LandGrab Economics: Making Sense of the Facebook-WhatsApp Deal
February 25, 2014
Facebook made a big splash last week by announcing the acquisition of messaging service WhatsApp. Since then analysts have done their sums every which way in an attempt to gauge whether the amount paid – $19bn in stock plus cash, give or take a billion – makes sense on any level. That said, no one seems to doubt that the purchase makes strategic sense for a social network whose user growth and engagement is slowing. But the price tag is sticking in many people’s throats.
One measure used by Zuckerberg as well as analysts has been dollars paid for each Monthly Average User (MAU). $19bn for 450m MAU = $42.22 per user. Versus $33.33 and $47.50 per MAU paid for Instagram in 2012 and Friendfeed in 2009. Same acquirer – Facebook – and virtually the same 1990s metric – eyeballs – to rationalize each purchase.
A similar and much more meaningful measure, Daily Average Users (DAU) has also been quoted. By my calculation the amount paid for WhatsApp per DAU is somewhere in the vicinity of $60, whatever this means in real value terms. Still, most industry experts are finding it hard to get used to the astronomical amount paid for a 55-person outfit that doesn’t yet have a real, for-profit business model.
Zuckerberg seems to be making a habit of using the power of his dual-stock ownership structure to go out and buy companies for what all around him consider to be insane (but attention-getting) prices. Whether or not he bothered to consult his relatively powerless board before placing this latest bet – as reportedly occurred with the Instagram acquisition two years ago – is probably neither here nor there at this point. But considering that Snapchat reportedly turned down a $3bn offer from Google and/or Facebook (the rumor mill isn’t clear on whether both companies made a bid), I cannot for the life of me understand how the value went so sky-high even if, as rumored Google was also interested in WhatsApp. So, what kind of sense can we make of this latest M&A move?
To my mind, this is about Landgrab Economics, which applies to unusual situations that combine (a) a killer app generating rapid user adoption, (b) enormous perceived market potential, and (c) a race between leading players for market dominance. Other more emotion-driven motivators for a making a land grab acquisition may include vision, chutzpah, hubris, fear, envy, and/or desperation. The most common of these seem to be hubris, fear and/or envy, as demonstrated below in this sampling of aggressively priced acquisitions during the past decade or so – many of which proved disastrous in conception and/or execution:
Microsoft’s purchase of Hotmail in 1997 for $400m. (Fear – of being left behind by AOL in email, envy – of AOL’s cool factor at the time)
AOL’s merger with Time Warner in 2000 for $160bn. (Hubris – delusion of world domination by combining online and brick & mortar media giants)
@Home’s purchase of Excite in 2001 for $6.7bn. (Hubris – delusion about value of ISP business, which was rapidly commoditizing)
Yahoo!’s purchase of Geocities in 2001 for $3.6bn. (Hubris – delusion of world dominance in portals, which had already lost their “cool” factor)
eBay’s purchase of PayPal in 2002 for $1.5bn. (Vision – now the jewel in the eBay crown, as Carl Icahn is reminding everyone these days)
eBay’s purchase of Skype in 2005 for $2.5bn. (Hubris – no strategic fit, still no business model, but who was questioning Meg Whitman at the time?)
Google’s purchase of YouTube in 2006 for $1.6bn. (Vision – part of long-term goal to organize the world’s information, though still no business model)
Microsoft’s purchase of Skype in 2011 for $8.5bn. (Desperation – being left out of mobile and video/audio communications)
Facebook’s purchase of Instagram in 2012 for $1bn. (Vision and chutzpah – vision of photos replacing text as communication format, chutzpah in terms of value paid)
Yahoo!’s purchase of Tumblr in 2013 for $1.1bn. (Fear – of missing the blogging wave)
So how does the WhatsApp gambit stack up against this mixed gallery? My sense is that the price tag paid for WhatsApp was motivated mainly by fear and hubris. Fear – about the waning relevance of Facebook to critical users (especially teens and young adults), fear of social networking as a category becoming less cool and compelling than 1:1 messaging communications, and fear of Google swooping in if Zuckerberg hesitated. And Hubris – of a young CEO who, to put it bluntly, reports to no one and may fancy himself the new Bill Gates and/or Steve Jobs. Recalling the old saying about Jobs’ aim being to change the world vs. Gates’s aim to rule it, it’s not clear which of these models Zuckerberg is emulating more closely. That said, no one should under-estimate Zuckerberg’s readiness to place big bets and stand behind them.
To expand on the fear theme, a number of analysts have spotted Facebook’s (and social networking’s) Achilles heel: the fact that mobile and laptop users value private conversations via a trusted messaging medium more than they value broadcasts in a not-so-trusted public square such as Facebook. Furthermore, although Facebook has been monetizing effectively through mobile and other ads, it faces resistance to advertising and, more seriously, growing privacy concerns on the part of users in different countries. Third, in social networking and messaging Facebook is not by any means the strongest player in a number of important international markets such as China (zero), Europe, and Latin America. And fourth, Facebook seems to have acknowledged that its internal innovation engine is incapable of expanding its portfolio of killer applications as fast as they can be produced by young startups.
The Landgrab strategy is most appropriate when you are a leader but not yet convincingly the Gorilla in a super-category (cross-platform social communications), or you already are the Gorilla in one branch (i.e., social networking) in some markets but the super-category is still in flux. The latter case applies strongly to Facebook. So Landgrab strategies are for companies that are rolling the dice to be not just leaders but dominators in a major category and major mass market – in this case the entire globe.
Which brings us to a key question: What’s so compelling about WhatsApp (and the other broadband messaging services such as WeChat, Line, and Viber) that would make Facebook pay $19bn for a company that has $20m or so in revenues? As many analysts have pointed out in recent days, WhatsApp boasts 70% user engagement on a daily basis, and astounding growth of one million new users every day. This degree of engagement of existing users and enlistment of new ones demonstrates powerful network effects that Facebook must have been keenly aware – and envious – of. Overall, these free (or low-cost) messaging applications are Viral, Cool and Sticky, three attributes where Facebook is beginning to lag in its core value proposition, social networking.
What about the monetization problem? When set against the acquisition price, the insignificant amount of revenue generated by WhatsApp to date has been driving analysts and observers crazy. But it is important to understand that killer online apps targeted at consumers obey a different set of ground-rules for monetization than more conventional businesses. The number one priority of companies such as Facebook and WhatsApp is to achieve rapid Adoption – by users who may or may not ever become paying customers. Number two priority is Engagement – get them using the service as intensively as possible, and keep them using your service. Priority number three is Referrals – existing users enlist new ones in a self-reinforcing virtuous cycle, generating powerful network effects as the service becomes more prevalent. Number four objective is Monetization, where some or most users become paying customers.
By the time, the company has gained dominance reinforced by ongoing network effects, it can begin to change the rules of the game and start charging for services that were free, or charging more for services that were very inexpensive – such as the $0.99 a year that WhatsApp has been charging its users after the first year’s free usage – adding new services. This phenomenon is starting to be felt in the marketplace, with companies such as LinkedIn charging for professional recruiting services, Amazon recently increasing fees for its Prime service, file-sharing companies such as Dropbox ratcheting up the fees for their freemium-based services, and (soon to come to a theater near you) Netflix increasing fees for streaming movies.
The “four-gear” model described above – Adoption, Engagement, Referral, and Monetization – contrasts dramatically with the established principles of more conventional businesses, which tend to operate with Adoption closely followed by Monetization, then Engagement, and finally Referrals, as they serve and support their existing customers and generate references to get new ones. The acquisition by Facebook should give WhatsApp the time to figure out how to monetize its services as it increases adoption, intensifies engagement, and builds referrals.
Summary: This latest move by Facebook illustrates many of the characteristics of Landgrab Economics, with its concomitant risks and controversy. In terms of strategic fit, this acquisition makes a lot of sense. In terms of value paid, it is harder to justify. It’s difficult to avoid the feeling that Zuckerberg went off the reservation (once again) and struck a deal that was much more expensive than if there had been a thoughtful board-level evaluation and ensuing negotiations. Google was rumored to have offered $10bn, without a board seat for the CEO of WhatsApp, Jan Khoum. Facebook won by offering almost $20bn, with a board seat that doesn’t mean much in a company ruled by a CEO whose vote counts ten times more than anyone else’s. You judge whether Facebook paid too much or not.