Facebook is scared of the internet
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It is no wonder that Mark Zuckerberg got so defensive this week. As he was paying $1bn to eliminate the threat to Facebook from Instagram, an 18-month old photo sharing site, the web’s former giants were being humbled.
Yahoo, which unveiled another reorganisation under its fifth chief executive in five years, and AOL, which sold a portfolio of 800 patents to Microsoft for $1.1bn, are under attack from hedge funds. Both are worth a fraction of their value during the 1990s internet bubble.
Silicon Valley was always competitive but barriers to entry in the late stages of the social network boom are so low, and capital so plentiful, that creative destruction is on fast-forward. If Facebook, which is about to launch its initial public offering, will pay $1bn to neutralise Instagram, how much are Path, Pinterest and others yet to be invented worth?
This Monday produced a handy comparison of what one gets for a billion dollars: 800 patents from the early days of the internet; an old print business that brings in $3.3bn in annual revenues (AT&T’s Yellow Pages); or, in Instagram’s case, nice software and design, 50m happy users and a dozen employees.
The prize for spotting the bargain goes to Cerberus, the private equity group that bought the unglamorous but cash-rich Yellow Pages. Since Instagram has no revenues at all, it is impossible to judge exactly how much Mr Zuckerberg overpaid for a single app that became more fashionable than Facebook.
We know what he’s scared of – repeating the fate of many consumer internet companies (including social networks such as Bebo, which AOL bought for $850m in 2008 and sold last year for $10m). They can suddenly gain millions of users and huge valuations – and just as abruptly lose appeal and implode.
Nor is the fate of those that survive longer-term encouraging. After their initial trajectory flags, they acquire small competitors to defend themselves and to restore excitement. But the deals tend to fail – AOL has spent $2.3bn on acquisitions since 1999 and now has a market capitalisation of $2.3bn – and they drift unhappily.
The notable thing about the Facebook-Instagram deal is that the change in path has occurred so soon. It usually takes a year or two as a public company and pressure from growth-hungry investors for an internet company to start defensively buying nascent competitors.
It must then choose whether to wrap the new acquisition into other operations, and risk ruining its new property, or to keep it separate. The latter causes sprawl, with companies owning overlapping services, as Yahoo did with its former Photos, which duplicated Flickr, the photo-sharing company it bought in 2005.
Until Instagram, Facebook had taken the puritan approach. When it bought start-ups such as MailRank and Hot Potato, it integrated them into its existing services and kept the engineers, a deal strategy known as “acqui-hiring”.
Instagram’s size, and the fact that it works with competitors such as Twitter, made it different. It was becoming the biggest mobile photo-sharing service, thus threatening Facebook’s hold on web-based photo-sharing, but Mr Zuckerberg cannot simply absorb it.
“This is an important milestone for Facebook because it’s the first time we’ve ever acquired a product and company with so many users. We don’t plan on doing many more of these, if any at all,” he promised. But what happens when the next upstart distracts the attention of Facebook users?
There are already examples, including Path, a mobile social network for iPhone and Android (like Instagram) that was founded by former Facebook employee Dave Morin, and Pinterest, the fashion-orientated photo-sharing site. Pinterest, which was launched two years ago, has rapidly become the third most popular US social network after Facebook and Twitter.
Any technology company that plans to stick around has to be able to defend itself with acquisitions. Microsoft’s purchase of patents from AOL this week was a defensive move: it wanted to ensure it would not be blocked from developing new software by a competitor that refused to license them.
But the fact that Facebook is doing so before it matures – or even has its IPO – says something sobering about the internet. The combination of low barriers to entry, digital distribution, eager venture capitalists, ambitious software engineers and the chance of hitting the billionaire jackpot has brought hyper-competition.
Consumers benefit. Every day brings the launch of a free social network or mobile app that seeks explosive growth. They try out every combination of features – Instagram has Hipstamatic’s photo filters and a better array of sharing tools – and a few strike a chord.
No company, however, is safe. Warren Buffett is famously averse to technology investments because of their unpredictability, and the consumer internet has the shallowest moat of all. Facebook’s bulwark is the network effect of having millions of users but Instagram’s rise and the fall of Bebo, MySpace and others shows how fragile it is.
Mr Zuckerberg has so far avoided the pitfalls by handling the rise of Facebook cleverly, and reversing his mistakes rapidly enough not to alienate users. But as its growth has slowed in the US, he has clearly got worried at the growing competitive threats to its dominance.
Instagram was one but there are others, some of which would be even more expensive. The internet has a nasty habit of consuming its mature companies – Yahoo took 18 years from being founded in 1994 to get into its current state. Facebook will be lucky to last that long.