Rapid growth of WhatsApp should actually make Facebook frightened.

Ever since Facebook swapped the GDP of a mid-sized nation for a simple messaging service, the chart below is getting a lot of attention.  But I fear its main point is being missed.

Screen Shot 2014-02-24 at 8.53.57 am

Facebook got so excited by this sort of user growth that it spent $US19 billion buying WhatsApp. But it should be cowering.

Facebook’s biggest single virtue now, is that it’s the social network your friends are on. Facebook’s entire $175 billion market value hinges on the idea that this “network effect” is enough to lock you in and make sure you never leave. Is it?

The first person to install WhatsApp had no way to use it. The second person to install it could only contact the first one. The thing had no real value until a decent-sized circle of your contacts was on it. Despite this, despite the presence of other perfectly good options, like email, SMS, Viber, and despite its terrible IT-developer’s-idea-of-a-pun name, the application has grown faster than anything the web has ever seen.

WhatsApp’s growth shows people are now damn comfortable in the app store. Nobody is worried about hitting install, checking something out, and deleting it later. That represents an important – but predictable – change in consumer behaviour. And a major threat to the apps we already have installed.

Facebook perhaps recognises it could be gazumped. It is trying to make our commitment to Facebook a virtue, with, for example, recent videos reflecting our history on Facebook, etc. But if its major selling point is that it stores your old memories, will that be enough? If we all keep our Facebook – like we all keep our old school photos – but use something else for day-to-day use, then Facebook loses.

Screen Shot 2014-02-24 at 10.34.09 am

There’s another even bigger point to make here about the lesson of WhatsApp’s incredible growth.

When I wrote about Facebook’s acquisition of WhatsApp a few days ago I mainly just goggled at the incredible price. $US19 billion in cash and stock, or about $A21 billion. Since then I have had a very constructive argument with someone I respect greatly in the tech space, about what the point of the acquisition is.

I argued you could have lots of customers but no good way to monetise them. Twitter was a really good example, I said. The old-school capital market guys that floated facebook and were currently propping up their shareprice would, I reasoned, have to learn the hard way to not rely on their old-world model that says a successful business is one with lots of customers.

But I got an eye-opener in response.

“Don’t get me wrong, I wouldn’t buy FB shares at the current frothy prices either. Nor would I pay $19 Billion dollars for WhatApp. But the long-term play is a little more interesting than “monetise internet service”. The aim as I read it is to eliminate the existing rent-seeking middlemen (in this case, telcos) by undercutting their service. Then, once you have sufficient user lock-in and network effects, you can *become* the rent-seeking middleman, but at an unprecedented global scale! Not exactly a glorious ambition, but it may just work out that way.”

That made me think about the way I look at the internet.

There is one company that has created “sufficient user lock-in and network effects” to be considered the backbone of the internet. Google. Revenue of $15 billion and profit of $3 billion in one three-month period in 2013. Google is to the internet what the state-owned telecommunications companies were to the early days of the communication by wire. A behemoth.

Screen Shot 2014-02-24 at 10.36.04 am

The question then becomes, is Google a model for the rest of the net? Can Facebook et al do that too? Or is Google an outlier?

The telcos became rent-seeking middlemen by owning a network that could not be replicated. They had physical wires that they controlled. Competitors needed to make huge investments to beat them. There’s an analogy to Google there.

Google’s search results are so good not just because of its smart Page Rank algorithm, but because of its expensive web-crawling. Its competitors, like DuckDuckGo, use third-party results in their search results, because web crawling is expensive to do right:

“While our indexes are getting bigger, we do not expect to be wholly independent from third-parties. Bing and Google each spend hundreds of millions of dollars a year crawling and indexing the deep Web. It costs so much that even big companies like Yahoo and Ask are giving up general crawling and indexing. Therefore, it seems silly to compete on crawling and, besides, we do not have the money to do so. Instead, we’ve focused on building a better search engine by concentrating on what we think are long-term value-adds.”

Google’s core products, search and ads, are protected by both being smarter than the competitors, and expensive to replicate. They look safe.

But its various add-ons, like Maps, Gmail, Youtube and the play store could in theory be beaten. It has happened before. See: 10 Google services that failed and why.

Facebook’s offering is not necessarily expensive to replicate.  Open source social networks are out there. Market leaders diaspora and Movim both make privacy a big feature. Who knows what the spark will be that sets them, or something like them, on the path to exponential growth.

Goldman Sachs and JP Morgan take note. The Google model may prove to be a once-off. The internet will continue provide a lot of terrific services, but will not necessarily continue to provide a lot of money. The economic rule that price equals marginal cost of production in the absence of market power has not broken. And marginal costs online are often very close to zero.

Just to emphasise this point, I’d like to finish this piece by introducing you to an app called Telegram. It does everything WhatsApp does, but cheaper. There are no ads. There are no fees. And it is run by a not-for-profit.

Add me when you join. :)

 

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thomasthethinkengine

Thomas the Think Engine is the blog of a trained economist. It comes to you from Melbourne Australia.

One thought on “Rapid growth of WhatsApp should actually make Facebook frightened.”

  1. Greatly-respected tech dude here:

    I think this is an interesting argument, but there are a few points I take issue with. Firstly, the analysis of Google as Internet outlier seems to simultaneously claim that Google’s success is due to “lock-in and network effects” and to high barrier to entry, partly due to infrastructure costs. Depending on which of these are true, the conclusions are quite different. I would note that user lock-in and network effects (though they exist) are actually far lower for something like a search engine than for a social network. Without wanting to speculate too much as to what makes Google successful, I would also suggest having a quality product and yet another olde-world virtue that you have neglected: branding. Oh yes, branding and brand value on the Internet is a big deal. Check this out:

    http://finance.ninemsn.com.au/newsbusiness/motley/8801528/the-worlds-top-10-most-valuable-brands

    Seven of the top 10 most valuable brands in the world are in tech. Microsoft (Bing) have thrown mighty resources at trying to get to Google in search, but despite having quite a good product they have made limited headway. Not because of lock-in, not because of network effects, but because of Google’s brand power. People need a compelling reason to switch, not just a nearly-as-good alternative.

    Secondly, there is little evidence that Facebook’s network effects are breaking down. It still has its billion users. What makes Whatsapp compelling in the face of this are a couple of things. Firstly, Whatsapp has a different social modality to Facebook. This is quite a good analysis of what may be happening:

    http://stratechery.com/2014/social-conglomerate/

    The other interesting bit of data (which unfortunately I can’t find a citation for right now) is that WhatsApp’s users are mostly *not* existing Facebook users. Which means that rather than just being a defensive play, this is potentially about increasing the network effects and lock-in implied.

    Finally, on the position of being the middleman: I’m not suggesting that the new guys just go in and do what the dopey old middlemen did and hike fees to exploit their position. If they do that, they’ll lose users just as the old guys are now. But there are plenty of clever ways to make money once you sit between users and what they want. Lots of the Asian messaging guys (who are nearly as big as WhatsApp) are already making pretty big cash through messaging, in a variety of ways (note: not usage fees):

    So, in summary: you could be right. But don’t underestimate the reasons behind the hype (and yes, it is hype at the moment, but it doesn’t mean there isn’t a solid grounding under the froth). The Internet has the potential to concentrate control in the hands of fewer organisations than previous waves of the industrial revolution, and things are changing faster than ever before. My guess is that when the dust settles there will be a small number of very big players who will have no difficulty at all in figuring out how to turn their position into cash.

    Disclaimer: these are my personal views, don’t represent my employer, etc.

    Like

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