Why Facebook’s Acquisition Strategy Has Set Its Destiny

Facebook has become a web portal with the main underlying technology focused on serving ads

Things are going great right now

Facebook is a highly profitable and very successful company: revenues, users and operating cashflow are all increasing – and so is the company’s stock price as shown below:

And if we look at what is driving all this growth, then we see that it is based on solid fundamentals:

  • More users are coming online
  • Users are spending more time online because the web is delivering more value than before
  • Mobile devices are expanding the consumption envelope which in turn means more total time online
  • Social networking is a mature category: social networking is an application of the web – like Search. Today, the question is no longer whether you need to join a social network, but which one should you join?
  • Facebook is finding ways to increase the average revenue per user (ARPU) – for example by creating new types of ad unit and inserting those deeply into the user experience.

What would a Facebook rival look like?

In order for a service to truly compete with Facebook, it would have to be based on a proposition that would be radically different:  it would be no good offering just a few new features or removing ads, for instance.

Instead, the user proposition would need to resonate in a way that no other social network has so far managed – and it would need to have the potential to do so on a mass, global scale.

We have not yet seen any service proposition that even comes close to having the potential to deliver the sort of incremental value that would be needed to challenge Facebook: sites like Snapchat, Path, Viber, Secret, Whisper and the rest do not have the horsepower to truly rival Facebook. We would regard all of these sites as derivative services. While all these sites may become successful, they will be niche offerings.

If one takes a long view – meaning a decade and more (which is a timeframe that is short enough for it to be relevant for Facebook’s stock price today) – then the market will see dramatic change. For instance, we will see the emergence of personalised machine intelligence and, as we explain in our report on the Internet of Things (IoT), the entire internet might be moving towards a different architecture where super-capable personal devices will play a much larger role than they do today.

Hence, it seems very likely that new types of social service will emerge that will be as interesting to users as Facebook is today.

New social services can take hold within a few years: a startup can go from nothing to a massive global audience of 100s of millions of users in 2-5 years, maybe even less.

If a startup emerged which presented a serious threat to Facebook and that startup did not want to be acquired by Facebook, then Facebook’s monopoly position would be challenged.

Our working assumption is that, as the web develops, we will see the emergence of a new type of social service proposition that has the potential to become as big as Facebook, but would be used alongside Facebook. So we are thinking about mainly incremental benefits, not substitutional benefits being delivered to users.

The significance of this as far as Facebook is concerned is that this hypothetical rival would not result in a mass exodus of users from Facebook – it would simply see people use their Facebook accounts less and less, which would have a detrimental impact on the ad revenues Facebook was able to earn and, ultimately, the company’s market value.

To be clear, there is no sign of such a startup on the horizon but that does not mean to say that such a company is not being planned right now.

But Facebook doesn’t really have to worry about this for now – because the company’s strategy is to buy the competition.

When Facebook pays a lot of money for a pre-revenue start up it is NOT acquiring users

What did Facebook get in return for spending c. USD 18 billion on WhatsApp?

Facebook did not acquire WhatsApp’s user base, because those users were mostly already Facebook users. 

Facebook did not acquire any deep technology, because WhatsApp did not have any deep technology.

Instead, what Facebook actually acquired was incremental engagement time.

The same is true for Instagram and almost all of Facebook’s acquisitions.

Many have viewed these acquisitions in terms of the user base that is acquired. It is customary to divide the total acquisition cost by the number of users acquired to determine an average acquisition cost per user, which is then compared with the incremental needed from each user, initially to achieve a payback and then a return.

But we think that this is the wrong way to analyse what Facebook is doing.

The correct calculation is to look at what Facebook is paying per acquired engagement hour – because that is what can be monetised using ads. Most of the users that are being acquired via these acquisitions already have Facebook accounts, which they continue to use.

If Facebook’s largest acquisitions are viewed in these terms then they appear very differently: the battle is not for users, because Facebook already has those: instead, the battle is for engagement time.

While the time spent online is increasing, the rate of increase is quite small compared with the huge changes that can occur when a user starts actively using a new service: in this case, they are not going to stop using Facebook, and they are certainly not going to cancel their Facebook account.

Instead, they will simply use Facebook a bit less – but when this effect is multiplied over a large number of users, the result is a reduction in the total amount of ad inventory being created on Facebook.com. (This is one of the reasons why Facebook has cleverly begun targeting ads on Facebook users when they visit other websites that are part of the Facebook third-party ad network).

Facebook is headed towards the portal model, and we know where that leads

With annual revenues of USD 12 billion and 8,500 employees, Facebook is clearly a big company.

Facebook operates in a market where a tiny team can launch a new ‘explosive’ service within a few months – with no significant capital being needed.  There is simply no realistic way for Facebook’s product managers to compete with thousands of independent developers and entrepreneurs, all of whom are seeking the next big service idea.

In the case of Apple, the next big product requires years of work, a huge team and billions of dollars of investment. Sadly, for Facebook, there are no such barriers to entry.

Hence, Facebook has accepted that it cannot compete on service innovation. Accordingly, the company has slowed-down the pace of innovation in user features and simply reverted to buying services that gain traction.

Hence, most of Facebook’s acquisitions have been highly defensive plays: in most cases the company has acquired incremental engagement time, rather than a new technology or a new market (as noted above most of the users of WhatsApp already had Facebook accounts, for instance).

In this respect Facebook is very different to Google, for instance, which tends to acquire technologies and capabilities, and almost never audiences.

Most of the innovation on Facebook over the last few years has been focused on better monetising its user base and, where user features have been added, they have mainly been to provide users with more control over what Facebook does with their data.

Facebook dominates its own market to such an extent that it cannot use acquisitions to expand, as other companies do when they buy rivals whose operations are focused on an incremental market that the acquiring company is not already serving. The user bases of all of the services Facebook has acquired mostly already have Facebook accounts and so these acquisitions have not added incremental revenue in the way that many commentators appreciate.

Therefore, the capital that Facebook is putting up to buy these ‘up and coming’ players can be viewed almost as a fixed cost: the company needs to spend a steadily-increasing amount each year simply to retain control of the market and it does that by buying up incremental engagement time.


If Facebook maintains its defensive acquisition strategy, then it risks becoming an umbrella brand for a ‘smorgasbord’ of largely unrelated social services, each with its own brand identity, company culture and market focus.

In this view of the market, Facebook’s main focus would be on operating and controlling the technology assets that are needed to monetise the largest unified user group in the world.

Subsidiary companies would then be responsible for providing all end-user services: eventually, the technological complexity required to optimally monetise 2 billion+ users will far exceed that needed to provide the core social networking service. In some ways one could argue that Facebook has already crossed this line.

This road is familiar to AOL, Yahoo! and mobile operator content portals, who all found that the portal model will eventually unravel: all portals eventually become too big, too complex, too commercial and too slow. At this point, users start leaving.

We would point out that AOL and Yahoo! – as well as others – have survived the portal phase, but they have fallen from their former positions as market leaders.

We foresee a ‘Yahoo!-style’ outcome for Facebook: our judgement is that the likelihood that Facebook is as relevant in 10 years time as it is today is no better than 50%. And the following chart vividly shows just how quickly fortunes can change for web leaders:

However, regardless of what happens to Facebook, we are confident that social networking and, more generally, social media will go from strength to strength.