social commerce,gs,dec 2010

8/3/2019 Social Commerce,GS,Dec 2010

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December 8, 2010

Equity Research

Social networks vie with search engines to drive e-commerce

Global e-commerce may triple to $3 trillion by 2020E

We expect global e-commerce activity to grow from about $1 trillion in

2010 to about $3 trillion, or 14% of retail spending, in 2020. While e-

commerce companies themselves (such as Amazon) and search engines

(such as Google and Baidu) should benefit, we also expect social networks

(such as Facebook) to tap into the resulting advertising opportunity.

Social networks compete with search engines as traffic drivers

We believe that search engines direct consumers to commerce via the

wisdom of crowds; social networks via the wisdom of friends; and e-

commerce sites via the wisdom of prior shoppers. We assume search

engines and social networks will increasingly compete for consumers

attention, and thus for advertiser budgets.

Facebook to take share of contextual and performance advertising

We do not expect Facebook, or Facebook-plus-Bing, to develop a more

popular search engine than Google. However, we believe Facebook may

seize substantial market share from Google in contextual advertising,

which is 15% of Googles gross revenue, given Facebooks user profile

knowledge. Facebook may also pick up limited share from search engines

in performance advertising, given that Facebook is now 4%-9% of

upstream traffic to major e-commerce sites (up from 2%-4% in 2009).

We estimate Facebook will generate about $15 bn revenue in 2015

We forecast Facebook growing revenue from over $1 billion in 2010 to

about $15 billion in 2015, making it more than twice the size of Yahoo!

today, and around half the size of Google today. We estimate that about $3

billion of Facebooks revenue could be indirectly at the expense of Google,

reducing Googles revenue by 5% versus what it might otherwise achieve.

Social networks moderately important traffic drivers in AsiaPre-Facebook social networks (Tencent, Mixi, Cyworld) drive about 4% of

traffic to e-commerce sites in Asia, but focus on user micropayments rather

than e-commerce or advertising for revenue generation.

AMERICAS: RETAIL: RETAILERS DREAMING OF ADOTCHRISTMAS DECEMBER 6

Americas: Technology: Internet: Takeaways from our

e-commerce holiday trends conference call November30

Americas: Retail: GS/ICSC Annual Survey suggestsaccelerating sales into Holiday November 22

Amazon (Buy): Amazon expands presence in baby-care andconsumer products November 08

Amazon (Buy): Probably a 30-something not 20-somethingrevenue grower in 2011 October 22

Google (Buy): Deeper into display October 18

VALUATION AND KEY RISKS

Our 6-month, DCF-based target price for Google is $700,equivalent to 21X our 2011E EPS and 18X our 2012E EPS.Key risks include competition from Microsoft and Facebook.

James Mitchell, CFA

(212) 357-1849 [email protected]

Goldman Sachs & Co.

Ingrid Chung(212) 902-2360 [email protected]

Goldman Sachs & Co.

Adrianne Shapira


Goldman Sachs & Co.

Jordan Monahan


Goldman Sachs & Co.

Fred Krom


Goldman Sachs & Co.

Scott Kaufman-Ross


Goldman Sachs & Co.

The Goldman Sachs Group, Inc. does and seeks to do business with companies covered in its research reports. As a result, investorsshould be aware that the firm may have a conflict of interest that could affect the objectivity of this report. Investors should consider thisreport as only a single factor in making their investment decision. For Reg AC certification, see the end of the text. Other importantdisclosures follow the Reg AC certification, or go to www.gs.com/research/hedge.html. Analysts employed by non-US affiliates are notregistered/qualified as research analysts with FINRA in the U.S.

The Goldman Sachs Group, Inc. Global Investment Research

dotCommerce:

Social networks


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December 8, 2010 Americas

Goldman Sachs Global Investment Research 2

Contents

dotCommerce a $3 trillion global opportunity 2The wisdom of crowds, friends, and the interested 3Wisdom at work, and differing wisdoms in conflict 5We expect Facebook may challenge Google in two of the three ways that Google currently dominates the Web 6Existing Facebook revenue streams O&O branded revenue and micropayments 14Financial implications for Facebook, and for Google 15What could Google do to avert the Facebook threat? 18

dotCommerce a $3 trillion global opportunity

We estimate that global retail spending is about $20 trillion per year. Based on theexperiences of individual categories (such as books, which are about 25% sold online in

developed countries prior to the arrival of e-books) and individual countries (such as Korea,

where about 15% of retail spending is online in 2010), we believe that about 15% of retail

spending will have moved online in the next 5-10 years, for an approximate $3 trillion

revenue opportunity (see Exhibit 1).

Exhibit 1:We see global e-commerce sales surpassing $3 trillion by 2020$ millions and % of total

Source: Company data, Department of Commerce, Erwin, IDC, US Census, Goldman Sachs Research estimates.

While we see retailers, e-tailers and marketplaces as the largest and most direct

beneficiaries of e-commerce activity, they operate in a fragmented environment we

forecast the top three e-tailers and marketplaces possessing only 14% share of an

approximately $1 trillion e-commerce market in 2011. By contrast, we forecast a $40 bn

paid search market in 2011, but estimate that the top three search engines will possess 89%

market share. Furthermore, whereas e-tailer operating margins are typically in the high

single digits, advertising media operating margins both offline and online are typically in

the 20%-40% range.

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The wisdom of crowds, friends, and the interested

We see at least three Internet services that influence where a consumer shops online:

The wisdom of crowds search enginesConsumers may simply decide that wherever other people shop, they should do so too,

even if the other people are unknown to them. In the offline world, this is common

behavior at venues such as restaurants. Search engines such as Google are the purest

online expressions of this wisdom, as they look at where other people have clicked and use

that information, along with other tools, to rank responses to queries.

Advantages of search engines for determining where to shop include their ability to

capture the broadest range of data points.

Disadvantages of search engines include the fact that other shoppers may differ from

the current shopper in terms of nationality or income or interests.

Also, search engines have historically performed poorly at distinguishing good publicity

from bad publicity, as they give more weight to sites with many inbound links, even if

those links are critical. The New York Timesran a story about an eyeglasses e-tailer,

DecorMyEyes.com, whose owner boasted online that customer complaints improved his

Google ranking and thus his sales. (See A Bully Finds a Pulpit on the Web, November 26,

2010.) Google and some other observers attributed DecorMyEyes.coms success to other

factors, such as Search Engine Optimization tools.

For local results, Google provides a star-ranking system next to the listing that could

alleviate this issue (see Exhibit 2), but we believe sites that attract heavy commentary,

positive or negative, may still appear high up in search engine listings. Google has recently

addressed the above example via an adjustment to its algorithmic engine, but admits the

solution may be imperfect.1

1Being bad to your customers is bad for business on Googles official blog at

http://googleblog.blogspot.com/2010/12/being-bad-to-your-customers-is-bad-for.html.


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Exhibit 2:Google now incorporates local store listings and reviews within search results

Source: Google.

We believe that search engines are particularly useful at facilitating online shopping for:

Consumers deciding to purchase a commoditized product.

Consumers who are not sure which websites might stock a particular product, such as

an unbranded article of clothing.

The wisdom of ones friends social networks

Testimonials from friends, and the company of friends, often determine where consumers

shop and what they purchase. Social networks such as Facebook are developing tools that

facilitate purchase decisions based on friends recommendations.

Advantages of social networks include the trust people place in friends

recommendations because they know friends preferences.

Disadvantages of social networks include the fact that most people have a limited

number of friends (Facebooks average user has 130 friends) whose opinions they

respect, of whom only a limited subset may be relevant for any given purchase.

Social networks could theoretically work around the limited-number-of-friends problem by

enabling recommendations from ones friends-of-friends as well as ones friends, but we

believe such behavior largely dissipates the benefits of trust, and therefore defeats thepurpose of using a social network versus a search engine.

We assume that social networks are particularly useful at facilitating online shopping for:

Consumers going through a universal lifestyle change, such as new mothers looking to

purchase diapers for the first time, or young adults leaving college to start work.

Consumers looking to buy a product that fits in with products owned by friends,

such as a teenager buying skincare products, or an adult choosing a mobile phone

carrier on the basis of friends belonging to the same network.


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The wisdom of the interested recommendation engines

The views of other consumers who are not personally known to the shopper but who have

purchased similar items can be particularly helpful. These views are not usually available in

the offline world, except through specialist publications such as the Zagat Survey for

restaurants. E-commerce sites such as Amazon make recommendations to consumers

based on what other consumers who purchased the same products subsequently bought

too, supplemented by purchaser reviews.

Advantages of recommendation engines include:

- The ability to recommend products based on actual interest areas rather than

what ones friends or the world at large like.

- The capacity to highlight products that a consumer did not know were

available.

- The fact that reviewers are typically knowledgeable about the subject matter.

Disadvantages of recommendation engines include dependence on a relatively limited

number of reviewers, often with vociferous feelings on certain topics. For example,

several PC games that achieved high scores in Metacritic, a game review site, receivedlow scores on Amazons ranking system due to reviewers objecting to the games anti-

piracy features.

We believe that e-commerce recommendation engines are particularly useful at facilitating

online shopping for:

Consumers interested in a niche media topic, such as books on jazz or movies about

warfare.

Consumers who own a product that benefits from purchasing ancillary products, such

as a swimming pool and swimming pool cleaning equipment.

Wisdom at work, and differing wisdoms in conflict

Search engines and e-commerce sites have happily coexisted

Many consumers rely on search engines and recommendation engines together to

navigate online purchasing.

Signs of tension between search engines and social networks

We believe conflicts between the different finding methods will grow over time given:

The emergence of Facebook is propelling social networks to a more central e-

commerce role, and we believe consumers will generally use a search engine or a

social network, but not both together, when deciding where and what to purchase.

Search engines are moving downstream into roles traditionally fulfilled by e-

commerce companies, such as aggregating air ticketing data or selling discount

coupons.

E-commerce sites have developed tools to retain consumers within their sites. For

example, a consumer who wants to buy books may always go straight to Amazon

because they have paid for a Prime subscription, or a consumer who wants to buy

vacations may always go straight to Expedia because they have joined the companys

loyalty program.


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Google and Facebook increasingly competitive

Google and Facebook appear set on expanding into each others territory:

Google is trying to move closer to the social graph via initiatives such as Google Wave,

and to move closer to the transaction via initiatives such as Product Listings. Google

has also signaled a less cooperative relationship with Facebook by preventing Gmail

users from automatically uploading their Gmail contact lists into Facebook.

While we expect Facebook to rely on Bing rather than develop a standalone search

engine, we think that Facebook will increasingly seek to differentiate Bing through

creative use of Facebooks social graph information.

Facebook has launched an e-mail service that competes with Gmail, as well as other

mail services, such as those from Yahoo!, AOL, and MSN.

Google and Facebook have noted that the two can be complementary, citing Facebook as a

major traffic driver to Googles YouTube site. However, we estimate that YouTube

generates less than 4% of Googles gross revenue, and believe that the broader theme is

one of competition rather than cooperation.

Amazon and eBay seeking to leverage Facebook

In comparison, the major e-commerce sites appear to enjoy a more complementary

relationship with social networks. For example:

Amazon recently launched an integration service with Facebook, which:

o Provides media (books, music, movies) recommendations based on ones

Facebook profile.

o Highlights friends upcoming birthdays, and enables one to see friends

Amazon Wish Lists, to encourage birthday presents.

o Explores friends profiles to look for similar interests.

o Does not share purchase history or account information.

eBay provides a Group Gifting service with Facebook, which designates one person

as the organizer to choose a gift, and invites others to contribute funds.

A question which we discuss in more detail below is whether e-commerce companies will

not only launch integrated services on social networks, but also shift advertising spend

from search and toward social networks.

We expect Facebook may challenge Google in two of the three

ways that Google currently dominates the WebGoogles centrality to the World Wide Web and sector-leading profitability flow from three

factors, in our view.

The status of Google as the dominant search engine.

The status of search engines as the dominant means of navigating the Web. While this

statement may appear tautologous, directories such as Yahoo! represented the

dominant means of navigation during the 1990s.

The status of Google as the dominant provider of contextual advertising on third-party

websites.


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While the three factors are somewhat linked (Googles leadership in search provides it with

relationships with advertisers which in turn help it succeed in contextual advertising), they

are also somewhat discrete, and we believe Facebooks threat to Google will vary by factor.

A. We do not expect Facebook to challenge Google in search

We see limited risk of Facebook disrupting Googles search business directly given:

Googles competitive advantages in search arise due to its infrastructure capacity

(bandwidth and servers enable fast delivery of results), algorithmic expertise (honed

over years), and traffic lead (which informs Google which results to serve up).

Persistent consumer willingness to use one service for search and another for social

networking, which we have observed not only in Google-dominated markets but also

in non-Google, non-Facebook markets such as Russia and China.

We see moderate risk that Facebook providing Bing with user information will help Bing

pick up some search share at Googles expense. In November 2010, Bing disclosed that it

would use Facebooks data feed for Bing users signed into Facebook to:

Highlight search results that ones Facebook friends have liked. Because the average

user possesses 130 Facebook friends, and because only a minority of friends might

like products within each category, the number of queries which benefit from this

feature could be small.

Improve the relevance of results for people searches. Such searches account for

about 4% of Bings queries.

We view these features as incrementally positive for Bings search traffic, and thus

negative for Googles, but not as major share-shifters given their limited-use cases, and

given Googles incumbency and brand advantages.

B. We expect Facebook will take share from Google in contextualadvertising

Contextual advertising = brand advertising based on website content

Googles AdSense for Content service enables advertisers (initially small advertisers who

belonged to its AdWords search program) to run contextually relevant advertisements on

websites enrolled in Googles AdSense affiliate network. For example, an online retailer of

dog food might advertise dog food on blogs about dogs. Google pays out 68% or more of

the advertiser revenue to the websites where the ads appear. We estimate AdSense for

Content accounts for around half of Googles network revenue, or about $4 billion in 2010,

and that listings were historically the majority of this revenue, with display ads catching up.

By these estimates, contextual ads generate about 15% of our forecast $26 billion in total

non-search online advertising in 2010 (see Exhibit 3).


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Exhibit 3:We estimate around $26 billion in global non-search online advertising in 2010E$ millions

Source: Company data, Erwin, IAB, IDC, Universal McCann, US Census, Goldman Sachs Research estimates.

We believe Facebook is well-positioned to compete in contextual advertising because:

We estimate Facebook already serves over $1 billion per year of contextually relevant

advertisements onto consumers profile pages within Facebook, providing it with atechnology and advertiser base that it can easily extend to affiliate websites.

Facebook possesses information about Internet users based on their Facebook

disclosures, which can then be used to better target advertisements on affiliate

websites. Whereas Google might serve the same clothing ad to all visitors to a college

sports blog, Facebook could potentially serve college-specific clothing ads based on

the schools attended by its users. Facebook currently allows advertisers to target users

on the basis of: location, age, birthday, gender, keywords in profile information (such

as job title), education, workplaces, relationship status, language, and connections.

Financial assumptions: We estimate Facebook could achieve $3 billion contextualrevenue in 2015

Assuming Facebook starts serving contextual ads onto third-party sites during 2011, weestimate it might serve $300 million of ads in 2011. By 2015, we forecast total worldwide

contextual advertising at $9 billion, Facebooks share at $3 billion, and Googles share at $6

billion (see Exhibit 4).

Exhibit 4:We expect around $9 bn in total contextual advertising in 2015, with Googlecapturing around $6 bn (two-thirds) and Facebook generating around $3 bn (one-third)$ mn

Source: Company data, Goldman Sachs Research estimates.

2009 2010E 2011E 2012E 2013E 2014E 2015E

Worldwide online advertising 45,869 57,691 68,510 79,495 90,505 101,750 113,111

Year-over-year growth 1.0% 25.8% 18.8% 16.0% 13.9% 12.4% 11.2%

Worldwide search/performance advertising 26,426 31,456 37,393 42,925 48,673 54,793 61,541% of WW online ad 57.6% 54.5% 54.6% 54.0% 53.8% 53.9% 54.4%


Worldwide display & other advertising 19,443 26,236 31,117 36,570 41,832 46,957 51,570

% of WW online ad 42.4% 45.5% 45.4% 46.0% 46.2% 46.1% 45.6%


0

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Contextualadrevenu

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Google Facebook


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Googles minimum TAC on AdSense for Content today is 68% (to the website owner), and

we assume its average TAC is 75%, so that its net AdSense for Content revenue is about $1

billion in 2010E. If Facebook offers 85% TAC and some websites move from Google to

Facebook, Google might also need to pay a higher TAC. Google has historically paid lower

TACs than competitors but still delivered superior net revenue to websites because Google

served the most relevant ads from the largest number of advertisers; we assume that

Facebook could fully compete on relevance given its knowledge of user behavior.

We estimate that AdSense for Content is thus 5% of Googles net revenue in 2010, and

could be rather flat between 2010 and 2012. We view a period of no growth for 5% of net

revenue as not very material fundamentally for a company otherwise growing overall net

revenue 15%-20% per year, but are concerned investors could react adversely given that:

Investors may extrapolate Facebooks ability to challenge Google in contextual

advertising across to Googles core search business.

Investors reacted poorly to Googles withdrawal from in-China search provision, which

we estimate was a smaller business than AdSense for Content display.

C. We believe Facebook may develop into another web nexus

Yahoo!, the largest and most profitable online advertising company prior to the advent of

Google, was originally called Davids and Jerrys Guide to the World Wide Web. Google

pushed ahead of Yahoo! not by developing a better directory of interesting web sites, but

by providing a more-popular means than the directory for consumers to find web sites.2

Similarly we think the risk that Facebook poses is not that Facebook develops a better

search engine, but that Facebook provides a more-popular means than the search engine

for consumers to find certain categories of web sites. See Exhibit 5.

2A website from 2002, http://www.haystackinaneedle.com/faq/faq_directories.htm, explainsdifferences between directories and search engines, and recommends that advertisers pay $299 per

year to be included in the Yahoo! directory. It poses the Frequently Asked Question: Is it worth paying

$299 to submit my site to Yahoo? and responds For most sites, Yahoo delivers over 15% of the sites

traffic, so a better question is Can I afford not to submit my site to Yahoo?, before noting as an after-

thought that emergent search engines such as AltaVista do not require submission payments.


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Exhibit 5:Facebook has increased its share of traffic sent to major e-commerce sites,though not at the expense of GoogleGoogle and Facebook share of global page views, and as sources of traffic to selected websites(US data only)

Note: YoY changes rounded.

Source: comScore.

1 - Embedded web sites

We believe that certain sites will naturally derive substantial proportions of their traffic

from Facebook because they exist in a mutually-beneficial relationship with Facebook. For

example:

We view Zynga as effectively embedded because many consumers play Zynga games

on Facebook.

Global page views Global unique users

Oct-10 Oct-09 YoY Oct-10 Oct-09 YoY

Percentage of total

Google sites 10% 10% -1% 75% 75% 0%

Facebook 9% 6% 4% 49% 36% 12%

Google Facebook

Oct-10 Oct-09 YoY Oct-10 Oct-09 YoY

Embedded sites

Twitter 13% 14% -1% 26% 11% 15%

Youtube 13% 16% -2% 20% 8% 12%

Zynga 2% 2% 0% 51% 70% -18%

Average embedded 10% 11% -1% 32% 30% 3%

Informational sites

CNN 15% 14% 2% 8% 6% 2%

Digg 23% 31% -8% 6% 4% 2%

NYT Digital 28% 32% -4% 3% 2% 1%

Wikimedia 49% 48% 1% 4% 2% 2%

WSJ Online 20% 19% 2% 3% 3% 0%

Average informational 27% 29% -2% 5% 3% 2%

E-commerce sites

Amazon 20% 20% 0% 8% 2% 6%

Best Buy 17% 17% 0% 4% 2% 2%

eBay 11% 12% 0% 5% 3% 2%

eHarmony 9% 7% 2% 8% 5% 3%

Fandango 21% 20% 2% 6% 4% 2%

Netflix 12% 11% 1% 9% 4% 5%

Rue La La 14% 7% 7% 7% 4% 3%

Zappos 22% 18% 4% 5% 1% 3%

Average e-commerce 16% 14% 2% 6% 3% 3%

Online travel sites

Expedia 13% 15% -1% 2% 1% 1%

Kayak 11% 8% 2% 3% 1% 2%

Orbitz 13% 12% 1% 3% 1% 1%

Priceline 9% 10% -1% 2% 1% 1%

TripAdvisor 27% 21% 6% 2% 1% 1%

Average online travel 14% 13% 1% 2% 1% 1%


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We view YouTube as somewhat embedded because many consumers link to YouTube

videos on their Facebook profile pages.

We view Twitter as somewhat embedded because many consumers link their Tweets

to their Facebook profile pages.

2 - Informational web sitesFacebook has become an increasingly important supplier of traffic to informational

websites. The contribution per website varies to some extent with the seriousness of the

websites content. For example and per comScore, Facebook is 3% of traffic to the Wall

Street Journal Online, but 6% of traffic to Digg.

3 - Transactional web sites

Among major transactional websites such as Amazon, eBay, Fandango, Netflix, and

BestBuy.com, Facebook has moved from 1%-4% of upstream traffic in late 2009 per

comScore to 4%-9% of upstream traffic in late 2010, putting it behind Google but ahead of

Yahoo! or Microsoft. Among travel-related transactional websites, Facebook remains

immaterial, at 2%-3% of traffic, behind all three search engines.

We assume the sites where Facebook might first overtake all search engines, includingGoogle, would be sites related to social activities such as attending the movies (Fandango)

or dating (eHarmony).

Spontaneous versus influenced traffic

Looking at the growth rates above, we believe it is important to bear in mind that Facebook

has almost doubled its time spent online in the last 12-18 months. So the fact that

Facebooks traffic to a particular website has increased meaningfully over the same period

may merely reflect more consumers visiting Facebook before they (coincidentally) visit the

particular website, as opposed to Facebook getting better at directing traffic to that site. For

an offline comparison, if CBS was upstream from 4% of NBCs viewing, most observers

would conclude that those consumers were channel surfing and would have gone to NBC

without CBS participation, not that CBS was driving audiences to NBC.

Facebook needs to drive transactions, not just awareness, to captureperformance advertising

We believe that Facebook should be similarly effective to most entertainment or

informational websites at display advertising stimulating brand awareness or brand

loyalty hence how Facebook is already achieving about $1 billion per year in advertising

revenue. Display advertising is about 45% of online advertising, and we expect Facebooks

role in display advertising to grow with its traffic and its targeting technology. We focus

here on the other 55% of online advertising, performance advertising, which is intended to

stimulate consumers to an immediate transaction. Facebook poses disruption risk to search

engines and e-commerce sites if it proves successful at capturing performance advertising

dollars and stimulating transactions; if it only succeeds as a brand medium, then it largely

poses a risk to display sites, such as Yahoo!.

Given users are generally on Facebook to communicate with friends or be entertained, not

transact, its success as a performance medium may in turn depend on how difficult it is to

convert users from communications or entertainment mode to transaction mode.

Offline examples of such conversions include home shopping TV networks and

Tupperware parties.

Online examples include Googles Gmail advertisements, which serve ads to users

based on the content of their emails.


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We believe that Facebook will likely be more successful than Gmail for performance

advertising purposes given:

Facebook possesses more information about its users than Gmail, which has to guess

facts that Facebook knows, such as ones age or home location.

Facebook faces less entrenched competition than Gmail, which relies on capturing

share from established incumbents such as MSN and Yahoo! mail.

Consumers generally spend substantially more time on Facebook than Gmail.

What to watch for as signs of Facebook becoming a web nexus

We believe investors should look at Facebooks launch of new advertising formats and

tools, announcements from big online advertisers that they are spending heavily on

Facebook, and the presence or absence of user defections due to privacy issues as signs of

Facebooks progress toward becoming a dominant web nexus. Specifically:

Facebooks deployment of new advertising formats suitable for performance

advertisements, and Facebook's deployment of new tools for tracking its users

behavior and preferences across the web, such as the Facebook Like button.

Announcements that major transactional website advertisers, such as Expedia and

eBay, are increasing their spending on Facebook to tens of millions of dollars per year.

Expedia and eBay spend a few hundreds of millions of dollars per year on advertising,

much of it on search engines. However we caution that big online advertisers may

choose not to disclose their increased spend on Facebook for competitive reasons.

How willing the silent majority of Facebook users are to leave the service due to

privacy concerns. We do not view privacy complaints per se as a major issue, as they

typically reflect the views of a vocal minority of users who do not actually leave the

service anyway.

Financial assumptions Facebook could capture $8 billion inperformance advertising in 2015

We assume Facebook will see moderate success in converting users from communications

mode to transaction mode, and will therefore capture a moderate share of the performance

advertising market.

We assume that Facebooks traffic, which is growing faster than Googles, will move

up from around 9% to about 15% of time spent online by 2015, comparable to the rates

achieved by Yahoo! at its prime in the United States, or by Tencents communications

and social network platform today in China, while Googles share (including non-

American Google sites and YouTube), which has been flattening out at about 10%, will

remain at about 10%. Facebooks time spent would thus be 50% greater than Google's

(including YouTubes). See Exhibits 6-7.


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Exhibit 6:Facebook is rapidly closing the total timespent gap with Google sites% share of worldwide total minutes spent online

Exhibit 7:and narrowing the unique user gap too, witharound 600 mn versus Googles 1 bn% share of worldwide unique users

Source: comScore. Source: comScore.

We assume that Facebook will be around 15% as good at driving transactions and so

attracting performance advertising as Google. Thus Facebooks 15% of time spent

would be worth about 2.25 points of performance advertising, while Googles 10%

would be worth 10 points, so the performance market in total (including other search

engines such as Yahoo!, Bing, and Baidu) would be about 17.25 points. Facebook may

thus capture 13% of performance advertising.

We forecast worldwide performance advertising rising from $31 billion in 2010 at a

16% CAGR to $62 billion in 2015. Facebooks share could thus be 13% of $62 billion, or

about $8 billion (see Exhibit 8).

Exhibit 8:Facebook may capture around 13% of the performance ad market in 2015, withGoogle taking around 70%$ mn


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Oth er sites Go ogle Facebo ok


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We assume Facebooks gains are mostly at the expense of display

and offline, partly at the expense of Google

Allowing for Google not being the only search engine, and for Facebook stimulating new

advertisers to use performance advertising, we assume about one-quarter of Facebooks

gains would be at Googles expense, so Facebook could reduce Googles search

advertising revenue in 2015 by about $2 billion, or by 3%-4%.

Search engines sell advertisements on an auction basis, so a loss of spending to Facebook

could theoretically enable other advertisers who do not advertise on Facebook to reduce

their spending on Google as keyword prices fall. In practice, we believe that few advertisers

would stop spending on Google, and that many of those who spend on Google follow an

ROI discipline (meaning if Facebook generates traffic and Google continues generating

traffic, they will buy on both), so that the second-round impact would be modest. For

example, we believe that Bing and Yahoo! have signed up more advertisers due to their

recent adCenter/Panama platform combination, yet prices per click on Google have not

suffered despite advertisers who were previously exclusive to Google now advertising on

Bing and Yahoo!.

The ROI discipline issue comes down partly to whether consumers conduct fewer searches

on search engines because they are finding what they want through social networks. Given

the analysis earlier, we assume that social network-stimulated transactions would partly

complement and partly cannibalize search engine-stimulated transactions.

Existing Facebook revenue streams O&O display revenue andmicropayments

We estimate $1 billion display revenue on owned sites in 2010

Facebook has already established itself as a major recipient of branded, or display,

advertising on its own website, as opposed to performance advertising on its own website

(see performance section above) or display advertising on third party websites (see

contextual section above).

In June 2010, Facebook CEO Mark Zuckerberg commented that 2010 revenue estimates of

$1.0-$1.1 billion are not so far off in either direction.3 We assume that Facebooks display

revenue is about $1 billion in 2010, and may grow to about $3 billion in 2015, a little greater

than Yahoo!s display revenue of about $2.4 billion in 2010 (see Exhibit 9). Positive factors

versus our estimates include:

Facebook possesses more traffic than Yahoo! already, and we assume the gap will

widen over the next five years.

The overall display market should be about 100% larger in 2015 than 2010.

Negative factors include:

Facebook lacks some of Yahoo!s high-yielding content-driven inventory that appeals

to major advertiser categories, such as Yahoo! Finance and Yahoo! Autos.

The likely fragmentation of display advertising over the next five years.

3http://techcrunch.com/2010/06/22/facebook-revenues/


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Exhibit 9:We see Facebook capturing 6% share of the display/other online ad market in2015, with Google at 16% and Yahoo! at 7%$ mn


We estimate $300 million micropayment revenue in 2010

Facebook collects a 30% toll on micropayments made for services on its platform, such as

purchases of virtual seeds in the Farmville game. Based on financial results at social game

publishers, we assume that total spending on such micropayments may be about $1 billion

in 2010, and that Facebooks share may be about $300 million. We model that figure

growing at $200 million per year to about $1.3 billion in 2015, versus micropayment

spending on Tencent (including social and casual games akin to Farmville, excluding

massively multiplayer games akin to World of Warcraft) of about $2 billion in 2010. Positive

factors versus our estimates include:

Facebook operates mostly in higher-income countries than Tencents home market of

China.

Facebook will likely reach more consumers than Tencent, given its global reach.

Negative factors include:

Facebook relies largely on third-party apps on which it collects 30% of micropayment

value as revenue, whereas Tencent has relied wholly on first-party apps on which it

collects 100% of micropayment value as revenue.

Tencent charges for certain customization services, such as background wallpaper, for

which Facebook does not charge.

Financial implications for Facebook, and for Google

Facebook could achieve $15 billion revenue, $4.6 billion operating

profit in 2015

Given investor questions about Facebooks potential size and profitability, we attempt

below to size its business, using a range of scenarios. Facebook is privately held and rarely

comments on specific financial figures, so we base our estimates and hypothetical scenario

analyses on media reports, industry publications, and other third-party sources. At the

0

10,000

20,000

30,000

40,000

50,000

60,000

2010E 2011E 2012E 2013E 2014E 2015E

Display/otheradrevenue($mn)

All oth er sites Go ogle Yaho o! Facebo ok


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midpoints of our analyses (see Exhibits 10 and 11), we see the possibility that Facebook

could achieve $15 billion gross revenue in 2015, including:

$8 billion revenue from performance advertising on owned sites.

$3 billion revenue from contextual advertising on third-party websites.

$3 billion revenue from display advertising on owned sites, up from about $1 billion in

2010 and compared to Yahoo! achieving $2.4 billion in 2010.

$1.3 billion revenue from Facebook collecting a 30% toll on micropayments associated

with the Facebook site, up from about $300 million in 2010 and compared to Tencent

achieving about $2 billion in 2010.

Assuming a 30% operating margin on this gross revenue (at the midpoint of our scenario

analysis), higher than Yahoo!s margin and lower than Googles margin, Facebooks 2015E

operating profit could be around $4.6 billion (see Exhibits 10 and 11). The analysis below is

purely for illustrative purposes and, given limited disclosures by Facebook itself, we

provide a range of scenarios around our base case.

Exhibit 10:Hypothetical Facebook income statement, based on midpoints of our 2015E scenario analysis (see Exhibit 11)$ millions

Source: Goldman Sachs Research estimates.

In our scenario analysis (see Exhibit 11), we sensitize by the following to arrive at

hypothetical operating profit figures for Facebook in 2015E.

Revenue Our base case assumes the math above.

Our lower case assumes that Facebook does not succeed in the performance

advertising market.

Our upper case assumes that Facebook achieves performance revenue equal to twice

our base case assumption.

Margins

Our base case assumes 30% operating margins on gross revenue, between the levels

achieved by large Internet company peers such as Google and Yahoo!.

Facebook income statement 2010E 2011E 2012E 2013E 2014E 2015E

Gross revenue

Display ad revenue (on Facebook sites) 1,100 1,540 2,002 2,402 2,763 3,000

% change yoy 57% 40% 30% 20% 15% 9%

Contextual ad revenue (on third-party sites) 300 1,750 2,363 2,717 3,000

% change yoy NM 483% 35% 15% 10%

Performance/search ad revenue 500 1,500 3,750 6,188 8,000

% change yoy NM 200% 150% 65% 29%

User payments revenue (net) 300 500 700 900 1,100 1,300

% change yoy 67% 40% 29% 22% 18%

Total gross revenue 1,400 2,840 5,952 9,415 12,767 15,300

% change yoy 100% 103% 110% 58% 36% 20%

Operating income NM 0 446 1,412 2,873 4,590

% change yoy NM NM NM 216% 103% 60%

Operating margin (gross) NM 0% 8% 15% 23% 30%


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Our lower case assumes 25% operating margins, similar to our estimate for Yahoo! in

2011.

Our upper case assumes 35% operating margins, closer to our estimate for Google in

2011.

Exhibit 11:Hypothetical Facebook 2015E operating profit, sensitized by revenue andmargin scenarios$ billions

Source: Goldman Sachs Research estimates.

What might Facebook be worth?

Recent purchases of Facebook stock on secondary markets such as SharesPost4 imply that

Facebooks market value is about $40 billion today; however we caution the liquidity on

these markets means they may not be indicative of ultimate valuation.

We estimate Facebook could capture 5% of Googles revenue by

2015

Of our forecast revenue for Facebook, we estimate that:

$2 billion of the $8 billion revenue from performance advertising on owned sites might

be at the expense of Google, $1 billion at the expense of other search engines, and $5

billion at the expense of offline advertising.

$1 billion of the $3 billion revenue from contextual advertising might be at the expense

of Google, and $2 billion incremental.

$2 billion of the $3 billion revenue from display advertising might be at the expense of

display incumbents such as Yahoo! and AOL, and $1 billion incremental.

All of the micropayment revenue would be incremental.

Facebook could thus reduce Googles revenue in 2015 by about $3 billion, or 5% of our

current 2015 Google gross revenue forecast of about $57 billion. We assume the

percentage impact on Googles 2015 profitability would be similar, as competition from

Facebook for affiliates could reduce Googles margins on its contextual business.

4SharesPost is an online marketplace for private investments, posting real-time transaction data andrepresenting more than 30,000 institutional and individual investors. Transaction and valuation

information is available to registered users; registration is free.

Revenue ($ bn)

Cases Lower Base Upper

$7.3 $15.3 $23.3

Lower 25% $1.8 $3.8 $5.8

Base 30% $2.2 $4.6 $7.0

Upper 35% $2.6 $5.4 $8.2

Operatingmargin


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Exhibit 12:Gross revenue comparison for large online advertising companies, 2010E-2015E$ millions

Source: Company data, Erwin, IAB, IDC, Universal McCann, US Census, Goldman Sachs Research estimates.

What could Google do to avert the Facebook threat?

We believe Facebook is a more serious threat to Google than other Google rivals have

proven because:

1. Facebook will likely capture more time spent online than Google. We believe Google

can only neutralize this factor by building a comparably popular social network, as

most people offline as well as online spend more time interacting with each other than

interacting with information, something that would be difficult for Google to achieve.

Even where Google previously enjoyed success with its own social network, Orkut, in

India and Brazil, Facebook is now gaining on Orkut. We attribute Googles challengesto Facebooks good fortune, Googles cultural bias toward engineering rather than

marketing, and, possibly, to consumers preferring to keep certain searches (from

searching for surprise presents to searching for divorce lawyers) away from their

friends and family. AOLs accidental release of search logs in 2006 provided ample

personal information that users would likely prefer not appear on their Facebook

Profile pages.5

5http://plentyoffish.wordpress.com/2006/08/07/aol-search-data-shows-users-planning-to-commit-

murder

0

10,000

20,000

30,000

40,000

50,000

60,000

Google Yahoo! FacebookInternetcompanyadrevenue($mn)

2010E 2011E 2012E 2013E 2014E 2015E

Internet company gross revenue 2010E 2011E 2012E 2013E 2014E 2015E

Google 29,058 35,059 40,047 45,695 51,344 57,049

% of total 50% 51% 50% 50% 50% 50%

Yahoo! 6,321 5,543 5,717 5,998 6,256 6,50

% of total 11% 8% 7% 7% 6% 6%

Facebook 1,400 2,840 5,952 9,415 12,767 15,300

% of total 2% 4% 7% 10% 13% 14%

Total online ad revenue 57,691 68,510 79,495 90,505 101,750 113,111

% change yoy 19% 16% 14% 12% 11%


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2. Many people provide more shareable information to Facebook than they provide to

Google. We believe Google can neutralize this factor if it can scrape social graph

information from Facebook. Googles investment in Zynga likely represented a step

toward scraping data such as Facebook friend lists, as well as a building block to an

alternate social network. However we think that Facebook is in a sufficiently strong

position relative to its apps providers that it can prevent them passing such

information along to Google. More broadly, the challenge Facebook poses is not onlyits size relative to Google, but its size relative to every other social network, meaning

consumers may be more likely to leave Gmail for another e-mail service than to leave

Facebook for another social network.

That said, we believe the known unknown threat Facebook poses to Google is the single

most important factor limiting Googles multiple expansion in recent months. While

fighting a competitor with more traffic (per comScore) and greater public excitement (see

The Social Network) may be a new experience for some Google employees, we believe

that Google still enjoys a privileged competitive position relative to most media companies,

inasmuch as we expect its core search business to generally hold share. We therefore think

that Facebook concerns are already fairly reflected in Googles valuation.

A global perspective search engines and social networks aroundthe world

Social networks send some traffic to e-commerce sites in China, less in Japanand Korea

Non-Google search engines and non-Facebook social networks are popular in several

regions, notably East Asia (China, Japan, Korea) and the Former Soviet Union. Analyzing

upstream traffic to East Asian e-commerce and online travel sites suggests that the

Japanese and Korean social networks, Mixi and Cyworld, send relatively little traffic to local

e-commerce sites, whereas China social network Tencent sends substantial traffic to Chinae-commerce sites, helped by major China e-commerce site Taobao not advertising on

Baidu. We do not think the e-commerce sites spend much on Tencents social network

tools either, though they do advertise on its portal.


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Exhibit 13:Social networks are moderately important traffic drivers in AsiaSources of traffic to selected websites

Source: comScore.

We believe Asia social networks have focused on micropayments, not advertising

Many of the Asia social networks were popular before the emergence of Facebook, butunlike Facebook they have relied more on user micropayments than advertising revenue,

so they have promoted themselves to advertisers less than Facebook.

We therefore think that even though social networks became prevalent in East Asia before

the United States, the United States may be a better laboratory for assessing how

effectively social networks can benefit from the booming dotCommerce opportunity.

Oct-10 Baidu Google Japan Naver Average Tencent Mixi Cyworld Average

Informational sites

Sina 7% 7% 5% 5%Sohu 12% 12% 9% 9%

Yahoo! Japan (homepage) 1% 1% 0% 0%

Daum 8% 8% 2% 2%

Average informational 10% 1% 8% 7% 7% 0% 2% 4%

E-commerce sites

Taobao 4% 4% 9% 9%

Dangdang 8% 8% 6% 6%

Amazon.cn 11% 11% 4% 4%

Rakuten Ichiba 9% 9% 0% 0%

Amazon.co.jp 18% 18% 1% 1%

Gmarket 7% 7% 1% 1%Average e-commerce 7% 13% 7% 9% 6% 1% 1% 4%

Online travel sites

Ctrip 15% 15% 4% 4%

eLong 14% 14% 7% 7%

Average online travel 14% 14% 5% 5%

Social networksSearch engines


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Reg AC

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