Facebook’s profits grew at an impressive clip over the past five years. But sales growth slowed in the first quarter of 2012 and earnings dipped – a bad sign?

Facebook Advertising Not Yielding a Return on Investment

A Reuters/Ipsos poll  found that

  • 4 out of 5  Facebook users say they have never bought a product or service as a result of advertising or comments on the site.
  • 34% of Facebook users are spending less time there than six months ago.
  • Only 20% are spending more time there.

The most frequent Facebook users are aged 18 to 34, according to the survey, with 60% of that group being daily users. Among people aged 55 years and above, 29% said they were daily users.

Of the 34% spending less time on the social network, their chief reason was that the site was “boring,” “not relevant” or “not useful”. Privacy concerns ranked third.

Experts say the website needs to do much more if it is to succeed in turning its 900 million users into advertising dollars. According to  eMarketer analyst Debra Williamson:

“It shows that Facebook has work to do in terms of making its advertising more effective and more relevant to people.”

GM agrees. In May, just before Facebook’s IPO, GM, America’s third largest advertiser, announced they were pulling $10 million in advertising from Facebook, having judged that it had little impact in reaching consumers. GM will continue to use Facebook platform to promote its vehicle brands, including a $30 million operating budget for content creation and management.

Rob Enderle, an analyst with Enderle Group criticizes:

“I have never felt that [Facebook] had an advertising model that would generate benefits for advertisers,”  I think the advertisers will eventually figure out that they’re not getting a return from their advertising, so like General Motors they’ll pull out. GM was the early warning here.”

Why Facebook Isn’t Yet Paying Off

1. Insufficient Metrics: Larry Chiagouris, a marketing professor at Pace University’s Lubin School of Business points out that when you are only trying to influence future purchases by promoting a brand, gauging the effectiveness of an advertising campaign is difficult.

2. Insufficient Engagement: Chiagouris pointed out that engagement is insufficient for two reasons, and, “when you put these two problems together, the results of this survey are not surprising. In fact, I’m surprised it’s not higher. I would have said nine out of 10.”

  1. Despite having 900 million users, a significant number open accounts and don’t use them.
  2. The medium distracts the user from commercial messages:

“The truth is to be successful you have to engage consumers, but the problem Facebook faces is when people go on the site they are either uploading their own content or looking at what their friends and family are doing, and so they’re not paying attention to any commercial messages.”

Advice to Marketers and Investors: Don’t Invest Yet

Chiagouris  thinks Facebook is a “wonderful” service with a strong future that has managed to build a community of millions online. But he advises that it is not quite ready for investors and marketers to invest heavily just yet:

“When you hear about a major sophisticated marketer announcing a large investment in Facebook, that would be a sign that it’s a meaningful digital property to invest in,” he said. “But they’re not there yet.”

Analysts also think Facebook will face difficulties deriving revenue from the growing number of Facebook users who access the site using mobile devices, through which Facebook derives much less advertising revenue than through a desktop PC. Facebook rivals Google and Apple currently dominate the mobile arena.

These findings underscore investors’ worries about challenges Facebook faces creating revenue that pushed the stock down 29% since its initial public offering a month before, which reduced its market value by $30 billion to roughly $74 billion. Shares of Facebook were lately down 2 percent at $26.36. Facebook’s $16 billion IPO, one the world’s largest, made the U.S. company founded by Mark Zuckerberg the first to debut on markets with a capitalization of more than $100 billion.

Critical Challenges Ahead

Ad Revenues Critical: Facebook warned in a regulatory filing for its IPO that it obtains “a substantial majority” of its revenue from advertising, and that “loss of advertisers, or reduction in spending by advertisers with Facebook, could seriously harm our business.” In fact, revenue from advertising represented 85% of its overall revenues of $3.71 billion in 2011. While Facebook generated $3.7 billion in revenue last year, mostly from ads on its website, sales growth is slowing.

Fierce Competition: Facebook also faces stiff competition online from entrenched Internet powerhouses like as Google. Actually, Facebook owes a large part of its success to Yahoo’s bad business moves. Yahoo created Yahoo Groups to build communities online, but it failed to focus there when it decided to compete with Google instead. They failed, and this left an opening for social media sites like Facebook to erode its dominance. Enderle warns:

“If Facebook doesn’t do something to get the value to advertisers up, and to improve the value users get from Facebook, they could become another Yahoo, or a shadow of their former self,” he said. The reality is [Facebook] is not in the social networking business, it’s in the advertising business, and not developing skills in the area that makes you money is just silly.”

Facebook Fatigue: Gartner analyst Ray Valdes commented:

“Keeping users coming back is crucial for all social media services. Facebook continuously has the challenge of Facebook fatigue, of the novelty factor wearing off, and therefore they have to introduce new kinds of interaction.” He cited new features such as the “Timeline” interface and the planned $1 billion acquisition of mobile photo-sharing app Instagram.

Smartphone Advertising Glitch: Increasing use of smartphones to access Facebook has been a drag on the company’s revenue, since Facebook offers only limited advertising on the mobile version of its site. Analysts say the company has yet to figure out the ideal way to make money from mobile users.

Facebook’s Response

Facebook referred to case studies of companies such as Nutella, which found that a 15% increase in sales was attributable to Facebook, and restaurant chain Applebee’s, whose Facebook ads delivered a threefold return on investment. And GM rival, Ford Motors, plans to continue advertising on Facebook as a growing and important part of their media strategy.

Facebook is still perfecting the effectiveness of its ads, but the potential is tremendous. Google, the world’s No. 1 web search engine, generated roughly $38 billion in revenue last year. Google’s search ads, which appear alongside the company’s search results, are considered among the most effective means of marketing.

Related: Analysts wonder how low Facebook shares will go

Snap! principle of online advertising:

Put your money where the metrics can show the most impact.