Not that Big Y is completely dead or anything, but the company is a pale shadow of its formerly glorious self. "Yahoo! is still making money, it's still profitable, still has 13,000 employees working for it, but it's 10% of the value that it was at the height of 2000. For all intents and purposes, it's disappeared."

Jackson paints the history of the Web in broad strokes: The Yahoo! generation was all about information portals, the Facebook generation went social but still relied on a big, comfortable browser experience, and the next generation knows how to make mobile money. And just as Yahoo! ruled the first generation but failed to adapt to the demands of the second, Facebook will probably fall on its face in the mobile transition.

In short, Jackson says, "Facebook can buy a bunch of mobile companies, but they are still a big, fat website and that's different from a mobile app."

Jackson may be a little harsh on the track record of previous-generation leaders moving into a new era, but he's on the money with Facebook. If Facebook can't make money off mobile users, the company is doomed in the long run.

But don't take Jackson's word for it
That oh-so-central website may lose its money-making powers, too. According to a minty-fresh Reuters study, four out of five Facebook users have never made a purchase of any kind based on ads they saw on Facebook.

That would explain why General Motors (NYS: GM) is pulling its entire Facebook ad budget to refocus on other forms of marketing. That's a big hit to Facebook's credibility, given GM's huge presence in the advertising world. When was the last time you sat through a football game without catching a Chevy commercial or two? And I bet you pass a couple of GM billboards on your daily commute. If Facebook isn't good enough for this marketing powerhouse with a $3 billion annual ad budget, why should other consumer brands pay top dollar for Facebook's empty eyeballs?

Nobody goes to Facebook to shop. Likewise, a sales pitch in your face when you just want to hang out with friends is unwelcome, to put it mildly. And when the ads don't work, advertisers stop paying for the privilege of displaying them.

"Fewer clients. Less money." Where do I sign up?
But that's not all. That Reuters poll also found that users are engaging less with Facebook than they used to. While 20% of users surveyed said they spend more time on the site today than they did six months ago (yay!), 34% said the opposite (boo!).

And the thing is, these trends can accelerate faster than you'd think. Another recent study, this time done by West Point academics with Army funding, noted that a very small clique of tastemakers tend to control the behavior of large social networks. For example, less than 1% of the now-defunct Friendster network could quickly make or kill a trend. The tipping point -- where all your friends seem to be doing it, so you might as well do the same -- can be deceivingly small.

So what happens if all the really cool kids leave Facebook for the next red-hot social network? The exodus might be shockingly fast.

The West Point study is part of a larger defense project on how to manipulate tribal structures or terrorist networks in the nation's best interests. If the conclusions apply to Afghan tribes and Friendster, I don't see why Facebook would be immune.

Loyalty rewards?
You might wonder how hundreds of millions of Facebook users could suddenly throw away everything they've invested in the site to find a new hunting ground. Fair point -- all the hours spent on the site should translate into some kind of loyalty, right?

But I'll raise two objections to that theory:

  • People spent insane amounts of time and effort on Friendster, MySpace, and Yahoo!, too. Where did those loyalties go?
  • Facebook is built for the now. The address book is valuable but could easily move elsewhere -- with or without Facebook's cooperation. But status updates, wall posts, pokes, and casual games hardly exist once they roll off your screen. History doesn't matter here. It's all about instant gratification, which is a Teflon-slippery consumer hook.

As you can see, Facebook must change dramatically to stay relevant and to stay profitable. The changes that are necessary to keep users coming back may not be compatible with the ones designed to juice the cash flows. On top of all that, Facebook is run by one person with dictatorial say-so -- and I'm not sure Mark Zuckerberg likes change very much.

Zuck could overcome all these challenges and prove us naysayers dead wrong, but that's an unlikely outcome, in my opinion. That's why my CAPScall on Facebook is a big red "underperform" vote -- even after the post-IPO share-price collapse. This stock is not worth $60 billion, even under optimistic assumptions, and the future is jam-packed with risks. There's one recent tech IPO you should be buying, and Facebook ain't it.

At the time this article was published Fool contributorAndersBylundholds no position in any of the companies mentioned. Check outAnders' holdings andbioor follow him onTwitterandGoogle+. The Motley Fool owns shares of Facebook.Motley Fool newsletter serviceshave recommended buying shares of General Motors. The Motley Fool has adisclosure policy. We Fools may not all hold the same opinion, but we all believe that considering a diverse range of insights makes us better investors. Try any of our Foolish newsletter servicesfree for 30 days.

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