How to make $240M of Microsoft equity disappear

Last week a few press articles described how Google apparently lost to Microsoft in a bidding war to invest in Facebook. (MS won – investing $240M in Facebook)

Did Google lose? I’m not so sure… by “losing” it may have just pulled off one of the savviest negotiations I’ve ever seen. Google may never have been interested in Facebook, only in pumping up its value to ensure Microsoft overpaid.

Why?

Because Google is planning to destroy Facebook’s value.

Facebook – like all social network sites – is a walled garden. It’s like a cellphone company that only allows its users to call people on the same network – for example if you were a Rogers cellphone user, you wouldn’t be allowed to call your friend who is a Bell cellphone user. In Facebook’s case you can only send notes, play games (like my favourite, scrabblelicious) and share info with other people on Facebook. Want to join a group on Friendster? To bad.

Social networking sites do this for two reasons. First, if a number of your friends are on Facebook, you’ll also be inclined to join. Once a critical mass of people join, network effects kick in, and pretty soon everybody wants to join.

This is important for reason number two. The more people who join and spend time on their site, the more money they make on advertising and the higher the fees they can charge developers for accessing their user base. But this also means Facebook has to keep its users captive. If Facebook users could join groups on any social networking site, they might start spending more time on other sites – meaning less revenue for Facebook. Facebook’s capacity to generate revenue, and thus its value, therefor depends in large part on two variables: a) the size of its user base; and b) its capacity to keep users captive within your site’s walled garden.

This is why Google’s negotiation strategy was potentially devastating.

MicroSoft just paid $240M for a 1.6% stake in Facebook. The valuation was likely based in part, on the size of Facebook’s user base and the assumption that these users could be kept within the site’s walled garden.

Let’s go back to our cell phone example for a moment. Imagine if a bunch of cellphone companies suddenly decided to let their users call one another. People would quickly start gravitating to those cellphone companies because they could call more of their friends – regardless of which network they were on.

This is precisely the idea behind Google’s major announcement earlier this week. Google launched OpenSocial – a set of common APIs that let developers create applications that work on any social networks that choose to participate. In short, social networks that participate will be able to let their users share information with each other and join each other’s groups. Still more interesting MySpace has just announced it will participate in the scheme.

This is a lose-lose story for Facebook. If other social networking sites allow their users to connect with one another then Facebook’s users will probably drift over to one of these competitors – eroding Facebook’s value. If Facebook decides to jump on the bandwagon and also use the OpenSocial API’s then its userbase will no longer be as captive – also eroding its value.

Either way Google has just thrown a wrench into Facebook’s business model, a week after Microsoft paid top dollar for it.

As such, this could be a strategically brilliant move. In short, Google:

  • Saves spending $240M – $1B investing in Facebook
  • Creates a platform that, by eroding Facebook’s business model, makes Microsoft’s investment much riskier
  • Limit their exposure to an anti-trust case by not dominating yet another online service
  • Creates an open standard in the social network space, making it easier for Google to create its own social networking site later, once a clear successful business model emerges

Nice move.

13 thoughts on “How to make $240M of Microsoft equity disappear

  1. Kim Feraday

    Interesting. Do you know how robust the security model is? That would be something of a concern — as a user can I set a policy that will work across all platforms so that someone can’t access my profile/network information without my permission?

    My other comment is that even if Facebook opens up the app there’s other ways they can compete. My understanding is that they’re going to start mining profile data to target advertising. They can enrich the data use advanced analytics to provide more targetted offers than their competitors (maybe that $250M will be useful after all). If they do succeed in building up a rich set of profile data, and provide a robust security model, they could also position themselves as a master profile service.

    Reply
  2. Kim Feraday

    Interesting. Do you know how robust the security model is? That would be something of a concern — as a user can I set a policy that will work across all platforms so that someone can’t access my profile/network information without my permission? My other comment is that even if Facebook opens up the app there’s other ways they can compete. My understanding is that they’re going to start mining profile data to target advertising. They can enrich the data use advanced analytics to provide more targetted offers than their competitors (maybe that $250M will be useful after all). If they do succeed in building up a rich set of profile data, and provide a robust security model, they could also position themselves as a master profile service.

    Reply
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  4. David Eaves Post author

    Hi Kim,

    I’ve got no sense how robust the security model is… I think this is all very early stages. My assumption though is that your concern is one that a number of people will share and so someone, somewhere, will code up a solution for it…

    As for your second comment… Facebook has already opened up their aps (hence scrabulous – my favourite) but there is some charge for using it. They could let anyone develop software on their platform in the hopes that this will generate better ads… but I’m not sure that is the business model which MS paid for or by which they were evaluated on.

    It also won’t help them get around a bigger problem. If the whole social networking thing moves to common, open standards, what will facebook do? If you could have a profile that was far more customizable on a social networking platform that allowed you to connect with other platforms, would you choose it, or a walled off facebook…

    My sense is that it’s going to be like choosing between “internet access” and AOL… with Facebook playing the role of AOL.

    Reply
  5. David Eaves

    Hi Kim,I’ve got no sense how robust the security model is… I think this is all very early stages. My assumption though is that your concern is one that a number of people will share and so someone, somewhere, will code up a solution for it…As for your second comment… Facebook has already opened up their aps (hence scrabulous – my favourite) but there is some charge for using it. They could let anyone develop software on their platform in the hopes that this will generate better ads… but I’m not sure that is the business model which MS paid for or by which they were evaluated on.It also won’t help them get around a bigger problem. If the whole social networking thing moves to common, open standards, what will facebook do? If you could have a profile that was far more customizable on a social networking platform that allowed you to connect with other platforms, would you choose it, or a walled off facebook…My sense is that it’s going to be like choosing between “internet access” and AOL… with Facebook playing the role of AOL.

    Reply
  6. Jeremy Vernon

    Facebook is burger now.

    Google has astronomically more data on what kinds of ads appeal. Since ad performance is based on consumer interests in particular products – something that requires less guesswork when you know what websites they look at and search terms the use, versus how old they are and how many friends they have. Not only will they have user’s social profile, they’ll have their email and search habits – in short 90%+ of their web usage.

    OpenSocial will then allow Googe to plug into browsing habits, real-life social connections, and usage of sites outside its normal purview like eBay or Amazon.

    The API offers behavioural reporting as well as static relationship tracking. Allowing Google to track social-network vectors – social trends in other words, likely before anyone is conscious of them.

    Reply
  7. Jeremy Vernon

    Facebook is burger now. Google has astronomically more data on what kinds of ads appeal. Since ad performance is based on consumer interests in particular products – something that requires less guesswork when you know what websites they look at and search terms the use, versus how old they are and how many friends they have. Not only will they have user’s social profile, they’ll have their email and search habits – in short 90%+ of their web usage. OpenSocial will then allow Googe to plug into browsing habits, real-life social connections, and usage of sites outside its normal purview like eBay or Amazon. The API offers behavioural reporting as well as static relationship tracking. Allowing Google to track social-network vectors – social trends in other words, likely before anyone is conscious of them.

    Reply
  8. Jeremy Vernon

    I think, as has been proven (by Google particularly but by the web en tota), that security concerns from a value-statement is a conversation not worth having outside the realm of technical problem solving.

    It’s analogous to asking “Is the system going to be usable? I don’t want to use software that isn’t usable…”

    Security is a basic requirement for software just like usability. It is the DEGREE of security, usability and utility that differentiaties particular applications from their competitors.

    When it comes to privacy and data collection – software has always made this proposition. Added value through sacrificed privacy… The system will explain what data it will collect and the value that a user can derive from it.

    Many thought GMail would fail because they believed users wouldn’t want Google to read their mail. It didn’t fail, but it didn’t replace email in all other form. The software was worth the privacy sacrifice to some and not others.

    The same is true of any such software – anything that embeds itself into your social life implicitly makes personal information a requirement.

    Reply
  9. Jeremy Vernon

    I think, as has been proven (by Google particularly but by the web en tota), that security concerns from a value-statement is a conversation not worth having outside the realm of technical problem solving.It’s analogous to asking “Is the system going to be usable? I don’t want to use software that isn’t usable…” Security is a basic requirement for software just like usability. It is the DEGREE of security, usability and utility that differentiaties particular applications from their competitors.When it comes to privacy and data collection – software has always made this proposition. Added value through sacrificed privacy… The system will explain what data it will collect and the value that a user can derive from it.Many thought GMail would fail because they believed users wouldn’t want Google to read their mail. It didn’t fail, but it didn’t replace email in all other form. The software was worth the privacy sacrifice to some and not others. The same is true of any such software – anything that embeds itself into your social life implicitly makes personal information a requirement.

    Reply
  10. Kim Feraday

    Jeremy,

    How will they get the user’s profile? Applications will still only be able to get access to the profile data that they are publishing their app on (MySpace, Linkedin etc.). Google can’t just suck the data out. So unless everyone signs on to Orkut (not likely unless you’re in Brazil) you don’t get the real benefit which is access to the data across networks to build more user centric apps.

    So ultimately, platforms with large user communities will still have signficant advantage. And now Facebook can potentially get access to additional data and other capabilities from MS as well. Their are also alot of other places they could go to enrich data as well. That’s why I still think Facebook could just open up their platform — if they enhance how I can control access to my profile data beyond what they do now, they could increase the value of the platform by making it a default destination to hold that data and make it a preferred destination for developers.

    Google wants the same thing. I think likely they’ll both be around for a while, particularly since the real battle is between MS and Google.

    Reply
  11. Kim Feraday

    Jeremy,How will they get the user’s profile? Applications will still only be able to get access to the profile data that they are publishing their app on (MySpace, Linkedin etc.). Google can’t just suck the data out. So unless everyone signs on to Orkut (not likely unless you’re in Brazil) you don’t get the real benefit which is access to the data across networks to build more user centric apps. So ultimately, platforms with large user communities will still have signficant advantage. And now Facebook can potentially get access to additional data and other capabilities from MS as well. Their are also alot of other places they could go to enrich data as well. That’s why I still think Facebook could just open up their platform — if they enhance how I can control access to my profile data beyond what they do now, they could increase the value of the platform by making it a default destination to hold that data and make it a preferred destination for developers. Google wants the same thing. I think likely they’ll both be around for a while, particularly since the real battle is between MS and Google.

    Reply
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