Facebook Inc (NASDAQ:FB) no longer has to be the best, and this has a lesson for anyone buying social stocks.
As TechCrunch notes, FB stock has used a new Instagram feature called “Stories” to cut the growth rate of rival Snapchat, much as it previously used a feature called “Subscribe” to cut into the growth of Twitter Inc (NASDAQ:TWTR).
The aim is not to kill rivals. The aim is to deliver something “good enough” to cut into those rivals’ growth, to degrade their value and to keep those users who already depend on Facebook from leaving by increasing their switching costs.
A Strategy With A History
This is a strategy with a very long history.
In your grandfather’s day, back when mainframes were all the rage, and programmers wore ties, International Business Machines Corp. (NYSE:IBM) did this repeatedly to rivals like Burroughs, Univac, NCR Corporation (NYSE:NCR), Control Data and Honeywell International Inc. (NYSE:HON). These rivals, called at the time the “BUNCH” for their initials, could only survive by going into other businesses.
Burroughs and Univac, by the way, are now Unisys Corporation (NYSE:UIS).
In your father’s day, when PCs were the new thing, and portable meant they had a handle, Microsoft Corporation (NASDAQ:MSFT) used the same strategy against Apple Inc. (NASDAQ:AAPL) and its Macintosh. Windows was not the best graphical user interface, but it was good enough, it was cheaper, and it was more open to software developers. The “network effect” from this eventually made Apple a niche player.
Understanding Network Effects and FB Stock
So it is today with social networking, especially on mobile platforms.
Facebook no longer has to be the best in a new niche, on a feature-for-feature basis. It just needs to be good enough to keep most of the people dependent on it from leaving the platform, the way a peloton in a bicycle race can catch a breakaway — stay in the bunch, keep up a steady tempo and the lone rider will tire.
But this fact also has big implications across the social sphere. Once a company’s “network effect” makes it the 800-pound gorilla in a space, the attractiveness of other solutions wanes, consolidation takes place and the oxygen of capital that start-ups need to survive moves on.
Facebook CEO Mark Zuckerberg understood this history. That’s why he launched the Open Compute Project in 2011, investing enough in its own data centers to make Facebook independent in the cloud. That is why he made Facebook a “mobile first” company in 2013, closing projects that focused on desktops. He knew that getting there “first with the most,” as the military strategists say, is the key to winning the war.
The Lesson: Buy Facebook
What does this mean for investors? Simple. If you want to be in social, if you want to be in mobile, close your eyes to the price and buy FB stock.
Yes, at $125/share it is trading at 60 times earnings. But it had $17 billion in revenue last year, and already has nearly $12 billion for the first half of this year.
More important is that Facebook has achieved control over the mobile-social market. It’s on the hill everyone else wants to get on, and that hill is heavily fortified by data centers, programmers and enough cash to buy into any niche it wants. Even if Facebook has to take or develop the second-best solution in a particular niche, it can now use network effects to slowly crush the best solution in that area.
Until the great game of technology moves off mobile platforms and social networks, just buy FB stock.
Dana Blankenhorn is a financial journalist and futurist who dabbles in fiction, his latest being The Reluctant Detective Travels in Time. Write him at email@example.com or follow him on Twitter at @danablankenhorn. As of this writing he owned shares in AAPL and MSFT.