Facebook bought instagram in 2012 for an estimated

Introduction After going public in 2012, Facebook immediately expe- rienced a fair amount of criticism and quite a bit of inves- tor uncertainty. However, Mark Zuckerberg, Facebook’s founder and CEO, was pleased to report that, as of one year later, on January 30, 2013, the firm had surpassed Wall Street’s expectations. Moreover, in only eight years, Facebook’s growth resulted in it becoming the largest social networking platform in the world.

Nevertheless, Zuckerberg and his top management team knew that they needed to consider how to adjust the firm’s strategies to compete as a public company, partly in response to the belief among some users and analysts that Facebook was losing its ability to satisfy customers and shareholders simultaneously. In this regard, what should the firm do strategically to ensure its long-term and profitable growth? While Facebook’s advertiser base is constantly looking to the firm for additional innovative means to target users, its inves- tors are questioning its ability to monetize its user base. Relatedly, in a highly dynamic and competitive industry, how will Facebook out-innovate its rivals and retain cus- tomer “mind-share”? Along with his top management team, Zuckerberg concluded that the firm should focus on both worldwide and domestic market growth. With many recent product innovations and strategic changes, 2013 and the few years beyond were expected to defining ones for the young, public social networking firm.

Facebook’s Timeline At the age of eleven, Facebook founder’s Mark Zuckerberg’s orientation and actions hinted that he could become a successful entrepreneur. Born in 1984 as the

only son to a psychiatrist and a dentist, he quickly gained a sense of reasoning and adaptability that allowed for complex, yet creative thinking. Growing up in New York, middle school offered excess spare time that Zuckerberg used to write software. After learning basic program- ming from his father, a private tutor – who constantly referred to Zuckerberg as a “prodigy” – was hired.1 During high school at Phillips Exeter Academy, he cre- ated a music player as a product for sale by his newly founded company, Intelligent Media Group. Zuckerberg declined Microsoft and AOL’s offers to purchase this firm.2 Winning several awards in math, astronomy, and physics, Zuckerberg set his sights on Harvard University, claiming on his college application that he was fluent in French, Hebrew, Latin, and ancient Greek.3 It was at Harvard that Zuckerberg’s truly invigorating path began.

Getting Started Given his early interests, the fact that Zuckerberg majored in computer science and psychology in college is perhaps not too surprising. He began his journey by writing a program called CourseMatch that allowed stu- dents to coordinate and strategically select their classes. Soon after this, he created Facemash. Facemash gave students the opportunity to rate others based on looks and then post these results online. Popularity for this site increased to the extent that campus networks were over- whelmed and malfunctioned, forcing Facemash to shut down.4 Zuckerberg next embarked on creating a social network that he dubbed “Thefacebook.” The young entrepreneur dropped out of Harvard during his sopho- more year to develop his soon-to-be multibillion-dollar company.5

Working with his roommate Dustin Moskovitz, fel- low investor, Peter Thiel, and former Napster employee,

CASE 12

Facebook

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Sean Parker, “Thefacebook” was renamed “Facebook.” By 2007, Facebook Platform, which allowed programmers to create social applications within Facebook, was complete. The characteristic blue-colored website design stemmed from Zuckerberg’s color-blindness, which limited him from clearly seeing the colors red and green, but allowed visual clarity with the color blue.6 Later that year, Beacon was created as a social advertising foundation. This led to a massive increase in growth for Facebook as both students and companies could now derive value from the com- pany. In August 2008, Facebook hired Sheryl Sandberg to be its Chief Operating Officer and, in an effort to reach new markets, in October 2008, in addition to its local headquarters in Palo Alto, California, Facebook set up its international headquarters in Dublin, Ireland. By July 2010, the company had over 500 million users and by the end of 2012, the user base totaled 1 billion.7

Earning Respect In 2009, Vanity Fair magazine ranked Zuckerberg as the 23rd most influential person of the Information Age; in 2010, the magazine chose him as the most influential person.8 Fast Company selected Facebook as the most innovative company of all in 2010 while Glassdoor indi- cated that employees identified the firm as the best place to work in both 2011 and 2013. Zuckerberg currently has an employee approval rating of 97 percent.9 Mentors such as Apple’s Steve Jobs and Netscape’s CFO Peter Currie were serving as mentors for Zuckerberg regarding issues such as developing and using financing strategies and creating management teams.10

Expanding Acquisitions have played a significant role in Facebook’s success. Beginning in 2008 with ConnectU, Facebook has forged relationships with many influential compa- nies over the years. The firm uses acquisitions to add products and technologies; but most importantly, to gain access to valuable human capital. Zuckerberg once elab- orated on Facebook’s acquisition strategy saying, “We have not once bought a company for the company. We buy companies to get excellent people.”11

From 2008 to April 2013, Facebook acquired over 30 companies. The majority of these companies were never intended to survive as independent businesses. Facebook uses the acquired employees to improve Facebook capa- bilities and develop new businesses. It acquired companies such as Rel8tion, Beluga, Snaptu, Chai Labs, and ConnectU, as shown in Exhibit 1. Each acquired business brought knowledge to Facebook in a strategic area of weakness.

Exhibit 1 Acquisitions

Acquisition Date Company Business

23 Aug 2005 Facebook.com AboutFace

19 Jul 2007 Parakey Offline applications/ Web OS

23 Jun 2008 ConnectU Social networking

10 Aug 2009 FriendFeed Social networking aggregator

19 Feb 2010 Octazen Contact importer

2 Mar 2010 Divvyshot Photo management

13 May 2010 Friendster patents

Intellectual property

26 May 2010 ShareGrove Private conversations/ Forums

8 Jul 2010 Nextstop Travel recommendations

15 Aug 2010 Chai Labs Internet applications

20 Aug 2010 Hot Potato Check-ins/Status updates

29 Oct 2010 Drop.io File hosting/sharing

15 Nov 2010 FB.com domain American Farm Bureau Federation

25 Jan 2011 Relation Mobile advertising

2 Mar 2011 Beluga Group messaging

20 Mar 2011 Snaptu Mobile app developer

24 Mar 2011 RecRec ComputerVision

27 Apr 2011 DayTum Information graphics

9 Jun 2011 Sofa Software design

9 Jun 2011 MailRank Email prioritization

2 Aug 2011 Push Pop Press Digital publishing

10 Oct 2011 Friend.ly Social casual Q&A service app

8 Nov 2011 Strobe HTML 5 mobile apps, SproutCore

2 Dec 2011 Gowalla Location based service

9 Apr 2012 Instagram Photo sharing

13 Apr 2012 Tagtile Customer loyalty app

5 May 2012 Glancee Social discovery platform

15 May 2012 Lightbox.com Photo sharing

21 May 2012 Karma Social gifting

18 Jun 2012 Face.com Face recognition platform

14 Jul 2012 Spool Mobile bookmarking and sharing content

20 Jul 2012 Acrylic Software

RSS app “Pulp” and secure database app

24 Aug 2012 Threadsy Social aggregator

28 Feb 2013 Atlas Atlas advertiser suite

14 Mar 2013 Hot Studio Design agency

Source: http://en.wikipedia.org/wiki/List_of_mergers_and_acquisitions_by_ Facebook

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For example, in August 2009, Facebook acquired a news feed company called FriendFeed. Before the acquisition, Facebook’s news feed required users to refresh the data manually and user posts that received comments did not move up to the beginning of the news feed. With the acquisition, Facebook leveraged FriendFeed’s superior technology into the Facebook platform. However, the key to this and to the major- ity of Facebook’s acquisitions was the knowledge and experience gained from the human capital that arrived with the acquisition. In the case of FriendFeed, Facebook gained four key employees that had previ- ously played a major role in launching Google maps and Gmail as Google employees before starting FriendFeed.12 The talent and experience of these tal- ented individuals was the foundation for enhancing Facebook’s ability to provide this type of functionality for its users.

In 2010, Facebook formed a strategic partnership with Zynga, one of the largest and most successful pro- viders of web-based social games.13 This partnership allowed Facebook to enter into the promising online gaming space while simultaneously attracting a younger user base. In return for helping Facebook, Facebook stated that it would help Zynga reach specific monthly growth targets and would give Zynga a portion of the revenues from ads placed on its game pages. In return, Facebook required that Zynga not launch its games on any other social platform.14

In March 2011, Facebook acquired Snaptu. Snaptu provides application software for services such as Facebook, Twitter, and LinkedIn that allows these ser- vices to be featured on phones. Snaptu’s employees also became a part of Facebook.15

In 2012, Facebook faced competition in a major business unit: photo sharing. Instagram, a popular photo sharing application on iPhones, was gaining popularity and planning to launch an Android ver- sion. With analysts speculating it could rival Facebook in photo sharing,16 Facebook evaluated the competi- tor and decided to complete a $1 billion dollar acqui- sition of Instagram. This acquisition, completed in September 2012, allowed Facebook and Instagram to share activities and core competencies and created additional value for users. It also helped strengthen Facebook’s competitive advantage in photo sharing by gaining market power and economies of scope. The sharing of intangible and tangible resources between the two business units also created value for end users and helped strengthen Facebook’s presence on mobile devices. Facebook’s VP of Engineering,

Mike Schroepfer, explained the reasoning behind this acquisition:

So many of us at Facebook love using Instagram to share moments with our friends…and for so many people, shar- ing photos with friends is an important part of the Facebook experience. That’s why we’re so excited to bring Instagram to Facebook and see what we can create together.17

Facebook has since made Instagram available to all smart phones. Unlike its other acquisitions, the Instagram acquisition was the first major acquisition that involved the purchase of a product with already engaged users. This acquisition was also different in that Facebook allowed Instagram to operate as a standalone service and not incorporate into the Facebook mobile experi- ence. Instagram benefited from the strong engineering team and infrastructure at Facebook and brought recip- rocal experience by utilizing the seamless benefit of the Instagram mobile experience.18 As of February 2013, Instagram had over 100 million Monthly Active Users (MAUs).19

Following the Instagram acquisition, Facebook acquired several additional companies including Spool, Acrylic Software, and Threadsy. In the case of Spool, which offered a mobile bookmarking service, Facebook decided to discontinue the product offering. However, Facebook will be utilizing Spool’s five programmers to enhance the Facebook mobile experience.20

Facebook utilizes partnerships to help strengthen and enhance product offerings to customers. These strategic partnerships broaden and expand the Facebook experi- ence and provide the firm’s users with an engaging and complete product. In September 2011, Facebook chose to form partnerships with media companies Netflix and Spotify, thus allowing users to update their news feeds with information about what they were currently doing. Users could now seamlessly notify their connections about what they were listening to or watching.21 In 2013, Facebook enhanced its partnership with Trend Micro, a global cloud security leader, and Rovi, an information database of movies, TV shows, and celebrities that can be tied to Facebook user profiles.22 Facebook’s partnership with Rovi will allow advertisers to advertise to specific customers groups that they want to target.23 These stra- tegic partnerships add value to the Facebook experience, which increases Daily Active Users (DAUs) and MAUs, leading to increased revenue.

Going Public Facebook filed for its initial public offering on February 1, 2012. As detailed in the filing, Zuckerberg would

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retain a 22 percent ownership share and would own 57 percent of the voting shares. The shares were valued at $38/share, valuing the company at $104 billion, the largest valuation to date for a newly public company. One day before the IPO, Facebook announced it would sell 25 percent more shares than originally planned, raising the IPO to $16 billion. Trading began on May 18, 2012 at a price of $42.05; but by the end of the week, the stock had dropped 16.5 percent to $31.91. In less than four months, the price had declined to $17.55 and as of April 16, 2013, the share price was $26.92, represent- ing one of the most disappointing IPOs in recent his- tory.24 More recently, Facebook’s market cap exceeded $64 billion and showed a monthly growth rate around 2 percent.25

Inside Facebook “Give people the power to share and make the world more open and connected.” Facebook Mission Statement.26

Mission After evolving for over four years from its original mission to “connect people through social networks at colleges,” Facebook has transferred its focus from sim- ply connecting college students to that of empowering all users. Facebook impacts the world by expanding the global user community, providing the most com- pelling user experience to increase user engagement, improving advertisement opportunities for businesses, creating engaging and easy-to-access mobile products, and developing a scalable infrastructure.27 In a 2009 interview with Forbes, Mark Zuckerberg stated his vision in regard to the impact Facebook could have on the world:

Building a good economic engine is what allows all these other platform companies and advertisers and other part- ners to exist, and be a part of this ecosystem. Ultimately, what being … a company means to me, is … not being just that—building something that actually makes a really big change in the world.28

Although Facebook’s scope has expanded, its pur- pose remains the same: giving people a way to share information in an easy and exciting way. Users are invited to share their photos, hobbies, educational back- grounds, friends, and just about every other piece of information about themselves. With the encryption of a powerful search engine, a continuously increasing num- ber of companies, groups, and individuals establish con- nections within seconds.

Culture Facebook itself operates under a developer-centered cul- ture where the focus is less on the flashy features of a new product and more on the logistics behind products. Yee Lee provides a very important message in his article, “How Facebook Ships Code.”29

Engineers [at Facebook] generally want to work on infra- structure, scalability, and “hard problems” — that’s where all the prestige is. It can be hard to get engineers excited about working on front-end projects and user interfaces. This is the opposite of what you find in some consumer businesses where everyone wants to work on stuff that cus- tomers touch so you can point to a particular user expe- rience and say, “I built that.” At Facebook, the back-end stuff like news feed algorithms, ad-targeting algorithms, memcache optimizations, etc., are the juicy projects that engineers want.

These developers are referred to as the “offensive line” as they are the backbone of the Facebook team. One of the key aspects that sets Facebook apart is its celebration of its “offensive line.” It ensures that the difficult jobs, those whose effects are less noticeable for the end user, are the ones that people at Facebook are most excited about doing. These jobs are the most highly respected occupations at Facebook and because of this, Facebook has managed to create a culture that would be challeng- ing to duplicate or imitate.

Core Themes An employee of Facebook for over three years, who previously worked for Google, cited four core themes at Facebook that countless others have echoed and confirmed.30 The first is Autonomy and Responsibility, which enables all employees to govern their own work, resulting in a sense of ownership and pride. The sec- ond theme is Focus on Impact, which entitles devel- opers and engineers to create whatever they want in their mission to have a positive effect on end users. As Facebook accumulated a significant user base, it focused on scaling horizontally, moving fast, and finding the right people. Facebook placed its engineers on small, independent teams and allowed them to make choices that had major impacts on the direction of their respec- tive product lines. For example, historically, only three engineers have run Facebook’s photo sharing service – the largest on the Internet. This type of control given to employees makes coming to work exciting and has created a culture at Facebook where changes designed to meet customers’ needs can be quickly made.31 The next theme is Facebook is Run by Hackers. What this

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tongue-in-cheek theme implies is that employees enjoy the ability to innovate and create new products based on extensive research into every small detail. The final theme is Growth and Coaching. A dominant culture that has evolved is described as “no fear of failure.” This hon- ors the concept that triumphs come out of failures, and this atmosphere plays a huge part in Facebook’s success. Additionally, coaching allows for a constant embedding of continuous progression. With these motivations sug- gested by the four core themes, the source of much of Facebook’s enthusiasm is obvious.

Outside Facebook Social Networking One of the most innovative creations in the twenty- first century is social networks. Connecting the world through schools, families, businesses, photos, and just about every other piece of information, social networks thrive on people sharing their life stories. In the last ten years, the most important networks have been Facebook, MySpace, Twitter, and LinkedIn, with several additional sites surfacing within the last few years. Facebook in particular is considered a disruptive innovation that has interfered with search engines such as Google and Yahoo!

Social networking sites serve three main purposes in addition to connecting people: advertising, employee and idea screening, and application development and gaming.

In September 2012, Facebook generated over $1 bil- lion per quarter from advertising revenue. Facebook’s advertisers range from Ford Motor Company and McDonald’s to Dell and Nike. Procter & Gamble esti- mates that it generates $500 million in sales from Facebook advertisements. Over 3,800 Wal-Mart stores have their own Facebook page.32

These sites also provide a platform for employers to monitor current employees as well as find and screen possible new employees. With this screening, new infor- mation may lead to new social capital for a firm. Access to new ideas via social networking is critical to the inno- vation process. This process allows for a type of integra- tion among suppliers and buyers that is difficult to find elsewhere.33

The last major source of innovative activity involves application, software, and gaming developers. Creations for Facebook apps and electronic platforms and oper- ating systems have become especially popular. Zynga, a game development firm, developed the highest grossing online game on Facebook, FarmVille, and represented 12 percent of Facebook’s total revenues.34 Whether acting

as a hosting service, development platform, employment locater, or an innovation hub, “social networks” is a fas- cinating innovation with seemingly unlimited potential to identify and serve customers’ needs.

The Industry Facebook is influenced by several factors, most notably its customers. Customers can be divided into two catego- ries: users and advertisers.

Users have tremendous power over Facebook as they constantly demand innovation and Facebook care- fully listens to their needs, ever mindful that switching costs to another social network are relatively nonexis- tent. With every move Facebook makes, users send a signal— sometimes positive and sometimes negative. Small incremental innovations, such as tweaking the position of a box, may be seen as a positive or incon- sequential change to users. Larger radical innovations, such as the creation of a personal “timeline” and refor- matting an entire profile page, often cause the users to divide into two categories: those who appreciate the alteration and those who do not.

While user influence is high, the opposite is seen with advertisers. At first glance, one might conclude that advertiser power is high because Facebook depends on its advertisers for profit. This, however, is quite the con- trary. Because Facebook supplies a lucrative customer base and despite speculation around the measurable impact of advertising on Facebook, the power held by advertisers is actually low. Placing advertisements on Facebook is incredibly targeted and effective. The COO of Facebook, Sheryl Sandberg, revealed that of the 60 studies conducted by Facebook in 2012 on how its adver- tisements impacted offline and online sales, 70 percent showed a ROI of better than three times, and 49 percent showed a ROI of better than five times. This large ROI for companies comes from Facebook’s ability to target a narrow field of customers. For example, Facebook claims it can reach an 18- to 28-year-old woman with 90 per- cent accuracy. This compares to the industry average of approximately 35 percent.35

In April 2013, Facebook was testing an advertising feature that lets advertisers and agencies use Facebook Exchange (FBX) to take into account the browsing behaviors of Facebook users outside of Facebook.36 This feature will provide advertisers the opportunity to display advertisements to users that have already browsed their sites or access information about the products or ser- vices it offers.37 These advertisers will be able to describe a typical customer to Facebook and then utilize FBX to find those customers. This will significantly increase

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the ability of advertisers to interact directly with their most valuable customers. In 2012, Facebook brought in almost $5 billion in advertising revenue, accounting for 84 percent of total Facebook revenue.38 This reliance on advertising revenue requires Facebook to ensure that advertisements are social, relevant, and well integrated with other Facebook content.39

There were over 6.8 billion mobile subscrip- tions worldwide at the end of 2012 and that number is expected to continue to grow.40 Mobile platforms have quickly become one of the fastest growing segments of advertising. According to Gartner Research, spending in this space would likely reach $11.4 billion in 2013.41 Recently, Facebook chose to allocate a large amount of its R&D to mobile products. Advertisers pay a premium to advertise to mobile users, which makes up for the lower volume of advertisements. Facebook’s new approach to offering services to mobile devices involves its recent launch of Facebook Home. Facebook wants to interact with users continually throughout the day as they access their mobile devices. Facebook believes it can earn a significant amount of revenue by strategically placing advertisements that target specific mobile users. Home takes the Facebook application that many mobile phone users have installed and completely integrates it with the user interface of the phone. It was initially released on April 12, 2013 and will be preloaded on a new HTC smartphone.42

While some firms such as P&G claim results, others such as Coca-Cola are skeptical. With its 62 million fol- lowers on Facebook, Coca-Cola has publicly questioned Facebook’s quantifiable effects on sales.43

Competitors Facebook competes against direct competitors as well as others with the ability to attract its customers’ “mind- share.”44 Twitter is an example of a direct Facebook com- petitor while Google examples one of Facebook’s indirect competitors. The industry is growing rapidly, imitation costs are low, and it is difficult for firms to protect their competitive advantages for an extended period. In addi- tion to Facebook, there are four main players in the social media industry: Google Plus, MySpace, LinkedIn, and Twitter. Comparisons of Facebook relative to a few of its competitors appear in Exhibit 2.

Google Plus Google Plus, aggressively pushed by chief executive Larry Page, is a new social network leveraging the exist- ing Google infrastructure to compete with Facebook.

With nearly 100 million users utilizing various accounts and products such as email, profiles, and gaming, Google represents Facebook’s largest competitor and seem- ingly has the capability to attract a substantial share of the social networking market. Google maintains a sig- nificant level of awareness among corporate users due to its popular Gmail service. It has begun to capitalize on this advantage by creating Google Plus for business. This service not only allows companies to establish their own social networking presence on Google Plus, but also integrates with Google’s many features such as Google Search and Google Ads.45 To expedite its growth and use, Google recently required all of its users to sign up for Google Plus. Competitors within the dynamic social net- working space are rushing to create ways to differentiate themselves and increase their average revenue per user (ARPU). While Facebook accounted for 46 percent of logins for social media in recent times, the percentage of logins through Google is increasing.46

Twitter This online “micro blogging” service was established in 2006 by Jack Dorsey. With over 200 million users and 1.6 billion “tweets” per day, Twitter has become one of the most iconic and visited websites on the Internet.47

Exhibit 2 Competitor* Comparisons (as of December 31, 2012)

Google LinkedIn Facebook

Revenue 50.18B 972.31M 5.09B

Quarterly Revenue Growth

36.2% 81.0% 40.1%

Gross Profit 29.54B 846.79M 3.72B

EBITDA 16.28B 125.51M 1.19B

Net Income Available to Common Share- holders

10.79B 21.61M 32.0M

Market Cap 257.98B 19.63B 63.42B

Profit Margin 21.4% 2.2% 1.0%

Operating Margin 26.7% 5.9% 10.6%

Return on Assets 10.1% 3.2% 3.1%

Return on Equity 16.6% 2.8% 0.6%

Total Cash 48.09B 749.55M 9.63B

Total Debt 7.21B 0 2.36B

Current Ratio 4 2 11

Operating Cash Flow 16.62B 267.07M 1.61B

*As a private company, financial data for Twitter is not publicly available.

Source: Yahoo! Finance. http://finance.yahoo.com/

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The estimate of the firm’s advertising revenues for 2013 was $583 million with the projection for 2014 being that this figure would double, surpassing $1 billion. The larg- est reason for growth is mobile ad revenues. Robert Hof from Forbes comments, “Unlike some leading online advertising companies such as Google and Facebook, which have been struggling to contend with lower mobile ad prices that have depressed their growth, Twitter has found mobile has been its key moneymaker.”48 Its quick and simple posts make mobile ads an ideal location and advertisers are flocking to exploit this channel.

MySpace MySpace, engineered by Chris DeWolfe, implemented a strategy very similar to Facebook in its origination. This firm initially targeted the same audience as Facebook, had enormous capabilities, and was purchased by News Corporation, a large media corporation with profes- sional management to lead its unique resources. Started in 2003, the site pioneered social networking and once boasted more users than any other social media site. However, its rise to popularity in the teenage and young adult category from 2005-2008 plummeted in 2009. Once a music-centered social platform, with the advent of Facebook, MySpace chose to reposition itself as a “social entertainment destination” and ultimately, alienated many of its followers.49 While Facebook and other competitors focused on introducing a platform where developers could co-design, MySpace chose to build everything in-house. Although it designed many features, MySpace neglected to deepen its differentiating factors and in the end, other networks capitalized on this opportunity.50