Yesterday Facebook announced “Home,” a homescreen takeover application for Android that makes Facebook your phones primary interaction surface. Here are my initial reactions.
First, this is a smart move by Facebook as an attempt to counter the threat of unbundling that is posed by apps. Competing apps unbundle different pieces of functionality (Twitter for status, Instagram for photos, Foursquare for location, Kik for messaging, etc). Facebook has rightly recognized that whenever you have unbundling there is an opportunity for re-aggregation.
Second, the idea of making the re-aggregation be around people is an interesting one. Our portfolio company Brewster has been working on some related ideas. Eventually though I expect that there is no single organizing principle for re-aggregation (not functions, not people, not locations) but rather we need overall contextual awareness. For example, the surface I want my phone to present to me when I first pick it up in the morning is quite different from the middle of the day and for each of those there will be variations depending on whether it is a work day or I am on vacation, my current location and so forth.
Third, personally I can’t imagine choosing Facebook to be the re-aggregator on my phone. I would want a company to do that which is neutral across all the other networks (a network of networks) and whose interests are better aligned with those of its endusers. In the past I had hoped that Google would be that company, but that was before Google decided it had to have its own apps for everything. Now I believe this is an opportunity for startups.
Fourth, this is a clear example of how much more open for developer innovation Android is than iOS. Whether or not you like Facebook Home, this could never have been done by a third party on an iPhone. I have long predicted that its excessive control will come to bite Apple and in addition to seeing more people personally make the switch to Android, I am now also encountering more startups that develop Android first and in some cases Android only.
I have my previous Nexus S still at home and may use it to try out Facebook Home when it comes out. I am curious whether anybody reading this can see themselves making Facebook their Home. Also, would love to get reactions to the concept of the phone becoming a smart re-aggregation point for unbundled functionality.
Yesterday Facebook announced its long awaited search offering which they are calling graph search. It is the logical way to make the graph data that Facebook has been accumulating on its own and through its open graph accessible to users. Graph search is launching in beta with the obvious types of searches: people based on interests, places, movies, books, music, etc based on people. This is of course what Google has been fearing and why Google has been doubling down on Google+ at every turn (and I happen to agree with Brad Feld that Google’s patience has the potential to pay off).
At this point then it couldn’t be clearer that Facebook and Google are on an epic collision course. What is disappointing to me is that both are pursuing a vision which seems counter to the spirit of the internet as a collection of small pieces loosely joined. As an enduser I would much prefer a rich ecosystem of competing smaller services that work on specific problems, such as foursquare and yelp for places, netflix and vudu for movies, rdio and spotify for music, etc. The desire for a network of networks has also informed how we have invested.
I continue to believe that smaller services focused on specific areas can ultimately deliver a richer experience for endusers and also avoid a concentration of power. But the individual players are up against the powerful effects of supermodularity of information based production functions. On the margin I can make a better recommendation for say books if I also have information on movies. The big question then is whether the resulting complementarities doom us to face a few highly integrated players or whether it is possible for independent services to be sufficiently differentiated as to offset this advantage.
The shift of usage away from the web and to mobile is going on in full force. About half of the US population now has a smartphone and that penetration is rapidly growing. That shift has been widely cited as a problem for Facebook. But generally the problem is stated in terms of a smaller advertising opportunity on mobile devices as a result of screen size. That goes back to Facebook’s own amendments to their IPO filings, in which they stated:
“Although the substantial majority of our mobile users also access and engage with Facebook on personal computers where we display advertising, our users could decide to increasingly access our products primarily through mobile devices. We do not currently directly generate any meaningful revenue from the use of Facebook mobile products, and our ability to do so successfully is unproven.”
The real problem, I am beginning to think, is more dramatic: the shift to mobile may make Facebook less relevant altogether.
Why? Mobile devices are doing to web services what web services did to print media: they unbundle. On my phone another app is just a button push away and there is relatively little that fits on each screen. So it is just as much effort to go to another part of the Facebook app as there is to go to a different app altogether. So Facebook for mobile may not be Facebook at all but rather a combination of say Instagram, Kik, Twitter, Foursquare and others.
Facebook seems to realize this to some degree already. They launched a standalone messenger app and of course more importantly they acquired Instagram. There are also persistent rumors of Facebook working on a phone. Even if they come out with their own phone on all other phones they will have to compete with best of breed point applications. So the challenge here is what Facebook can do to make its own individual apps be part of a suite that together is more compelling. That may turn out to be a tough nut to crack.
Andy Baio provided an excellent perspective on Facebook’s acquisition of Instagram by analyzing the price per active user. This analysis shows that at about $30 per user this deal is far below many previous acquisitions. It also indicates that Yahoo’s acquisition of Broadcast.com continues to stand as the most outlandish deal at more than $10,000 per active user. At USV we have tracked a meaningful number of investment rounds across our portfolio and the data from this suggests that $30 per user falls well within the observed range of valuations (even when looking at registered instead of active users, assuming that a meaningful percentage of registered users are active).
But there are two important questions that this analysis does not consider. First, how should the dollars per active user change as a company’s user base grows larger. Many of the comps had smaller users bases and hence arguably more growth ahead of them (that was of course also the argument for the crazy Broadcast.com valuation but that growth never materialized). On the other hand for companies with network effects there is an argument to be made that the per user value should go up as the company grows larger: end users are getting more value from a larger network, making the service stickier, thus increasing lifetime value. Since Instagram is a network this argues in support of the valuation. That argument is particularly strong for a service such as Skype which has very strong network effects and is well reflected in the per user value.
Second, what is the steady state realistic value of each enduser? This is where things get a lot more difficult. It is unclear what the right business model for a service such as Instagram is. Charge for special filters? Charge for storage? Run advertising? To get to to $30 per active user if you assume a 10 year average user retention you have to get of around $4 per year per user (assuming an 8% discount rate). That has proven easy for social games companies such as Zynga (which can achieve as much as $2 per active use per month) but the precedents in photo sharing seem less compelling. For instance if you look at typical conversion rates to a paid account in the low single digit percentages, then those who do pay would have to pay annually around $80 - $100 which suddenly seems like a lot.
As with any of these discounted cash flow valuation exercises there are a lot of dials to turn here, such as the discount rate or how long users are retained (obviously 20 years would make a big difference over 10 years) and I am sure one can come up with theoretical constellations that justify the $30 per user. But it would appear that as a practical matter photo sharing services to date have not monetized that well. It would be great to get some data here from people who operate other services but I don’t believe that Yahoo ever broke out the economics of Flickr, but Fotolog was acquired for only $90 million at pretty large scale.
So did Facebook overpay for Instagram? Probably not. Photo sharing is an important core activity on Facebook and there was a meaningful threat of Instagram “unbundling” that activity from the rest of Facebook. If acquired by someone else such as Google that could provide the engine for a broader effort and potentially hollow out Facebook. As a defensive move spending 1% of its presumed market cap makes eminent sense in the near term. But that does not imply that similar services that don’t achieve critical mass should count on valuations even remotely close. It also raises an interesting question whether Facebook will have to make similar acquisitions repeatedly in the future to protect its core network.
Conversely, did Instagram sell too early? The above analysis suggests not. The deal removes all operational and monetization risk. It is all the sweeter considering how much equity the founders were holding and how small the team was. If they had wanted to double down from there they would have had to commit to building something much larger (not in terms of number of users where growth was strong, but in terms of potential for per user revenues).
If Yahoo had any shred of credibility left with developers then it has succeeded in destroying that with its misguided patent lawsuit against Facebook. But the suit isn’t all bad. It has the potential to become a catalytic event for broader social awareness of the perils of software patents, similar to how the SOPA/PIPA battle moved copyright and its enforcement into more of a mainstream issue. That was sort of the gist of Mark Cuban’s post.
The first group of people who should really start to get engaged are engineers. After all, they are the one’s whose work becomes — as Andy Baio put it — “weaponized” in the hands of corporations. A first step here might be to change how patent assignment works. Engineers at a startup could require that assignment is made only for defensive purposes instead of unconditionally. This would prevent the kind of fate that befalls so many of the patents when companies are either acquired, get into trouble or fail (and their patents are acquired by a non-practicing entity, better known as a troll).
As another approach (albeit one that might take more time to construct), companies could assign their patents to a pool that would be used for defensive purposes only. RPX does something along those lines but seems to be geared at big corporations and in RPX’s case the patents are still available for offensive purposes as well (at least as far as I know).
Between mobilizing developers and approaches to peer producing research to invalidate patents, I believe it is possible to build enough outside pressure on the system to achieve some real change.
Earlier today I participated in an Oxford-style debate in London of the motion “Facebook Is Not Your Friend.” I argued for the motion together with Baroness Susan Greenfield. Taking the opposing view were Ben Hammersley and Lewis Iwu. This was a lot of fun as the Baroness and I have very different takes on this subject. She came at it from a neuroscience and cultural perspective with a concern over what a shift away from time spent in person to time spent online will do to how people think of themselves and others (e.g., will we become less empathetic?).
My own arguments were quite different and came in three parts: privacy, identity and control. Below is what I had prepared in advance. What I actually said was of course slightly different:
Let’s start with privacy. Scott McNealy famously — or depending on your view infamously — said “your privacy is dead - get over it.” And there is a sense in which he was right. Everything we do leaves an electronic trail — increasingly that includes activities in the real world due to our constant companion, the smartphone. And anyone who has access to our electronic trail can not only inspect it but potentially publish it to the entire world with the push of a single button. In that sense our privacy *is* dead. But in another sense it still exists. There are strong human conventions around privacy expectations. For instance, we expect a private email sent to a single recipient to be considered private. That is we would be surprised and upset if that email was posted to the Internet. It’s possible and it happens but there is a convention around that being a breach of privacy. The same goes for text messages and instant messages. Now Facebook is not your friend because it gives you a misleading sense of privacy. Something posted to your 500+ best friends and possibly their friends is hardly any more private than something you shout from the roof top. Yet Facebook with its privacy controls gives you an illusion of privacy. Twitter — and full disclosure we are investors in Twitter — has a more binary and I believe more honest model of privacy. You can publish to the world or you can direct message a single individual. One is clearly public, the other clearly private.
Until fairly recently the norm for identity at web sites was a username. And there was a rich universe of usernames out there. Some people, myself included, chose to use their real name as their username. On most services you can find me as albertwenger. But many more chose some kind of fun name, sometimes referred to as a handle. Similarly, people could choose to be represented by a picture of a cat or a dog instead of a picture of themselves. In other words, we allowed ourselves at least on occasion to be someone else online. Pseudonymous expression was an important part of online speech just as it had been of speech and publishing in the offline world. Facebook is not your friend because Facebook is aggressively pushing its “real” identity model as the default identity model of the Internet. There are a rapidly growing number of services and sites that either support only Facebook login or default to it. Facebook is also promoting its comments solutions to publishers. The lure of Facebook virality is hard to resist, but it makes the Internet a more boring and uniform place and ultimately will have a chilling effect on expression. In particular in combination with the uncertainty about what’s public and private people will think twice about what they do on services that are connected to their Facebook identity.
Finally let’s consider control. The Internet was designed on a set of principles that helped create a network with no single point of control. It is called the “Internet” because it is really a network of networks, or “small pieces loosely joined.” That design has served all of us who use the Internet incredibly well. It has unleashed a huge wave of innovation because companies did not have to ask for permission when putting up web sites and services. Parts of the Internet can evolve separately from each other and the connecting standards make that possible. Facebook is not your friend because it is trying to be “the one network to rule them all” by exerting control over the Internet ecosystem. Instead of being an open connector between services, the way Internet standards are, Facebook is an interested party that controls how viral different services are and plays favorites. For instance, it has a special deal that gives Spotify far more exposure than other services. Put differently, unlike the Internet itself, Facebook is not a level playing field. In the short run we may not care that much. But in the long run this control will be detrimental to innovation on the Internet. No one player should have a dominant role or become a single point of failure for the Internet.
I meant to post all of this before the debate but then got busy with meetings here in London. There was a livestream of the debate and tomorrow the video archive should be available on Youtube. Ben and Lewis were able to convince more of the undecideds but our side carried the day in absolute numbers. One of my favorite comments from the audience was: “I find Facebook incredibly useful, but I know it is not my friend.”
I was going to write a post about Facebook’s valuation, but Bill Gurley has done such an excellent job, that the better idea is to point at his post explaining “Why Facebook Clearly Belongs in the 10x Revenue Club.” There is one other important point to consider in thinking about Internet company valuations in the current economic environment: low interest rates. Companies that are still growing and have a lot of room for future growth have a fair bit of their value sitting in the future — that’s certainly true for a company such as Facebook. As we are currently in a global deflationary environment (*) the discount rate being applied to these future cash flows is lower than it has been in a very long time and possibly ever. When I started learning about DCF models in the late 80s, a common rule of thumb was to use 7% for the risk free rate of return!
The (*) above is to indicate that we have been expanding the money supply like never before but the lending multiplier has contracted even faster and supply is far outstripping demand in combination resulting in a deflationary environment.
PS If anyone has seen a good analysis of revenue composition for Facebook (advertising versus credits, assuming that’s even disclosed in the S1) please let me know
So Facebook settled with the FTC over privacy and Mark Zuckerberg wrote another apologetic blog post (as pointed out by Liz Gannes this is his tenth). Part of the need for these apologies comes from Facebook’s aggressive approach to releasing features which at some level is admirable in a company of their scale. But what is really driving the problems is a fundamental conundrum about privacy in the digital age. Anything that was private a second ago can be made public by someone else with often little more than a click. One click public-making if you so want.
There is no doubt that this extremely powerful technology will over time transform our conceptions of private and public. I highly recommend Jeff Jarvis’s book Public Parts as it provides some interesting historical and cross cultural contexts. What the book makes eminently clear is just how much “private” and “public” are social constructs and how fundamentally they have changed with past changes in technology.
These large scale social changes, however, tend to take much longer than the underlying technology changes that drive them. So we now find ourselves in an in-between period. We have the one-click public-making technology but we still (mostly) have our previous notions of public and private. Facebook started out by incorporating these previous notions deeply into the system but it is difficult if not impossible to get to the kind of clear lines that people are still looking for in a system of Facebook’s complexity (e.g., what is the privacy expectation around something shared with friends of friends?).
What has worked much better for people to date is to have easily understood conventions around the privacy expectations for completely separate types of communication. If you text or IM a person your expectation is one of privacy. That’s the primary reason a site such as bnter hasn’t taken off yet. It goes fundamentally against the grain of people’s expectations of privacy for a particular type of communication. The same is largely true for email, which is why even smart people get caught in sending emails to reporters who then occasionally publish those as on the record conversations.
When we have settled into whatever our new social constructs will be (and I don’t expect that to be anytime soon), the discussions we are having now will seem as quaint as the debates over whether newspapers could publish photographs. I don’t know what exactly those new constructs will be, but I highly doubt that reflecting them in software will require users to make complex adjustments to privacy settings.
Yesterday, Techmeme was ablaze with posts about sharing on Facebook’s Open Graph. A CNet post by Molly Wood with the title “How Facebook is ruining sharing” appears to have kicked it all off. In it she argues that the automated (“frictionless”) sharing via Open Graph apps results in a lot more noise rather than signal. Marshall Kirkpartrick at RWW holds the same view in a piece titled “Why Facebook’s Seamless Sharing is Wrong”. Robert Scoble — not that surprisingly — is more optimistic about the benefits of automated sharing despite calling his post “The Facebook Freaky Line” and Josh Constine at Techcrunch thinks we just need better tools to curate what ex-post facto what was shared automatically in his post on “Facebook and the Age of Curation Through Unsharing”.
The arguments in these pieces are mostly about signal versus noise and about what people are comfortable sharing (or unsharing - really, who would want to do that?). But somewhat surprisingly every one of these posts seems to take sharing with Facebook as single network, the one network to rule them all, as a given. Questioning that view seems to me the most important critique of Facebook’s Open Graph. I believe we will be better off in a world with a proliferation of different networks for sharing different things with different people. I personally want to share my location with a different group of people (foursquare) than my game play (Heyzap) or my music listening (ex.fm). These different networks can provide functionality and graph models (symmetric, asymmetric) that are specific to the type of content I am sharing.
Sites and apps that essentially delegate their sharing and hence ultimately their discovery primarily or entirely to Facebook are missing the opportunity to build a network of their own with features that work best for their participants. In such a world, all of these networks don’t need to live in isolation though. There is an opportunity for a network of networks to exist. Twitter is well positioned to play this role. When I have a moment on foursquare, or Heyzap, or ex.fm that I do want to share more broadly, I can always choose to broadcast it to the public network which connects everyone. That sharing to the network of networks will carry with it a particularly high signal value.
Following f8, there has been a new explosion of discussion around Facebook’s voracious data gathering. For instance, Facebook keeps cookies on your machine even when you are logged out which allows them at least in principle to track your visits to sites with Facebook social plugins. Add to that the Ticker, which is really just Beacon redux with better timing and some semblance of an opt-in, and you have a ton of data on your activities on the web flowing to Facebook. Since I have been bothered by this for some time, I have come up with a setup that makes me feel more in control.
Before describing the setup, I should point out that I don’t really use Facebook actively other than (a) to sign into some sites that require it (eg canv.as) and (b) respond to the occasional Facebook message from a friend. I am happy to use individual services which together work better for me than Facebook (Tumblr, Twitter, Foursquare, Kik - it is not by accident that USV is an investor in these). So if you are a super active user of Facebook, the following may not really work for you.
First, I periodically visit the settings page in Facebook and make sure that I am opted out of features such as instant personalization or letting people automatically add stuff to my profile through tagging. I do this periodically because as Facebook’s service evolves they are changing the settings accordingly (this is not a criticism, simply a statement of fact and over time they have actually simplified the controls). Second, I use multiple browsers. I use Chrome as my workhorse and have gmail, gcal, twitter, tumblr open in it at all times. I use Firefox for most of the services that I try out and this is where I tend to be logged into Facebook. Finally, I use Safari in private mode and have cleared all cookies. Any and all personal browsing and transactions take place through Safari.
While this may seem like overkill, I find that it not only lets me be less concerned about Facebook’s data gathering but also I wind up having just enough tabs open in each browser that I can readily navigate. On the Mac, Alt Tab switching makes going back and forth between the three a breeze. The only occasional hold up occurs if I run across a URL in one browser that I want in another which then requires a quick copy and paste.