๐๐พ Facebook: This is Zuckerberg's World and We're Just Living In It ๐ฝ
Diving underneath the hood of the world's largest social media platform.
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This week weโre diving deep into one of the behemoths of technology - Facebook. The omnipresent and monopolistic social media business that has taken over mobiles and computers all over the world.
In this weekโs episode we cover:
The Facebook monolith and its recent financial performance
Data privacy laws and their impact on Facebookโs growth
Facebookโs growth aspirations and its purpose to connect the world
Integration across the social media stack and predicting Facebookโs next move
We all know what Facebook is, and chances are, youโre probably using it. But do you really know what is it?
Facebook is a technology company that owns a suite of social media and technology applications. The core of their business sits across four key social media apps:
Facebook - The Facebook app is a social media platform that enables users to create profiles and connect with other users on the platform to communicate, transact and share content. Facebook monetises this app through the use of targeted advertising that is shown to users
Messenger - Originally part of Facebook and eventually spun out into its own app. Messenger is an instant messaging app where users can send online messages to each other. Recently it has also enabled B2C messaging, allowing businesses to directly message and interact with their customer base
Instagram - Acquired by Facebook in 2012 for $1bn, this has arguably been one of the most successful technology acquisitions of all time. Instagram is a photo and video sharing social media app that enables users to post and share digital content with their followers. Similar to Facebook, this app generates revenue through targeted advertising to its users.
WhatsApp - Another messaging app, this one was acquired for $19bn in 2014. Currently WhatsApp has limited integration with the other Facebook apps and has almost no monetisation
Additionally, Facebook has suite of other apps including Workplace, Facebook Reality Labs, GIPHY, Masquerade. These applications are less well-known but show the breadth of Facebookโs reach on the internet.
Currently, Facebook is a $84bn business, with over 3.45bn monthly active users (MAUs). This means across the globe, there are 3.45bn users who use one of Facebookโs core applications (Facebook, Messenger, Instagram or WhatsApp) every month.
There are currently 4.66bn active users of the internet on the planet, so based on raw numbers Facebook has a 75% penetration in their total addressable market. Once you factor out China (1.4bn people - where Facebook is banned), Facebook has an approximate 70-80% market share in their TAM. Thatโs unbelievable market penetration.
How does Facebook make money?
Facebook generates its revenue predominately from advertising. As a user on Facebook, you interact with a variety of groups, users and interests. You also broadcast your interests to the rest of the user base through comments and Facebook posts (weโll refer to this as User Generated Content โUGCโ). Facebook uses this information about you to show you targeted advertising based on your interests.
Packy McCormick compares Facebook and Google in this post here and outlines how Facebook can show you ads based on your interests.
Whileย Google is intent-basedย -- I search for shoes and Google serves me ads for companies that make shoes --ย Facebook is interest-basedย -- I am a 24-35-year-old male with feet who likes running, so companies that sell running shoes can reach me, and others like me, across Facebookโs properties (and on other sites via its Audience Network). Google can show me different variations of something I want, Facebook can show me products I didnโt even know I wanted.
We discuss this in our podcast - based on your Facebook profile, Facebook can show you ads for products and services within multiple degrees of the content youโre interacting with. For example, if you interact with content on โpodcast microphonesโ, Facebook can start to send you ads for headphones, podcasting studios and even soundproofing panels.
Facebookโs โcustomersโ are businesses who are looking to advertise to Facebookโs users - they pay money for access to your attention through their apps. As Facebook increases its penetration in markets and becomes more mature, more and more of your screen will become advertising, further increasing and growing their revenue.
How does Facebookโs advertising algorithm work?
The Facebook algorithm is the machine behind its incredible growth. Facebookโs ability to show the right ad to a specific user is one of its core competitive advantages. How does it work?
Facebook takes inventory of every possible post available in a userโs networkย in order toย predict what type of content people would want to see in theirย feeds,
The system then scores each of these posts based on the signals a user gives to them (likes, shares, comments, tags, and so on) to predict how valuable a user would find these posts.
Postsย thatย are most unlikely to engageย theย userย areย then discarded based onย past behavior. These are the posts that a user would have indicated notย toย like and see less of as they present misinformation or clickbait content.
After narrowing down the relevant posts with a final score, the system then ranksย the onesย that a user might take an action more often on than the others.
And finally, Facebook arrives at a sweet spot of presenting the mostย properย content in as many varieties and sources as possible.
What is Facebookโs strategy?
Source: BCG
Facebook is one example of a platform business that operates a โdigital ecosystemโ, and you can see how their actions in the market reflects the stages in the above diagram.
In mature markets, Facebook is focused on monetisation - creating value through advertising and enabling businesses to grow and expand their own businesses as a direct result of Facebookโs many platforms.
In other markets, EMEA and Asia Pacific, Facebook is still at the first stage of this process and trying to grow its user base and build network effects. Once it hits critical mass, they can skip steps 2 and 3 because their product is already mature and monetise their platforms.
This also holds true in the other segments that Facebook chooses to play in - consider WhatsApp, one of their portfolio platforms. One could argue theyโre at stage 2 or stage 3 of this process. They donโt need to invest resources into growing its user base because when they acquired WhatsApp, it was already at critical mass as a platform. But since its acquisition, Facebook has rolled out improvements to the platform and once they begin to monetise it, Facebook taps into a new revenue source that targets over 2bn active users around the world.
This is a tried and tested playbook by Facebook. Weโve seen it happen with their own platform, now Instagram and in the future WhatsApp. When you consider their broad suite of applications and how they start to move from the โGrowโ phase to the โMonetiseโ phase, theyโll continue to seek new areas of the market they can add to the โFacebookโ ecosystem in order to continue their strong growth trajectory.
How has Facebook been performing?
Source: Facebook Q1 FY21 Earnings
Facebook is a cash machine with incredible profitability and a strong user base. If you placed these metrics on an investment thesis, scrubbed of any company names, youโd probably think this is an amazing business:
Revenue growth: Averaging 28% YoY between โ18 - โ20
Profit margin: EBIT margin of 38%,
Monthly active users: Averaging a 13% YoY increase between โ18 - โ20
Average revenue per user: Increased by 48% in the last year
Combined this with its market penetration and future growth prospects as they increase their penetration in other geographies (they predominately generate their revenue from US and Canada), Facebook becomes an incredibly attractive business for investors.
But once you reveal these amazing metrics belong to Facebook, it becomes less attractive despite the strong financial performance. Facebook has a lamentable brand and reputation amongst Governments and the media and this casts doubt on the long term prospects of the business.
What are the regulatory risks surrounding Facebook?
Facebook has been the subject of countless regulatory investigations, negative media headlines, documentaries and articles by disgruntled employees. It has been involved in scandals, implicated as a tool used to influence the US election, and more recently, temporarily banned Australian news from its platform. Facebook is in the crosshairs of regulators around the world, and this is concerning because it questions how well Facebook could grow in the future. While the hammer has not yet come down, Facebookโs future is uncertain and despite its strong fundamentals, makes it difficult to speculate what the future holds.
Consider this 2 x 2. below. Each box represents a future for Facebook and the environment Facebook operates within.
Source: Fresh Capitalโs โstrategic analysisโ - weโll trade you strategy work for a microphone!
Right now, Facebook is arguably living in the orange box - low regulation, low market consolidation. Itโs thriving in this box. But as regulators look to restrict Facebookโs access to user data and threaten to break up the monolith, it may start to shift to the yellow or green future.
And in either of those boxes, Facebookโs future is uncertain, and subsequently, its future growth and financial performance.
But letโs assume for now, that Facebook remains in the orange box. What is Facebookโs future?
Facebookโs purpose is to give people the power to build community and bring the world closer together. As Facebook continues to acquire other platforms, increase its market penetration (especially in EMEA and Asia Pacific). We believe it could model itself down two future paths (obviously there are way more than two, these are just two examples of what Facebook could be)
Full Stack Integration - Facebook takes a leaf out of Googleโs playbook and starts to integrate across all its platforms. Facebook has started to integrate messaging across its platforms, but we mean full Google-esque integration. Facebook OS, Facebook hardware, Facebook Payments (this is a still a thing!) to become a fully integrated technology player. For Facebook, they can create a seamless user experience across all their platforms to enable users to connect across both software and hardware. Imagine using your Facebook VR headset and connecting it to your Facebook device, to interact with people around the world in real-time. Facebook starts to shift from social platform business to a complete platform business.
Application Integration - Integrating all its applications into one app - akin to a Facebook OS. Weโre talking a platform analogous to WeChat. No hardware and entirely software. Any interaction with another human being - social, transactional, societal. Whether its unilateral, bilateral, 1:1 or 1-to-many, its all done via Facebook. At the moment, Facebook does some of this through a few apps, but looks like itโs building the infrastructure to slowly integrate all its platforms into one.
Both these futures are interesting and possible for Facebook, especially as it starts to leverage its acquisitions - Oculus, Facebook Reality Labs (formerly CTRL-Labs) and even its hardware, Facebook Portal and move into either one (or both) of these future directions.
Whatโs your final verdict on Facebook?
Interestingly, as Facebook consolidates its position in the market through either one of those paths (or both), it will undoubtedly continue to draw the attention of regulators and the media alike. So as Facebook continues to execute on their aspiration to be where people connect and build communities, its future, and the attractiveness of it as an investment, will become less certain until regulators make a decision.
If youโre interested in more Facebook analysis and the impact of regulation on the business, check out the latest episode of our podcast here!
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One last thing! We know that Facebook is a behemoth of a business to cover and we canโt cover it all, so hereโs some of our favourite analysis for extra reading:
Aggregator Theory by Ben Thompson (Stratechery)
How Andreessen Horowitz Bunted on an Instagram Investment by Nicole Perlroth (NYT)
Why Facebook Canโt Fix Itself by Andrew Marantz (New Yorker)