Facebook’s IPO and the Music Industry

Originally published in the mar-2012 issue of The Music Business Journal – Berklee College of Music

Less than ten years ago, Harvard student Mark Zuckerberg developed Facebook. Since then, many books, an Oscar winning movie, and, of course, the Internet have covered its remarkable story. A new turning point was announced at the beginning of February, when Facebook declared its intention to cease being a private company by filing papers for a public offering with the Securities and Exchange Commission (SEC).

Facebook’s IPO, i.e, its initial public offering, is expected to raise $5 billion or more. Diagnostic company data, released for the first time, indicates gross revenues of $3.7 billion in 2011, with net profits of $1billion. This margin of about one-to-three is impressive.   Close to nine-tenths of all receipts are in advertising; third-party companies using its social platform make up the remainder with commissions on sales of products and services.

The company’s trade value is estimated at $75 to $100 billion, and the projection is much, much, higher than the average multiple of twelve times net profits (Facebook would exceed the average by a factor of seven or more). Behind these bullish perceptions lie the rapid spread of Internet connectivity and the growth of mobile phone usage, especially in emerging countries.

Facebook reported that it has 845 million users and adds 451 every minute. It expects to reach the one billion mark in August, after its first public offering. That means that one in every seven people in the world will be connected via the website. More than four-fifths of the Americans connected to the Internet are also users of the website, and last year slightly more than half of the advertising revenue was generated just in the US. After the stock flotation, the company is said to have plans to expand globally creating more possibilities to grow ad revenue in prominent markets such as India and Brazil. Another big challenge for Facebook is to penetrate the Chinese market, where the website is currently blocked by the government.

Mr. Zuckerberg will still control most of the voting rights at Facebook. However, his decisions are now accountable to stockholders, whose concerns are more financial.  Because of this, Mr. Zuckerberg decided to write directly to potential investors and explain clearly his social mission and vision. He wrote that Facebook was created “to make the world more open and connected.” Zuckerberg acknowledged the necessity of profits, but, he added, “we don’t build services to make money; we make money to build better services.”

Facebook’s API

By encouraging and providing the tools for people to share anything from weekend pictures to articles recently read, Facebook has changed user behavior on the Internet. Every user, for instance, acquires an identity that other people and companies can interact with. In many cases, Facebook has removed the barrier between music artists and their fans by connecting them directly through the platform. It has also created a powerful recommendation tool, allowing users to share what they like so that others can appreciate, and engage, their artist of choice.

For example, the Facebook Application Programming Interface (API) allows other websites to communicate with Facebook and use its tools. It allows for a more personalized social experience, for instance, by embedding its ubiquitous Like button. Moreover, Facebook’s sign-in process eases sites’ registrations. Even MySpace, once a pre-eminent music network, is trying to reemerge as a sophisticated recommendation engine and music discovery tool that runs through Facebook.

Facebook’s presence is felt too as consumers trend towards streaming services. The freemium model allows listeners to access a vast catalog of songs and play them either for free, with some advertisements, or for a monthly fee that allows access to some benefits. Spotify, Rhapsody, MOG, and RDio are the main services here and all of them are using the Facebook API to permit access for users, connect them to their friends, and observe their listening habits.  Without Facebook, the impact and reach of these services would probably be much diminished.

Music Marketing and Zynga

In fact, a new generation of artist managers is now taking advantage of Facebook in order to break new artists. Berklee Alumnus Nils Gums is the businessman behind Internet sensation Karmin, with Amy Heidemann and Nick Noonan (both are also from Berklee). After producing more than thirty music videos for their channel on YouTube, the duo hit it big with 54 million views on a cover of Grammy winner Chris Brown’s “Look At Me Now.” The exponential force of Facebook’s Like and Share buttons was apparent. Karmin has since signed a deal with Epic Records and appeared on NBC’s Saturday Night Live. For that matter, marketing tools like Reverb Nation, Topspin, and BandCamp are based on the concept of the artist communicating directly with fans. That generally means going through Facebook.

A niche market that often falls below the radar of the music industry is gaming.  Yet Zynga, the company behind FarmVille, CityVille and many other social games that run through the Facebook API, accounts for 12% of the entire Facebook revenue. Composers and music publishers should take notice.  Last year Zynga developed a special avatar for Enrique Iglesias to showcase exclusive music in their games, while Lady Gaga’s Born This Waysingle was first released exclusively for players of FarmVille. Games, in short, are becoming an important platform for music discovery and artist promotion.

A New Standard

The biggest challenge for Facebook will be to meet investors’ expectations. More sources of revenue will be likely needed. Facebook could invest its surplus IPO cash in startup companies that advance Facebook’s platform—like Google has done with Google Ventures. The benefit to the startup is not just the money tendered but the mentoring opportunity that founding entrepreneurs receive from Facebook. On the other hand, even a small pick of winners could bring Facebook untold market power gains. In the meantime, there might be added value from a more expert management of advertising data. It is likely that Facebook will enter the advertising market seeking an important new acquisition.

The future of Facebook looks promising, and so do the benefits that the music industry might reap indirectly from a successful IPO.  However it is extremely important for Facebook to be aware of the risks of loosing its users – their most important asset. Since Facebook’s business model is based on mining data, issues surrounding privacy may rise as the company becomes more aggressive and pays more attention to its bottom line.

By Luiz Augusto Buff