Tech

Shira Ovide is a Bloomberg Gadfly columnist covering technology. She previously was a reporter for the Wall Street Journal.

Facebook has a tortured but financially advantageous relationship with its suppliers -- that is, the people and companies that keep the social network stocked with posts, photos and videos. Those people and companies make Facebook an entertaining hangout. And Facebook essentially keeps all the money generated there. 

But that is about to change.

Facebook will start to test slotting commercials into the middle of videos that media and entertainment companies publish on the social network, tech news publication Recode reported on Monday. And the company has agreed to let the video creators keep 55 percent of the money from those video ads, just as YouTube does. 

Facebook executives until now haven't been wild about slotting in ads before or within videos. People will fixate on Facebook’s flip-flop, but the much, much bigger deal is the compensation change for the media and entertainment companies that helped Facebook become the place where the world spends a huge share of its leisure hours. And the shift could damage the best business model in technology. 

Profit Powerhouse
Out of nearly 200 U.S. companies with at least $15 billion in yearly sales, only five have wider operating profit margins than Facebook
Source: Bloomberg
Note: Rankings include the 185 U.S. companies with at least $15 billion in trailing 12 month sales. Operating margins for each company's most recently reported quarter

Facebook has become -- surprisingly -- the perfect business for the smartphone age, and a big reason is it has spent essentially nothing to keep users enthralled. For the most part, companies that publish political articles or cooking videos on Facebook don't make money directly from that material, although they use those items to assemble a big fan base and then point those people to websites and apps where the companies make money selling ads or subscriptions.

Those articles and cooking videos keep users hanging out on Facebook, and the company keeps all the money it makes from selling advertisements that fill in gaps between those posts and videos they paid nothing to publish. It may not be fair, but it has made for a wildly successful and profitable business. 

If Facebook is now willing to give 55 percent of ad dollars from those video ads, that means cracks are emerging in Facebook's free ride with its army of content suppliers. (Facebook also has experimented with splitting ad dollars with semiprofessional video stars who have attracted television-sized audiences on YouTube.)

Sharing money is more equitable but could damage Facebook's finances. Consider Alphabet Inc.’s YouTube. The video website makes roughly one-third of the money Facebook generates from each user. It's not clear exactly why. Facebook may be doing a better job stuffing ads into every spot it can. Surely part of the gap is explained by Facebook paying almost nothing to stock the social network with posts, photos and video, while YouTube hands off 55 cents of every dollar it generates to the creators of popular videos.

Internet ARPU-01

Facebook may be wagering that even if it must start giving away a cut of advertising money it's worth it if companies have more financial incentives to create video for Facebook, which in turn will keep users coming back and staying for longer stretches. Facebook is an expert at making money from users' attention. 

It may also be that Facebook had no choice. Some media and entertainment companies have started to complain about their inability to make money directly from videos and stories published on Facebook. It could be that Facebook is getting worried it will be left with too few cooking videos and Trump stories to keep users interested for hours. 

In any case, Facebook's crossing of the Rubicon on revenue sharing is an important moment. This could be the point in Facebook's development that helps it endure as the biggest and most valuable attention hog on the internet. Or it may be the step that helps Facebook stay popular but at too high a price.

This column does not necessarily reflect the opinion of Bloomberg LP and its owners.

To contact the author of this story:
Shira Ovide in New York at sovide@bloomberg.net

To contact the editor responsible for this story:
Daniel Niemi at dniemi1@bloomberg.net