Why is Facebook worth more than Yahoo?


Mike Arrington at TechCrunch published a ‘valuation metrics’ for social networks yesterday. Read the whole article here.

What struck me is that somehow Facebook seems to be getting a significantly higher valuation than companies with comparable business models, for example Yahoo. How can that be right?

Let’s take a step back and think this through. The valuation of a company corresponds to its ability to generate revenue, to do so profitably, being able to grow fast and have a high probability that the revenue is not going to dry up soon. All this depends on a company’s business model.

As far as I am aware, there are only a few ways in which you can generate revenue on the Internet. Each of these revenue opportunities converts usage into money. Different business models are doing so at different rates:

Business Model

…version with notes:

Business Model

Using this (admittedly very rough) estimate, we see that Search is a superior business model in terms of converting traffic into revenue.

Taking a cut of a real world transaction (eBay) also converts traffic well into cash.

Premium subscription and advertising work equally well, both at some 1/3 of the efficiency as Search.

Back to the original question: how is Facebook running a different business to Yahoo and why should Facebook be able to command a premium valuation above and beyond of Yahoo’s? They are both mainly display advertising-based businesses.

At best, Facebook can command a valuation that is in line with what companies like Yahoo can command. I have read many reviews where people criticised Facebook’s advertising programme, but let’s leave that aside for the moment.

Yahoo’s market cap today is some $30bn. If we (roughly) attribute half of that to its search business and overseas activities, then the market cap based on US display advertising would be roughly $15bn. If Facebook can generate some ¼ of Yahoo’s traffic, and if it has some 50% efficiency of converting traffic into revenue, then it should have some 1/8 of Yahoo’s value. (Maybe slightly higher, if you take into account that Facebook is growing rapidly. Maybe slightly lower, if you take into account that Facebook is not profitable.) Let’s say that is $2bn.

Unless Facebook (or any of the other social networks for that matter) can come up with a better way than display advertising to monetize its traffic, then the way in which it should be valued shouldn’t really be different from the way in which Yahoo is valued.

What is remarkable about Facebook is not its amazing ability to convert its traffic into revenue (it is not a Google). What is amazing is how quickly it managed to grow its traffic. It grew from nothing to 35 million users in four years. Now that is amazing and that is the real strength of social networking. You can grow a great business in a very short period of time. But the monetization is still dependent on the display advertising business model. I guess you can’t have it all.

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Don’t compete with Google where it is strong

Many start-ups are trying to usurp Google, over 1,000 in fact. In my view, most of them are likely to fail, because they don’t really add that much value. Here is why I think that.

Google (and live.com and Yahoo! Search, and ask.com) all fundamentally answer the same question a user has: “Where can I find…” This is very important. With Google, you fundamentally ask the question of “show me the most relevant websites where I can find the following keywords”. The vast majority of search start-ups out there do the same thing, to answer where you can find information. They just try to do it better. Frankly speaking, this is a lost battle. In order to take any significant market share, you would have to do significantly better than Google. That is a very hard thing to do. So, why bother?

I think a much better way of looking at this space is not to address the where question, but a different one. For example: “How do I…” Here, the user doesn’t want to know where to find information on a keyword, but wants an answer to a specific question. For example how to file a tax return. There is one company in this space that is doing well, it is called Mahalo. Jason Calacanis at Mahalo seems sometimes amazed about how much traffic the ‘how to’ pages at Mahalo get. To me, this makes a lot of sense. Human editors are very good at processing slow-moving content where insight is required. ‘How to’ matches that very nicely. Even I started using Mahalo for ‘how to’ questions, it actually works quite well. Have a look at the compete stats to see how much traffic they get overall.


I think there are many other questions search engines can answer. For example, you could ask “How good is X”. For example, I am convinced a review aggregation search engine would do extremely well. I cannot remember how many times I have typed in the name of a product and ‘review’ just to get to all the crap sites out there that list where I can buy stuff, when all I want is to see all the reviews on a product, regardless of where they originate from. How hard can it be to aggregate reviews from some 1,000 leading sites and to display that on a central site with back-links to the original sites? Some start-ups like testseek reevoo or buzzillions are going in this direction, but I think they don’t go far enough.

UPDATE: I forgot to mention the “What is…?” question. That has been covered by Wikipedia. Very difficult to compete with that.

I am sure there are many other examples out there that can work. In my mind, when you try to build a new search engine, don’t ask yourself how you can make the where answer better, rather ask what other questions would be really valuable that Google cannot answer.

The best way to compete is to not compete. Particularly not with companies like Microsoft or Google.

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