Facebook Credits: a shaky media platform

Apart from Facebook insiders, who stand to become fabulously wealthy when shares of the company formally start trading sometime in May, no one was happier to see the social network’s IPO registration statement on Wednesday than the folks at Zynga.

Back in December, when Zynga was preparing for its own IPO, it revealed that 95 percent of its revenue comes through the sale of virtual goods on Facebook using Facebook Credits, making the social game developer dangerously dependent on a single business relationship.

With the release of Facebook’s red herring, we now know the embrace is mutual. Sales of virtual goods in Zynga games account for 12 percent of Facebook’s total revenue and its only meaningful nonadvertising revenue stream. For now, at least, Facebook can no more quit Zynga than Zynga could quit Facebook.

The relationship points to Facebook’s limits as a monetizeable platform for other content owners, at least in the near term and to the risks Facebook faces as it tries to become a major media platform.

Facebook makes money off Zynga by taking a 30 percent cut of the revenue the game developer earns from the sale of virtual goods in FarmVille, CityVille and its other properties. Users purchase those goods using the social network’s virtual currency, Facebook Credits. Currently Facebook requires that in-app purchases for all apps classified as games be made using its Facebook Payments system.

According to the S-1, Facebook “may seek to extend the use of Payments to other types of apps in the future,” including, presumably, other types of media apps. For a startup like Zynga, which creates apps expressly for the Facebook platform, the 30 percent revenue share requirement is a price worth paying for access to the Facebook platform. For more established media companies, however, the mandatory use of Facebook’s in-app Payments system could be a red flag, just as a similar requirement by Apple has been for many content owners.

For the release on Facebook of Abduction, for instance, the first Hollywood movie to be made available for rent on the social network the same day it appeared on DVD and Blu-ray, Lionsgate avoided using Facebook Credits, choosing credit cards and PayPal as payment options instead. If other media companies follow Lionsgate’s lead, the direct purchase and rental of media content may not develop into as significant a revenue stream for Facebook.

Facebook itself, in fact, seems ambivalent about expanding the use of Facebook Credits beyond in-app virtual goods to the purchase of real goods and services, which would subject the company to myriad laws and regulations covering money transmission, electronic funds transfers, anti-money laundering, gambling, banking and lending, import and export restrictions, and the sale of gift cards and other prepaid instruments. In its S-1, Facebook notes that it has applied for “certain money transmitter licenses and expect to apply for additional money transmitter licenses in the United States.” But it warns, “Our efforts to comply with these laws and regulations could be costly and result in diversion of management time and effort and may still not guarantee compliance.” Failure to comply could subject the company to “monetary fines or other penalties such as a cease and desist order, or we may be required to make product changes, any of which could have an adverse effect on our business.”

One area where the use of Facebook Credits for purchases and rentals could add real value for content owners is overseas, because they act like a global currency. Miramax, for instance, is experimenting with the use of Facebook Credits to rent movies through its Miramax eXperience Facebook app in the U.K., Turkey, France and Germany. At the Streaming Media West conference in November, Miramax’s senior VP of strategy and business development, Mitzi Reaugh, told me the studio sees a significant potential upside in using Facebook Credits over currency conversions, to shield the money from fluctuations in currency values.

How far Facebook is willing to go to expand the use of its Payments system internationally, again, is unclear. Doing so would subject the company to additional regulations and potentially conflicting regulation in multiple jurisdictions, as well as international trade bodies, significantly increasing its compliance costs and risks. While Facebook’s mining of users’ data to sell advertising has also come up for scrutiny by regulators around the world, ad sales represent 85 percent of its revenue, making the cost of compliance with privacy rules a better investment at this point.

With a global, socially networked user base of 845 million, Facebook obviously has the potential to become a major distributor of paid premium content. Whether and when it realizes that potential, however, will depend on how quickly it puts in place the monetization tools content owners need and its own appetite for the costs and risks associated with becoming a full-fledged media platform. This week’s IPO registration filing does more to raise those questions than to answer them.

Question of the week

Should Facebook prioritize developing its platform or should it concentrate on ramping up ad sales?