Social Networks: How can the winner keep winning?

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Pavneet Singh Kochhar's picture

Facebook (FB) is the largest social networking site in the world. Founded by classmates at the prestigious Harvard University in 2004, the firm went through rapid growth in the past decade with over 1.5 billion active users every month [1]. FB's monthly active user base has increased every quarter in the past couple of years, primarily in the Asia-Pacific region owing to burgeoning youth population. FB’s revenue for 2015 was $17.93 billion, an increase of 44% year-over-year. FB is growing strong with Q1 2016 earnings of $5.3 billion and over 80% of its revenue coming from mobile advertising. This brings huge potential for the social media behemoth with mobile penetration increasing particularly in the developing countries. Through a series of acquisitions over the years, Facebook has diversified its portfolio, which includes Instagram, WhatsApp, Oculus to name a few.

 

                       

FB already plays a significant part in our day-to-day interactions and has been continuously experimenting to attract new users as well as keep the enthusiasm in the old ones. FB has started using "Trending Topics" to catch attention of users and help spread information quickly and the use of Instant articles prevents users from exiting the app. The recently introduced reactions beyond the like button will provide immense data to be used by FB’s algorithms to further personalize news feed and generate user specific ads [2]. Recently launched Facebook live video provides a unique way for users to connect to their friends and celebrities to connect to their fans in live time [3]. Majority of the content shared on FB today is in the form of videos and FB gets over 8 billion views a day, which is a significant revenue generator.

From the relative wealth chart, we can observe that the asset growth has increased significantly in the past couple of years. 2012 and 2014 were important as FB as bought Instagram and WhatsApp for $1 and $19 billion, respectively. This diversified their portfolio and provided data of millions of users around the world.  FB has maintained its CFROI level well above the discount rate which means that the company is creating shareholder wealth. The sales growth, margins and asset turns have been steadily increasing over the past few years. As such, market has responded favorably with shareholder return increasing every year since its IPO in 2012.

 

Relative Wealth Chart

According to HOLT scorecard estimates, Facebook is well ahead of its competitors. Comparison of asset turns and CFROI among some of the giant internet companies shows that FB is above the median value and has a significant potential to grow further. Measure of economic return (CFROI) among the peers show that FB's forecast CFROI is much higher than the value last fiscal year, while for most of its competitors forecast CFROI is lower than the current value.

 

Peer Comparison (HOLT Scorecard, CFROI, Assets Turns)

 

Peer Comparison (Economic Returns)

 

Facebook has grown leaps and bounds and have heavily invested in new technologies. Artificial intelligence (AI), which involves making computers act intelligently, have already made inroads in many sectors and products like Apple's Siri, Google's autonomous vehicles to name just a few. FB has been actively using AI for image recognition and targeted advertising. Recently FB launched messenger with chatbots, which are algorithms that can chat with users, answer questions and make suggestions. Now, users can buy flowers or request an Uber directly from messenger without switching apps. With over 900 million active users on Messenger, FB aims to generate significant revenue from this line of business.

As with any company, rapid growth brings new challenges and Facebook is no exception. According to a recent report, "original broadcast sharing" fell by 21% from 2014 to 2015. This means that people who were earlier sharing their personal stories have reduced. Recently, there have been allegations over how FB shows "Trending Topics". Critics say that human editors are behind showing important news instead of purely using algorithms and they chose to suppress certain conservative views, however, FB has denied that they blacklisted any topics. Using chatbots come with its own set of challenges as was shown by Microsoft's chatbot Tay, which started tweeting racist and sexist messages in response to users tweets. Furthermore, EU's General Data Protection Regulation (GDPR), which aims to give back control to citizens over their data, can have serious consequences on major tech giants. Despite these challenges, FB is still the preferred choice when it comes to sharing vacation photos, career updates, relationship statuses etc. and it is unlikely that users will get such information from anywhere else.

 

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Virtual Reality (VR) – Virtual reality involves presenting our sense such as sigh, smell, taste etc. with a computer generated virtual environment. Facebook's acquisition of Oculus VR in 2014 for $2 billion was a strong leap in the field of virtual reality. Facebook’s vision is that everyone will have virtual reality headsets much like today’s environment where smartphones cheap and common. At its recent F8 developers conference, FB showed how VR will be used to socialize with our friends. FB has to continuously invest in VR, however, they will face some serious competition from Microsoft’s HoloLens and Google’s Cardboard viewer, which has already sold 5 million units.

Understanding customers and markets – With 356 million youths in the age 10-24 years, India has world’s largest youth population in the world [4] and only 34% of total population, i.e., more than 450 million has access to internet. With a large section of population still devoid of internet access, FB planned to launch "Free Basics", which provides free access to certain services like news, travel, health information, jobs and sports. FB tied up with carriers to implement differential pricing, i.e., limiting the free access only to certain websites. This clearly goes against the very basic principle of net neutrality and favors large companies who are willing to shell out to make customers stay connected to their network, whereas startups that can’t pay will be hard hit, thereby stifling innovation. Through war of words between FB and the Telecom Regulatory Authority of India (TRAI) and TRAI receiving thousands of responses, they finally ruled in favor of net neutrality and banned all differential data services. The decision was welcomed by millions of Indians and the outcome is considered as one of biggest setback for the social media giant [5]. To summarize, FB failed to understand the needs and aspirations of its customers assuming that there strong position will help them garner support. Instead of providing unlimited access to restricted internet, a better solution would have been to provide limited access to the whole internet.

As they say "One man's loss is another man's gain", Google got in partnership with the Indian Railways to set up free Wi-Fi at 400 stations, which is termed as the "largest public Wi-Fi project in the world". Facebook has a big lesson to learn from this incident that with access to data customers are becoming smarter and organizations have to better understand to make logical decisions. After all, it is well-known that "there’s no such thing as a free lunch".

Monetizing WhatsApp – Considering a large user base (over 1 billion), WhatsApp can potentially follow WeChat's model of generating revenue through mobile games, ecommerce and in-app payments. FB has already started testing new tools to connect businesses such as banks with consumers [6].

Social Change - Facebook will continue to play a pivotal role in improving lives of people and overall societal development. FB has to lead a social revolution by stopping spread of hatred, discrimination and to some extent terrorism on its network. It is well-known that terrorist outfits like ISIS are actively using social media to recruit disenfranchised youths from Europe and many other countries. United States is spending billions of dollars to fight international terrorism [7]. As Islamophobia spreads in the western world due to recent terror attacks in Paris and Belgium and an ever increasing number of refugees entering Europe, anti-Muslim protests are happening in Europe and the US [8]. In one such rally in the US, people used FB to garner support, however, FB shutdown many of these pages spewing hatred. As political rhetoric is increasingly becoming caustic and hate crimes numbers increasing, such kind of activism is required on the part of FB to stop these hatemongers from disturbing peace and harmony.

 

 

Valuation

 

In its 10 years’ roadmap, Facebook plans to build an ecosystem of technologies, where developers and other companies can leverage it to build their products. All in all, with a warranted price of $232.56, there is a 94% upside which shows Facebook is poised for strong growth but will continuously face these challenges in the coming times - monetizing Instagram and WhatsApp, improving trust of users, enhancing security and actively engaging and retaining users. Times ahead will be exciting and challenging and as they say "Difficult roads often lead to beautiful destinations", Facebook has proven that in the past and will continue to do so.

 

References: 

[1] Facebook Climbs To 1.59 Billion Users And Crushes Q4 Estimates With $5.8B Revenue, retrieved from {http://techcrunch.com/2016/01/27/facebook-earnings-q4-2015/}

[2] Facebook’s Five New Reaction Buttons: Data, Data, Data, Data, and Data, retrieved from {http://www.slate.com/blogs/future_tense/2016/02/24/facebook_s_5_new_reac...}

[3] Facebook Thinks Live Video Is the Future. What If It Isn’t?, retrieved from {http://www.slate.com/blogs/moneybox/2016/04/06/is_facebook_live_video_th...}

[4] India has world’s largest youth population: UN report, retrieved from {http://www.thehindu.com/todays-paper/tp-in-school/india-has-worlds-large...}

[5] The inside story of Facebook’s biggest setback, retrieved from {https://www.theguardian.com/technology/2016/may/12/facebook-free-basics-...}

[6] WhatsApp Blog, retrieved from {https://blog.whatsapp.com/}

[7] $583 Billion Defense Budget Covers Russia, China, ISIS with New Weapons, retrieved from {http://www.thefiscaltimes.com/2016/02/05/583-Billion-Defense-Budget-Cove...}

[8] Anti-Islam movement PEGIDA stages protests across Europe, retrieved from {http://www.reuters.com/article/us-europe-migrants-protests-germany-idUSK...}

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