How Facebook Makes Money

Facebook made more than $40 billion in revenue in 2017, approximately 89 percent of which came from digital advertisements. The company announced second-quarter earnings on July 25, 2018, reporting $13.2 billion in revenue. Alongside Alphabet Inc. (GOOG), Facebook has emerged as one-half of a dominant duo in the digital advertising game. But unlike its rival, which allows advertisers to connect with consumers through keyword searches, Facebook generates revenue primarily from targeted advertising and user data.

Hold on a second, user data? That's right. In a series of scandals dating back to March 2018, Facebook has compromised user data, privacy, and security by granting multinational companies access to the personal information of its users. Most recently, The New York Times reported that Facebook gave several multinational companies the ability to access users' contact information, private messages, and friend lists. The companies include: Netflix (NFLX) and Spotify, which had access to users' private messages; Altaba (formerly Yahoo!) (AABA), which had access to the content published by a user's friends; Amazon (AMZN), which had access to the names and contact information of a users' friends; and Microsoft (MSFT), whose Bing search engine had access to the names on virtually every Facebook user's friends list. The exchanges took place as recently as last summer, which contradicts prior statements made by Facebook that the company had stopped selling access to user data years ago.

Advertisers can use the wealth of personal data about users from Facebook's product ecosystem for ads. For its part, the Menlo Park, California-based company claims that it makes the data anonymous and serves the information to advertisers in custom demographic buckets. Advertisers can further slice and dice the buckets based on their branding goals. They can serve up custom ads to Facebook users from specific income groups or regions, and target users based on other categories, such as sexual orientation, religion or political affiliation. Facebook has developed a broad variety of ad products for different stages of the branding lifecycle.

For example, its Facebook Dynamic Ads product enables advertisers to upload their entire product catalog and target customers at specific income levels. Similarly, its Lead Ads offering help advertisers in lead generation. These products have cemented Facebook's position in digital ads. While newer companies such as Snap Inc. (SNAP) are expected to garner substantial market share in the future digital ad market, Facebook's earnings suggest that it will remain a dominant player for years to come.

The company is preparing for the future by broadening its revenue canvas. It has emphasized videos and live broadcasts from its Facebook Live platform in its earnings calls in recent quarters. According to the company, the daily watch time for Facebook Live broadcasts has grown by more than four times in the past year. The social media giant has also inked deals with content creators to further promote video.

Another emerging area of growth for Facebook is its messenger service, which has recently begun displaying ads. According to Facebook CEO Mark Zuckerberg, the service's direct chat feature, which enables customers to chat directly with advertising businesses, already saw more than 2 billion messages being exchanged between users in the fourth quarter of 2017. Extending its influence in the sphere of messaging and chat, in 2014, Facebook purchased the popular messaging app WhatsApp for $21.8 billion. 

Facebook also has invested in emerging technology trends for future growth. "Over the next 10 years, we are developing consumer use cases around technology that are a big part of our future, but won't be a big part of our business for a long time," Zuckerberg said during the social network's first-quarter earnings call of 2017. Included among these use cases is virtual reality and bringing internet to parts of the world without connectivity. Again, these initiatives translate into future sources of revenue for Facebook, as more internet connections translate to greater usage and revenue.

It's hard to be sure how much money Facebook makes from user data because targeted advertisements, by definition, show users relevant ads by using their data. But in March 2018, the now infamous Cambridge Analytica scandal revealed that Facebook had been making money from user data far more directly than imagined.

On March 17, 2018, the Guardian and The New York Times reported that the data of approximately 87 million Facebook users had been exposed to hackers. The data breach is expected to have far-reaching consequences on Facebook’s revenues and the cost of doing business. 

Regulation and user concerns will likely drive up Facebook's costs of capital. In the testimony leading up to his April 11, 2018 Senate hearing, Zuckerberg said that the company was building new technology and “significantly” increasing its investment in security. “I’ve directed our teams to invest so much in security — on top of the other investments we’re making — that it will significantly impact our profitability going forward,” he said. 

Revenues from Facebook’s two largest markets – North America and Europe - are expected to be affected as a result of the fallout from the Cambridge Analytica scandal. Both are extremely lucrative markets for Facebook. In 2017, Facebook earned an average of $84.41 from each North American user and $27.26 from each user in Europe. In contrast, each user in Asia was worth $7.61. 

But the scandal is expected to have an adverse impact on Facebook’s revenue in its two biggest markets in two ways. First, advertiser concerns might lead them to pull out ads from Facebook’s plan and result in an overall decline in revenue per user. Second, the social media network’s revenues could take a hit in Europe due to new regulation. The General Data Production Regulation (GDPR), which requires that Facebook obtain user consent for their data, in Europe will result in a 7 percent decline in its revenue, according to Goldman Sachs. 

The good news for Facebook investors is that the company is making significant inroads into new markets, such as Africa and Asia. While these international revenue sources may not contribute much to the company's overall revenue, WhatsApp has become a runaway hit with users in Asia and South America. Other services such as Instagram, are also providing the company with inroads into new markets.