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Facebook heads towards profit By Nick Clark The Independent - Wednesday, 16 September 2009 Facebook has this week hit two significant milestones in its history. The social networking phenomenon now has a staggering 300 million regular users around the world, and has become cash flow positive for the first time ever. While experts agreed it was a landmark moment as the site really looks to take control of its future, one said the group had not yet cracked the “major hurdle to light the touch paper of profits”. Mark Zuckerberg, who created Facebook from his dorm room at Harvard just five years ago, revealed this week that users had grown at a rate of five million a week since July, to hit 300 million on Tuesday. “It's a large number,” he said before unveiling the company's grand scheme. “The way we think about this is that we’re just getting started on our goal of connecting everyone.” Analysts called the growth - up from 100 million last year and 200 million in March - “incredible”. Eden Zoller, analyst at Ovum, said: “Facebook's growth has been pretty consistently phenomenal. At that size, keeping the momentum isn't its sharpest challenge.” The real issue throughout the recent growth in social networking sites has been how the companies, which also include MySpace, Bebo, LinkedIn and more recently Twitter, were to turn their huge audiences into profit. Yet, Facebook's announcement this week was also promising for its investors. Mr Zuckerberg had predicted earlier this year that the group would be cash flow positive “sometime in 2010”. In the blog post on Tuesday he said Facebook was ahead of schedule after it “achieved this milestone last quarter”. He added: “This is important to us because it sets Facebook up to be a strong independent service for the long term.” Ms Zoller said: “Going cash flow positive doesn't necessarily go hand in hand with profits, but it is important as it means there is cash to play with and Facebook is less reliant on its institutional investors.” The group received a $200m investment from Russia's Digital Sky Technologies in May, which valued the group at $10bn. It also sold a 1.6 per cent stake to Microsoft in 2007. Facebook said its financial strength continues to grow despite the downturn, driven by the rise in users as the advertisers have followed. The company is private so it is difficult to track exactly where the money is made, but Mr Zuckerberg has said revenues should grow 70 per cent this year. “Facebook revenues are growing pretty fast, and it gives the group control over its future,” Ian Maude of Enders Analysis said, adding: “Revenues follow eyeballs but there’s often a bit of a lag as advertisers switch to a new medium.” Nick O’Neill, founder of unofficial news site allfacebook.com said: “If the company can cover the cost of scaling to 1 billion users and still manage to break even, there's no doubt that they will have a great opportunity to rake in billions.” He also predicted that the company would hit 380 million users by the end of the year. Facebook is principally funded by display advertising. The group is looking at different ways to use and deploy advertising on the site, after inital returns were weaker than expected. Now, rather than simple banners, brands can tailor their products to individual users. Nigel Gwilliam, head of digital at the Institute of Practitioners in Advertisers, said: “This is a milestone, but one has to be cautious about it. To not be haemorrhaging money is an achievement, but not one that signals wild profitability. Facebook has not yet demonstrated it possesses a licence to print money in the manner of Google and its paid-for search model.” He added: “Many consider the real value of websites like Facebook lies not in advertising but in engagement and participation. But no one has cracked the business model for this yet.” It has also boosted the move to profitability by cutting costs lifting efficiencies. Recently it cut the cost of hosting the millions of photographs uploaded each week with the launch of Haystack, which cuts storage constraints. The gift shop, where users buy each other virtual property, has also provide surprisingly lucrative. “How those future revenue models will play out is still unknown however advertising and initial revenues generated through the Facebook gift shop have apparently been able to support the company," Mr O'Neill said. Questions 1. Facebook... has become cash flow positive for the first time ever. a) Which of the following means that a business will have a positive cash flow? A. Total Costs is greater than Total Revenue B. Total Income is greater than Total Expenditure C. Total Revenue is greater than Total Costs D. Total Expenditure is greater than Total Income (1 mark) b) Explain your answer. (3 marks) 2. Explain two reasons why ‘Going cash flow positive doesn't necessarily go hand in hand with profits’ (6 marks) 3. Discuss the extent to which revenue from advertising will allow Facebook to make a profit in the future. (10 marks) 4. (Facebook) received a $200m investment from Russia's Digital Sky Technologies in May... It also sold a 1.6 per cent stake to Microsoft in 2007. Evaluate Facebook’s decision to accept these investments. (12 marks) Total 32 marks Facebook case study mark scheme 1. Facebook... has become cash flow positive for the first time ever. a) Which of the following means that a business will have a positive cash flow? Answer: B. Total Income is greater than Total Expenditure (1 mark) b) Explain your answer. (3 marks) Answer: Income is Cash flowing into the business (1 mark) or Total Expenditure is the money flowing out of the business (1 mark) If income is greater than expenditure then cash flow is positive (1 mark) Dismiss one of others accurately (1 mark) Question Question Number 2 Explain two reasons why ‘Going cash flow positive doesn't 6 Marks necessarily go hand in hand with profits’ Answer Mark Knowledge 2, Application 2, Analysis 2 Knowledge: up to 2 marks are available for showing 1-2 knowledge, e.g. by candidates defining cash flow and profit Application: up to 2 marks are available for relating the 1-2 above to Facebook e.g. Facebook has received capital from external investors such as M icrosoft; it has not been able to make a profit to date 1-2 Analysis: up to 2 marks are available for the explanation of the link e.g. investment from outside the business increases the cash position as it is an increase in Income, but it does not affect profit. Two reasons needed in the context of LL for full marks (3+3 marks) Question Question Number 3 Discuss the extent to which revenue from advertising will allow Facebook to make a profit in the future. (10 marks Level Ma Descriptor Possible Content rk 1 1- Knowledge: 2 marks are Profit is calculated by subtracting 2 available for a definition of total costs from total revenue profit 2 3- Application: 2 marks are e.g. Facebook charge businesses 4 available for candidates who to advertise on their website which clearly contextualise their increases revenue; Facebook’s responses costs are related to the maintenance of the website 3 5- Analysis: up to 3 marks e.g. Facebook is has a huge 7 are available for explaining number of users (300m at the increasing advertising may time of the article) and it could increase profits in the future therefore charge businesses far more than the costs associated with placing the advertising on the site, thus increasing profits 4 8- Evaluation: up to 3 marks e.g. Facebook adverts may be 10 are available for providing seen as ineffective as they are balance to the answer by easily ignored; Facebook itself perhaps arguing that may face complaints from users if businesses may not be the adverts are deemed to be too interested in paying for intrusive. advertising e.g. Facebook may have to offer A contextual conclusion the ability of targeted advertising should be provided to if it is to make large profits. This achieve the highest mark will mean that businesses wanting band of 7-8 marks to advertise will be far more confident that their money is well- spent and they should see an acceptable return as a result. Question Question Number 4 (Facebook) received a $200m investment from Russia's Digital Sky Technologies in May... It also sold a 1.6 per cent stake to Microsoft in 2007. Evaluate Facebook’s decision to accept these investments. (12 marks) Level Ma Descriptor Possible Content rk 1 1- Knowledge: up to 2 e.g. increased investment gives 2 marks are available for them more money to spend simple responses such as the business will receive more money QWC: struggled to use business terminology or write legibly with frequent errors in spg and/or weak style and structure of writing 2 3- Application: up to 2 e.g. Facebook has received capital 4 marks are available for investment from other media candidates who clearly companies (SKY Russia and contextualise their Microsoft) responses QWC: will use some business terms but the style of writing could be better/there will be some errors in spg/the legibility of the text could be better in places 3 5- Analysis: up to 4 marks e.g. these investments both 8 are available for explaining provide valuable cash to Facebook either benefits or costs of which it needs to pay for its rapid accepting these investments expansion. Website programming and maintenance as well as administration of accounts all QWC: candidate will use demands workers who have to be business terminology paid – this is a considerable cash well/style of writing is expenditure appropriate to the question/good spg 4 8- Evaluation: up to 4 marks The candidate balances their 12 are available for providing answers above to give two-sided balance to the answer, responses e.g. The danger is that Facebook has given up some control as it has allowed outside organisations to invest. There is also the possibility that despite the investment and expenditure, the website may not be profitable due A contextual conclusion to a lack of revenue stream from should be provided to existing advertising. achieve the highest mark band of 11-12 marks QWC: candidate uses Allowing outside cash investment business terminology by what amount to possible precisely and competitors will only be beneficial effectively/organises their if the cash is used effectively e.g. answer to provide a to develop more features of the coherent and fluent website that will allow Facebook to response/ good to excellent generate revenues that are greater spelling, punctuation and than its costs, thus generating grammar. long-term profit.