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How Facebook Dug Its Wide Moat

Facebook has a wide economic moat based on its 'social graph,' communications layer, and competitively advantaged platform for brands, application developers, and advertisers.

We look at three considerations for Facebook's moat: 1) Facebook as an identity, 2) Facebook as a platform, and 3) Facebook as a destination site. Largely, Facebook's ownership and control of its user data affords it substantial competitive advantages. Within Facebook, the company continues to build a rich database of friends, actions, demographics, and applications, but it only shares the data with business partners. Third parties cannot track information that happens on the Facebook platform.

Facebook as an identity: We believe identity is the most important component of a social network (and a reason why Google+ might still create value for  Google (GOOG)). Facebook partners can easily use the company's login credentials through Facebook Connect instead of requiring users to separately register a new ID and password. This functionality is good for both Facebook and the partner, as data can be more easily shared between the companies allowing for better personalization, ad targeting, and social functionality, such as sharing. Furthermore, we have seen data suggesting that websites convert casual users into registered users twice as often after deploying Facebook Connect login functionality. This rich data set is extremely difficult to replicate. Although all partners might not benefit, we believe Facebook has an early and sustainable advantage here.

Facebook as a platform: Using Facebook Connect to own a person's identify is important, but the platform creates a virtuous circle of the sharing of data between Facebook and its partners, including brands, merchants, and developers. Recognizing this opportunity, the company has made the obvious move, opening up its platform to third parties, including application and content developers. For mobile applications, iOS ( Apple's (AAPL) platform) and Google Android developers can connect their apps to the Facebook platform, as well. Through the social graph, third parties can 1) distribute applications and content for "discovery" by customers, 2) utilize Facebook data for better personalization (for example,
 TripAdvisor (TRIP) shows reviews posted by friends), and 3) use future platform capabilities, such as payments on Facebook advertising inventory. This value creates a virtuous circle between Facebook and its platform partners. Several tech luminaries have commented to us that Facebook integration is a best practice equivalent to optimizing a site for search engine discovery by Google and others.

Facebook as a destination: The traffic data alone is encouraging, though we believe this is the weakest pillar of Facebook's moat. Although the number of daily users has been increasing even faster than monthly users, we expect that competition for people's time and attention will naturally pull people away from Facebook's website. However, because many people use Facebook for communication rather than simple entertainment, we wouldn't expect users to abandon their usage of the website. The fact that more users are utilizing Facebook on a daily basis is encouraging, in our view.

Rick Summer does not own (actual or beneficial) shares in any of the securities mentioned above. Find out about Morningstar’s editorial policies.