Facebook whatsapp acquisition case study

Management Case Study Analysis

Professor David Collis and Research Associate Ashley Hartman prepared this case. Aakash Mehta (MBA 2018) was responsible for the 2018 revisions. This case was developed from published sources. Funding for the development of this case was provided by Harvard Business School and not by the company. HBS cases are developed solely as the basis for class discussion. Cases are not intended to serve as endorsements, sources of primary data, or illustrations of effective or ineffective management. Copyright © 2015, 2016, 2018 President and Fellows of Harvard College. To order copies or request permission to reproduce materials, call 1-800- 545-7685, write Harvard Business School Publishing, Boston, MA 02163, or go to www.hbsp.harvard.edu. This publication may not be digitized, photocopied, or otherwise reproduced, posted, or transmitted, without the permission of Harvard Business School.

D A V I D C O L L I S

A S H L E Y H A R T M A N

A A K A S H M E H T A

$19B 4 txt app WhatsApp...omg!

The $19 billion purchase price for such a young company without a fully developed business model is without precedent.

— Martin Garner, Senior Vice President at CCS Insight

The combination of WhatsApp and Facebook will allow us to deliver new and engaging mobile experiences, connect many more people around the world, and achieve our mission of giving people the power to share and making the world more open and connected.

— Mark Zuckerberg, Facebook CEO

In February 2014, Facebook announced the acquisition of WhatsApp for $19 billion. The acquisition closed in October 2014 at a final price of $22 billion ($4.6 billion in cash, 178 million shares, and 46 million restricted stock units), approximately 10% of Facebook’s market capitalization. WhatsApp, founded in 2009, was a relatively young company that employed only 50 people and earned merely $10 million in revenue in 2013 (see Exhibit 1). It was one of many mobile messaging services that allowed users to contact each other without paying costly text message fees. However, its popularity and growth potential enticed Facebook, which was looking for opportunities to expand its user base. CEO Mark Zuckerberg believed that WhatsApp was a logical next step that would help it achieve its mission of “making the world more open and connected.”

WhatsApp’s application was relatively simple and straightforward; in fact, one of its cofounders kept a Post-it note that stated “No Ads! No Games! No Gimmicks!” taped to his computer as a constant reminder of the company’s mission to focus on the messaging service, not extraneous add-ons.1 WhatsApp prided itself on the fact that it collected limited personal information about its users, requiring phone numbers but not names, genders, e-mails, or ages.2 In contrast, Facebook collected mountains of information on its users, asking for more and more personal data, encouraging users to fill in additional details, and tracking search histories to pitch targeted ads to users. When Facebook announced the acquisition, it vowed to keep WhatsApp operating independently, letting the founders control the direction of the company and allowing WhatsApp to stay true to its mission. Yet many debated the logic behind paying so much for such a small company with limited revenue streams. Was Facebook correct to purchase WhatsApp? Even at $22 billion? How could it create value if it did not integrate WhatsApp with Facebook?

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This document is authorized for use only by Yueying Li in Business Policy & Strategic Management - Fall 2018 taught by GLENN HODGES, Michigan State University from Sep 2018 to Jan 2019.

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Facebook

History

Facebook was founded in 2004 by Harvard undergraduate Mark Zuckerberg, along with two of his roommates as an online version of the College’s hard copy student directory. Despite initially being limited to students from a handful of educational institutions, Facebook quickly experienced rapid growth. It had 150,000 members based at 30 different colleges by June 2004, a mere four months after its initial launch.3 Given its early success, Zuckerberg moved to California to be in the heart of Silicon Valley and dropped out of Harvard to focus on the company full-time.4 Facebook continued to expand, inviting additional universities and eventually high schools to join. It reached 1 million users by the end of 2004 and topped 6 million users by the end of 2005 (see Exhibit 2).5

In September 2004, Facebook received its first round of funding, a $500,000 investment from angel investor Peter Thiel. Facebook continued to raise capital, obtaining $12.7 million in May 2005 and $27.5 million in April 2006. When Yahoo! offered to acquire Facebook for $1 billion during the summer of 2006, Zuckerberg turned down the offer, arguing that Facebook was worth more.6

Facebook continued to expand its user base throughout 2006, allowing workplaces to join and ultimately permitting anyone to become a member. It also developed additional features, such as messaging, groups, discussion boards, video sharing, and mobile access.

Although Facebook had included some international networks in its early stages, as of January 2008, there were only 34 million international members, representing 59% of Facebook’s users (see Exhibit 3).7 In order to advance its international expansion, Facebook launched an application that facilitated crowd-sourced translations to other languages. It first introduced versions in Spanish, French, and German, eventually reaching 65 languages by mid-2009.8 That year Facebook reached 95 million international members, or 70% of the Facebook user base. Its international growth continued to explode and hit over 400 million in 2010.9

Originally, Facebook could only be accessed through a web browser, but in July 2008, Facebook developed an app for the iPhone.10 Over the years, as more people used Facebook on their mobile devices, the company improved its app. From 2011 to 2013, the desktop-only user base steadily declined, while the mobile-only base increased significantly. The majority of users were classified as both desktop and mobile users (see Exhibit 4).11 As of June 30, 2014, Facebook had 1.07 billion worldwide mobile monthly active users (MAUs), a YoY growth of 31%.12

In February 2012, Facebook filed for an IPO (see Exhibit 5). As investors eagerly anticipated the transaction, Facebook announced it would sell 25% more than it had originally planned to offer in order to satisfy the high demand.13 Facebook priced its shares at $38, and was expecting to raise $16 billion, making it the largest technology IPO in the U.S. and the third-largest IPO in U.S. history.14 However, its debut was a fiasco, mired in technical problems, and shares barely ended above the offer price. Over the following months, Facebook’s stock continued to disappoint, slumping to half its offer price in September 2012. The lackluster performance was fueled by fears that Facebook was unprepared for the shift to mobile and suggestions that Zuckerberg was more dedicated to Facebook’s mission than to earning money.15

By September 2014, Facebook had 1.35 billion MAUs and 1.12 billion mobile MAUs. The company had successfully expanded internationally, and approximately 82% of its users were based outside the U.S. and Canada.16 In addition to its impressive growth, its users were highly engaged; in the U.S., users spent about 40 minutes per day on Facebook (see Exhibits 6a and 6b).17

For the exclusive use of Y. Li, 2018.

This document is authorized for use only by Yueying Li in Business Policy & Strategic Management - Fall 2018 taught by GLENN HODGES, Michigan State University from Sep 2018 to Jan 2019.

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Revenue Model

Facebook earned revenue primarily through advertisements and revenues from games played on Facebook. In 2014, Facebook earned $12.5 billion in revenues, 92% of which were from advertising (see Exhibit 7). Payments for games were only made on computers, but advertisements on Facebook came in several different formats and were shown on both mobile devices and personal computers. The News Feed ads were the most prominent and had higher levels of engagement, as well as a higher price, than other ads. News Feed ads had a small disclaimer stating “sponsored” but appeared directly in a user’s News Feed and looked quite similar to posts made by friends. The ads could also be “liked” or commented on, just like normal posts. On its website, Facebook also had a series of advertisements along the right-hand side of Facebook, next to a user’s News Feed. Advertisers took a variety of approaches in their ad formats, including offering coupons, promoting events, offering app downloads, linking to their websites, and encouraging users to “like” their pages.18

Mobile advertising had been introduced in mid-2012 and grew rapidly, accounting for 62% of Facebook’s ad revenues in June 2014 (see Exhibit 8). As COO Sheryl Sandberg said, “Marketers want to be where people are—that’s driving mobile [advertising] results.”19 Many expected smartphone penetration to continue growing significantly, which would fuel the demand for mobile advertisements. From 2013 to 2014, global mobile ad spending more than doubled to $42.6 billion.20 For 2015, this number was expected to reach $68.7 billion, with $28.5 billion coming from the U.S. alone. The growth in mobile advertising was so strong that it was projected that mobile ads would surpass display ads and become the second-largest digital advertising channel by 2016.21

Facebook sold its ads through a bidding process in which companies competed to show their ads to users. Facebook suggested a bidding range that depended on factors such as advertiser demand and target group selection. The actual price per ad varied depending on the auction, and companies never paid more than the minimum bid required to win the auction.22 On its Q2 2014 earnings call, Facebook stated that its average price per ad increased 123% over the same quarter the previous year. The number of ads it showed, also known as ad impressions, decreased by 25%, but ad revenue increased by 67% to $2.68 billion. In 2014, approximately 1.5 million firms advertised on Facebook, about 50% more than the number of firms advertising in 2013.23

Facebook did not report its average price per ad, but estimates regarding Facebook’s average CPM (cost per mille, or cost per 1,000 impressions) ranged from $0.25 to $0.66. Data on competitors, compiled from various sources, showed that the average CPM was $0.75 on LinkedIn and $2.75 on Google AdWords.24,25

Issues

Slowing growth and engagement User engagement was central to Facebook’s success, and the company needed to strike a delicate balance between drawing users to Facebook and keeping them entertained, while also showing ads to earn revenue. Facebook always added users every quarter, but the growth rate of adding users was slowing down. In 2013, Facebook saw its strongest growth from users over the age of 65, but there were mixed findings on the Facebook habits of teen users, with some sources claiming that teens were leaving the site in droves and others who noted that teens diversified their social network activity but still used Facebook frequently.

A Pew Research study stated that teens were losing enthusiasm for Facebook and socializing on other platforms.26 Princeton researchers even published a study suggesting that Facebook would be the next MySpace and lose 80% of its peak users.27 According to a Piper Jaffray survey, although 72% of U.S. teens aged 13–19 indicated that they used Facebook in the spring of 2014, only 45% stated that

For the exclusive use of Y. Li, 2018.

This document is authorized for use only by Yueying Li in Business Policy & Strategic Management - Fall 2018 taught by GLENN HODGES, Michigan State University from Sep 2018 to Jan 2019.

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they used Facebook in the fall of 2014 (see Exhibit 9).28 In contrast, comScore noted that the decline was minimal: 91.5% of 18- to 24-year-olds used Facebook in February 2013 while 88.6% used it in November 2013.29 Facebook itself reported a decrease in daily users among younger teens in Q3 2013 but stated that overall usage by U.S. teens was stable from Q2 to Q3.30

All agreed that although users spent a significant amount of time on mobile devices, Facebook was no longer the only player in the social network scene. Teens shifted their focus to other apps, such as Snapchat (a mobile photo-messaging app that deleted photos immediately), Instagram (a mobile photo-sharing app), Tumblr (a microblogging platform and social networking website), WeChat (a mobile text and voice message app), Pinterest (a web and mobile app where users stored, shared, and collected images), and WhatsApp (see Exhibit 10).31 In terms of photos shared, WhatsApp users shared 400 million per day, Facebook users uploaded 350 million per day, SnapChat users shared 350 million per day, and Instagram users shared 55 million per day.32

Another issue Facebook confronted was stalled growth in MAUs in developed countries. Over the previous couple of years, growth in the U.S., Canada, and Europe had been limited, and Asia was the main market driving user growth (see Exhibit 3). However, it was far harder to monetize Asian users, and it took almost five users in India to generate the equivalent revenue from one U.S. user.33 Despite user growth in some parts of Asia, Facebook encountered increasing competition from regional social networks, such as Cyworld in Korea or Mixi in Japan, which offered similar products, services, and online advertising.34

Mobile conversion Unlike some competitors, Facebook successfully converted its desktop- based website to mobile apps. In the U.S., 2014 marked the first time that people spent more time on mobile devices (excluding talking) than on desktops.35 Facebook’s conversion allowed it to capture a big market that was only expected to grow larger. In September 2013, COO Sheryl Sandberg reflected about Facebook’s mobile conversion and commented:

Mobile usage took off faster than anyone predicted. We all saw that it was growing. . . . We had a great mobile product but our product wasn’t as good as it needed to be a year and a half ago, and Mark really led the charge to rebuild our mobile product as apps and get us into the position that we can be today. . . . We’ve made a really important and dramatic shift from being a primarily web-based company to a mobile-first company in our products and our revenue.36

Facebook stated that its focus for the next few years was to create mobile products that allowed users to share any type of content with any group of people they wanted, a goal that tied into its mission of making the world more connected.

Privacy concerns Privacy concerns were almost a constant issue for Facebook, a company that frequently overstepped boundaries and consequently encountered harsh criticism. Users were upset about the amount of information Facebook collected about them and how little control they had over what information was made public. Even when Facebook installed privacy controls, they were cumbersome and overwhelming, leaving many people to simply keep the default settings.37

The first major blunder occurred in 2006 with the News Feed. This Facebook update frustrated many users because everyone was forced to participate, and users felt that the News Feed violated their privacy because personal information became publicly available for anyone to see. Shortly after the launch, Facebook apologized for the “big mistake” and instated privacy controls.38

For the exclusive use of Y. Li, 2018.

This document is authorized for use only by Yueying Li in Business Policy & Strategic Management - Fall 2018 taught by GLENN HODGES, Michigan State University from Sep 2018 to Jan 2019.

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Although Facebook had given users more control of their information, in 2009, Facebook changed its privacy settings so that the default was automatically sharing information with everyone. After several major organizations launched complaints, Facebook created a privacy guide and agreed to more stringent guidelines, including clearly notifying users when information was shared and obtaining consent for sharing the information when the situation wasn’t covered by privacy settings.39

The introduction of the Timeline in 2011 was another big concern for Facebook users; many were worried that old information would be uncovered, and users couldn’t control what was posted on their friends’ pages. The mandatory update angered users who didn’t like the new format and didn’t appreciate old information being shared. Facebook’s “like” button, where users liked status updates, photos, and company pages, among other things, became the subject of controversy in 2012, when it was discovered that users could be unpaid endorsers of a product just because they had “liked” it. Facebook settled a class-action lawsuit in 2012 and agreed to give users the opportunity to refuse to be unpaid endorsers.40

Instagram Acquisition

In 2012, Facebook offered to buy Instagram, a popular mobile photo-sharing service, for $1 billion in cash and stock ($300 million in cash and 23 million shares of Facebook stock). Due to a decrease in share price, Facebook ultimately paid $715 million to acquire the company. Instagram users could upload photos, customize them with filters, add hashtags to them, and share them with followers who could then like or comment on the photos. At the time, many claimed the purchase price was exorbitant and questioned why Facebook would buy a revenue-free photo-sharing app when Facebook already had the ability to upload photos.

Instagram was founded in 2010 by two Stanford graduates, Kevin Systrom and Mike Krieger. Instagram, grew very quickly, hitting 1 million users two months after it launched and reaching 30 million users in April 2012, when the acquisition was announced.41 Although it started as an iOS-only app, Instagram released an Android version just before the acquisition that recorded 5 million downloads in six days.42 Instagram had only 13 employees at that time.43

The week before Facebook acquired Instagram, Instagram had raised $50 million in funding from Sequoia Capital, Greylock Capital, Thrive Capital, and other investors at a $500 million valuation.44 Zuckerberg called Systrom the next day and negotiated to buy Instagram. Zuckerberg decided to hold private conversations with Systrom; he excluded lawyers because he didn’t want to turn Instagram off of the deal. Instead of consulting with the board of directors, Zuckerberg informed them of the deal once an agreement had been reached. Although Zuckerberg had voting control of 57% of shares, some critics found it surprising that Zuckerberg put together the deal independently, especially since Facebook was on track to launch its IPO the next month.45

After the acquisition, Facebook maintained that Instagram would be operated independently. Users were allowed to post to other social networks, to decide not to share photos on Facebook, and to follow people separately from Facebook friends. The acquisition allowed Instagram to use Facebook’s size to help transform Instagram into a more substantial service.46

Since the acquisition, Instagram continued its explosive growth, logging over 100 million MAUs in April 2013 and doubling its staff to more than 25 employees.47 Instagram climbed to the 200 million MAU mark in March 2014 and reached 300 million MAUs, surpassing Twitter, in December 2014. Approximately 70% of its users came from outside of the U.S.48 Staying true to its promise, Instagram maintained its independence.

For the exclusive use of Y. Li, 2018.

This document is authorized for use only by Yueying Li in Business Policy & Strategic Management - Fall 2018 taught by GLENN HODGES, Michigan State University from Sep 2018 to Jan 2019.

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In October 2013, Facebook began to monetize the acquisition, and Instagram revealed it would be launching advertisements in its feeds for U.S. users. Similar to Facebook ads, the Instagram ads had a small note at the top saying they were sponsored so that users could differentiate between photos friends posted and advertisements.

Instagram chose to be very selective in its choice of ad partners, and in order to make the ads the least disruptive possible to the user experience, Systrom vetted brands and preapproved all sponsored images. As of April 2014, it only had about 15 approved advertisers.49 Sandberg and Zuckerberg noted that Instagram would not be an important business for Facebook for a couple of years and that Facebook was intentionally moving slowly to monetize the acquisition because the focus was on user growth.50