Facebook tries to escape the Microsoft trap

Everyone wants a piece of Mark Zuckerberg's baby: Microsoft, Google, and now Yahoo, according to Kara Swisher. It's widely known that Zuckerberg, CEO of the hot social network, and his backers are asking for a high price on a small stake — selling 3 to 5 percent of the company at a valuation as high as $15 billion. But what no one seems to understand is the hold Microsoft has on the company, through an exclusive advertising deal that runs through 2011 — and how eager Facebook is to get out of that deal.


That may sound like madness. Isn't Microsoft supplying half of Facebook's estimated $150 million in revenues? And isn't the deal vastly unprofitable for Microsoft? Wouldn't Facebook be insane to try to wriggle out of, in essence, getting handed free money?

Yes, yes — and no.

When Facebook first inked the Microsoft ad deal, it made all the sense in the world. Advertisers with budgets of less than $50,000 who approach Facebook are directed to Microsoft to buy banners. Facebook's sales staff is simply too small to handle anything but the big deals, and they reward big-budget marketers with the most desirable inventory — sponsored items in Facebook users' "news feeds," the stream of updates that is now the dominant feature of the site. If Microsoft weren't selling those ads, they likely wouldn't get sold at all; Facebook simply doesn't have the manpower for it.

But Facebook is filling its offices with Silicon Valley's best and brightest, and those engineers now believe they have targeting technology, deeply integrated into the site, that can make those ads much more profitable. They also think self-serve advertising technology like Google's — no salesman required — can handle smaller advertisers' needs.

The problem, of course, is that software like this needs real-world feedback to really work. With Microsoft controlling Facebook's advertising inventory, Facebook can't test, improve, and tweak its advertising algorithms the way it needs to.

That's the card Microsoft holds. Its contract with Facebook is mutually binding; sure, it's providing Facebook with easy money, but that money has a cost — not developing Facebook's in-house ad platform. The longer it runs, the more Facebook falls behind.

I suspect that's why Microsoft CEO Steve Ballmer feels like he can get away with calling Facebook a "fad". That kind of trash talk is the negotiating tactic of a confident bluffer. Sure, he'd like to get a stake in Facebook — but on his terms, not Mark Zuckerberg's.

Swisher, who's been following the Facebook drama closely as well, thinks that Google and Yahoo might offer a deal to sell ads internationally on Facebook, as part of taking a stake. Perhaps — but I bet those deals will be short in term, and easily terminated. Facebook's management has learned from their Microsoft error.

Facebook's best move, though, may be to refuse the advances of all three giants, and take a large investment from the venture capitalists so eager to attach their name to Zuckerberg's hot startup. He could use some of that money, perhaps, to restructure Facebook's deal with Microsoft and give his company an easier out.

That would be the ultimate test of how confident Zuckerberg is in his engineers' technology. His mistake with Microsoft was taking the easy money. If he does it again — with Google, Yahoo, or Microsoft — then that's a sign that he's not a true believer.