Facebook Plays Offense and Defense in a Single Move

/// Facebook Plays Offense and Defense in a Single Move

April 11, 2012  |  Blog

SAN FRANCISCO — Is it crazy for Facebook, a start-up that has not yet even gone public, to be throwing $1 billion at Instagram, an even younger start-up?

To some, the rich price tag on the deal, announced Monday, was yet more evidence of a bubble in the technology industry, especially because Instagram, a mobile app that allows people to share their smartphone snapshots with friends, has not made any revenue.

But the history of Silicon Valley suggests that expensive purchases of start-ups by start-ups may not always be so crazy.

In 2002, the hot start-up turned juggernaut was eBay, then an online auction service. It bought a small online payments company, PayPal, for $1.5 billion. The PayPal division of eBay now brings in almost as much revenue as eBay’s merchandise.

In October 2006, a year after it went public, Google paid $1.65 billion for YouTube, a video uploading site that had no revenue and little prospect of profit. At the time, the price raised eyebrows. But YouTube dominated the competition and became a significant online advertising platform for Google.

Reid Hoffman, a co-founder of PayPal who went on to found LinkedIn, the social networking site, said in an interview on Tuesday that acquisitions were made partly to gain something valuable, but also to stave off the competition. “History shows they fail most of the time, but when they win it’s very valuable,” he said. “There’s always the blended question of opportunity and threat.”

Young hot technology companies are nothing if not aware of their mortality. Because so many started out by wounding an older tech giant, they know they can be killed, or at least severely injured, by that which lurks in the rented office space of Silicon Valley — an even hotter, younger technology company.

In part, that anxiety feeds the guiding logic here: eat the new start-up before it eats you, or before a competitor grabs it. And be sure to keep extending your reach if you want to stay relevant.

“Anything they can do they will do to keep customers coming back — that’s extremely valuable to these companies,” said Len Lodish, a marketing professor at the Wharton School at the University of Pennsylvania.

In this way, Facebook’s purchase of Instagram was an effort to push into a new area before its rivals. As YouTube and PayPal did for Google and eBay, Instagram offers something that Facebook desperately needs — a whole new audience that uses technology in a totally different way.

Never mind that Instagram has no immediate promise of making money. Facebook had to make another calculation before going public, which is expected to happen in the coming months, and confronting new pressures from impatient shareholders, said David Charron, who teaches entrepreneurship at the Haas Business School at the University of California, Berkeley.

That calculation was whether it was worth a billion dollars to be sure that Instagram would not lure away Facebook users.

But in the unpredictable world of Silicon Valley, sometimes buying the newcomer does not work.

In the spring of 2005, Yahoo, still a major player in search and online media, bought Flickr, a photo-uploading site. A Yahoo spokeswoman at the time described it as part of “the next generation of Web services.”

Yet Yahoo languished, and Flickr failed to innovate and keep pace with the shift to social networking, photo sharing and mobile devices. Today, Yahoo finds itself severely challenged by the next generation of Web services.

News Corporation, a traditional media company, spent over $580 million for MySpace in 2005, when it was the dominant social network. News Corporation sold MySpace last June, after its users had defected, chiefly to Facebook. The price: $35 million.

One challenge for Facebook will be to keep Instagram users happy. On Tuesday, some expressed fears that the app would be destroyed by its new owner.

A user named “monkm” wrote: “Congrats on the purchase … I must add however that most of us on IG are on here because it’s not FB.”

An especially vitriolic comment written by a user named “brianbrutal” said: “Stick to being overlord of Facebook. We don’t want you on Instagram.” The comment was deleted.

But several people welcomed Mark Zuckerberg, Facebook’s founder, back to the service after he shared a photo of his dog, Beast, giving the pet a moment of fame. It was only Mr. Zuckerberg’s fourth post on Instagram since he signed up for the service in October 2010. That is a lot of millions of dollars for each image.

Link: Facebook Plays Offense and Defense in a Single Move


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