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Facebook and the Innovators Dilemma

A Tanking IPO is the Least of Facebook’s Problems

Much has been said about the tanking Facebook IPO and the various reasons behind it. Amongst other things, it seems the insider bankers knew something the retail investors did not – that Facebook is likely to miss earnings targets in the near future.

While the insiders at Facebook and their banks clearly have the best information, it is hardly a surprise to anyone paying attention. I wrote about the valuation back in February and concluded the article with a warning that whatever you do don’t buy Facebook shares.

My warning, and those of many others more in tune than I am with these things, was based on the ridiculous valuation of more than 100 times earnings. This is between six and ten times higher than Google and Apple.

It is highly unlikely that Facebook can grow earnings fast enough to justify the valuation, and the smart money knows it.

There are several challenges facing Facebook that are well documented:

  • With a sixth of the worlds population on the books already user growth will slow
  • Facebook is not the ideal platform for advertising. Unlike when searching Google, Facebook users are not in the mood for advertising when socialising with friends
  • More and more users are accessing Facebook on their mobiles, and Facebook makes no money from mobile users
  • Facebook’s customers are the advertisers, and the users are the product. To make more money Facebook needs to deliver more value to advertisers, something that will often be in conflict with user experience (something their all powerful CEO does not want to do).

There is a bigger issue for Facebook however, an elephant in the room. The recent purchase of Instagram seems to indicate they are aware of it. Facebook didn’t need Instagram’s 30 million users, most of them would be Facebook users already. They didn’t need the technology, or at least not at that price. What they needed was to stop a competitor like Twitter or Google from fast tracking their own social sharing platform.

The Elephant in the Room is the Innovators Dilemma

Facebook at just eight years old is the industry behemoth, with a social sharing platform and user base that dwarfs all others. What’s more, they are in a game where there is one natural winner – users go where their friends are, and everyone is on Facebook. Anyone who has tried to move to Google+ has found the hard way that their friends aren’t there and won’t readily follow.

If you were to assume that Facebook has an unassailable lead, and that challengers will be niche at best, you would be right. But that would also be assuming that competitors will simply try and build a better Facebook, as Google has attempted with Google+.

History tells us that sustaining or incremental improvements always favour the incumbents. Google+ introduced a couple of handy enhancements in Circles and Hangouts, but Google+ is just another Facebook, and for the vast majority of users one Facebook is enough.

History also tells us however that radical or disruptive improvements and innovations favour new entrants. So much so that business history is littered with the carcasses of dominant incumbents that have succumbed to game changing innovations from new entrants.

Nobody is going to successfully build another Facebook, and few other than Google have pockets deep enough to try. But companies like Twitter, Pinterest and Instagram have and will continue to innovate around the edges. They are classic new entrants – introducing products that cater to markets that don’t need all the functionality of Facebook. Instead these new entrants focused on providing a small subset of functionality in a more advanced way.

While Twitter, Pinterest and Instagram are not taking users away from Facebook, they are taking user attention. With user growth slowing (or declining in mature markets), user attention is vitally important to Facebook because that is how they deliver more value to their advertising customers. Over time we are sure to see growth in focused new entrants all taking more and more user time from Facebook.

Of even more concern for Facebook is that one or more of these upstarts are likely to grow their platform over time to be a true competitor and eventually a replacement for Facebook. It has happened time and time again and there’s no reason Facebook will be any different. With companies like Google, and even Microsoft, sitting in the wings with piles of cash these new entrants could also have powerful allies. Both make money in entirely different ways to Facebook and can invest in and support new entrants that are disruptive to the Facebook model.

It’s hard to predict what these new networks and technologies will be, but they are inevitable. A couple to pop up recently include Path and Pair, both similar to Facebook but designed for more personal networks and sharing. I don’t think either is particularly disruptive, but both will take some attention. Twitter was disruptive, as is Pinterest. Instagram was obviously scary enough even with zero revenue for a $1B cheque. If you know what’s next – please drop me a line ;)

In the short term a cashed up Facebook will continue to buy their way out of the dilemma, but it won’t work. Sure they’ve stopped a competitor from grabbing Instagram, but the only possible value to Facebook is as another web property for their advertising (and not a very good one as most Instagram activity is mobile). In any case it’s just an add on to their existing model (an incremental or sustaining innovation).

The problem for Facebook like many dominant incumbents before them is that the only business to disrupt is their own. They are hardly going to create something or support something that kills off all or part of their cash cow. This leaves the disruption to others, and this is internet technology, disruption is a certainty.

Facebook are not going away any time soon. They have a billion users, a pile of cash, and have positioned themselves as part of the fabric of the internet. They will however progressively become more of the background, much like Microsoft. Probably profitable, with a huge customer base that doesn’t engage much with them, and not at all sexy, fast growing or very innovative.

Not sure what that makes their shares worth, but it’s surely a lot less than where they are now.

That’s my take, but here’s several more if you are interested:

Business Insider – What is Facebook Really Worth
Mashable – Facebook will Disappear?
TechCrunch – Bashing Facebook for all the Wrong Reasons

What’s your opinion? Share it in the comments below (you can even sign in using your Facebook ID if you’re keen!)

 

1 Response to "Facebook and the Innovators Dilemma"

  1. Lexi says:

    With the changes Facebook is making these days, from the changing Timeline to the forced ads that appears on newsfeeds, they’re annoying a lot of people. Meanwhile Google+ is being heralded as the fastest growing social media site though no one I know is on it, hahahah!

    http://eacsoft.com

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