Facebook Privacy Settlement Reveals Potential Revenue Problems (FB)

Posted by · June 22, 2012 3:28 pm

Mark Zuckerberg, founder and CEO of Facebook

After agreeing to a $20 million settlement in a California lawsuit earlier this week, Facebook may find itself losing more than the settlement entails. Already in a bind to find a growing source of revenue since it went public, the social site now appears to have lost one source it was hoping to tap for that growth—thanks predominantly to the terms of the settlement.

The lawsuit, which was filed by five Facebook users from California, alleged that the social network’s “Sponsored Story” feature violated state law by “publicizing users’ ‘likes’ of certain advertisers…without paying them or giving them a way to opt out,” noted a Sunday report from Reuters. This particular feature places what effectively amounts to an ad on a member’s profile page. By placing a friend’s name, profile picture, and claim that the person “likes” a given advertiser on a member page, a “Sponsored Story” is basically a shady way for advertisers to get free endorsements from the one’s that consumers trust the most—their friends.

By potentially cutting off this lucrative resource, this lawsuit could pose real problems for a public company that is yet to demonstrate to investors that it has long-term growth potential. The matter becomes even more concerning when one considers the difficulty that Facebook was already having convincing advertisers that it was a worthwhile place to spend their ad dollars.

While one might argue that this is a side effect of the looser definition users assign to the term friend on Facebook, others argue that the social site is just being too passive in its advertising methods.

“The fact is the advertisements are not irritating users,” argued analyst Rob Enderle, speaking to MSNBC’s Roland Jones. “Advertisers are not getting value because Facebook does not want to upset its users.” The “Sponsored Stories” approach, he says, simply aren’t having the effect that the traditional, more forward forms of advertising do.

Jones validates Enderle’s observations by adding the following:

Indeed, a Reuters/Ipsos poll earlier this month showed four out of five Facebook users said they have never bought a product or service as a result of advertising or comments on the social network site. And in mid-May General Motors very publicly yanked $10 million in Facebook advertising, saying paid advertising on the site isn’t effective.

But such a move away from “Sponsored Stories” is not so simple. The report goes on to note that changing the feature could cost upwards of $100 million, according to one economist. Furthermore, Facebook itself doesn’t yet seem convinced that its social advertising approach isn’t effective. Citing the lawsuit report, Jones recalls that Facebook COO Sheryl Sandberg estimates that a “Sponsored Story” advertisement is worth two or three times that of a regular ad without a “friend” endorsement.

Notwithstanding such an alleged benefit, however, Facebook does now have an obligation to preserve the longstanding right underscored reasserted in the California suit, which was decided by U.S. District Judge Lucy Koh. “California has long recognized a right to protect one’s name and likeness against appropriation by others for their advantage,” Koh wrote in her decision.

Although studies show that a majority of social network users are willing to share at least some vulnerable personal information to get something for “free” in return, such a willingness does not in any way make provision for sites like Facebook to repurpose user information as it pleases. In order to meet that obligation, Facebook has already made strides to be in better compliance with California’s Online Privacy Protection Act by requiring mobile app developers to include privacy policies.

And while that’s all well and good, two concerns remain. One, increasing user privacy surrounding Facebook’s recently launched App Center doesn’t quite address the original complaint raised by the suit. Actually, it redirects the conversation away from Facebook in a lot of ways. And two, if the Facebook revenue model relies so heavily on people not guarding their personal information, what does this mean for the company’s future on Wall Street?

For more on the effects of the Facebook privacy settlement…