mzl.olptcvsjThere’s nothing like $19 billion dollars to set the cat amongst the pigeons. And what’s more for something most people even those tech savvy neither use and, in many cases, haven’t heard of. Regular readers will be happy to learn that I have been watching this space for some time due to a long standing interest in the economics of telecommunication interconnection that I have based a few years research on. So let me try and pick this apart and give you my theory as to why Facebook acquired WhatsApp and for seemingly so much.

First of all, you don’t pay that sort of money for a small venture (on 30 or so engineers) if there wasn’t some competitive bidding. It has been rumoured that Google offered $10 billion but little else and it wouldn’t surprise me if another company were there too. But I suspect that Facebook paid a premium above that — effectively 10% of their company with a board seat because they needed to bring WhatsApp founders more cleanly into the fold; just as they did with Instagram.

Second, it is important to think of the whole deal. There is some cash but effectively WhatsApp and its founders are tied to Facebook. They are to be a Facebook division but otherwise manage themselves. In that respect, the acquisition seems almost financial rather than about control.

Third, WhatsApp has grown at an incredible rate, more than doubling its users every year. It is not unreasonable to expect it to reach 2 billion and with the Facebook link it will likely get there even quicker. That said, it has competitors and some of those competitors have greater regional shares especially in China, Korea and Japan. China is not an option for Facebook but one suspects the Japanese leader, Line, and the Korean leader will be simple buys if Facebook wants them. But they key thing here is that if you watched the app store rankings WhatsApp was volatile. Basically, as it broke through to communities it would sour up the rankings. That suggests that key locally driven network effects were at play.

Fourth, and this is where it gets interesting, WhatsApp is considered by “those in the know” to be “worse” than its competitors. It doesn’t offer games, emoticons etc. It is just a simple, bare bones messaging app. They, in fact, hate what apparently makes them “worse” opting instead for Jobsian simplicity.

Moreover, WhatsApp does not mine data or use ads. Those last features are in their blood. The assumption, of course, is that was what the extra $9 billion bought and WhatsApp will relinquish those values. But it strikes me that that is presumptuous. According to Wired, those values run deep.

“There really is no key to give,” Koum says. The US National Security Agency, he insists, has no access to users’ messages. “People need to differentiate us from companies like Yahoo! and Facebook that collect your data and have it sitting on their servers. We want to know as little about our users as possible. We don’t know your name, your gender… We designed our system to be as anonymous as possible. We’re not advertisement-driven so we don’t need personal databases.”

This is more than a business position for Koum. “I grew up in a society where everything you did was eavesdropped on, recorded, snitched on,” he says. “I had friends when we were kids getting into trouble for telling anecdotes about Communist leaders. I remember hearing stories from my parents of dissidents like Andrei Sakharov, sentenced to exile because of his political views, like Solzhenitsyn, even local dissidents who got fed up with the constant bullshit. Nobody should have the right to eavesdrop, or you become a totalitarian state — the kind of state I escaped as a kid to come to this country where you have democracy and freedom of speech. Our goal is to protect it. We have encryption between our client and our server. We don’t save any messages on our servers, we don’t store your chat history. They’re all on your phone.”

Yes, I know, everyone has their price but, for the moment, let’s assume that wasn’t the thing here.

Fifth, what about disruption? WhatsApp is one of those ideas that many people had: disrupt messaging which was a cash cow for the carriers. It was such an obvious idea that carriers actually had the same idea. In the US, that rationale has all but disappeared but it is still present elsewhere in places where data as a service hasn’t quite yet taken off. It will. But, of course, people are then saying that WhatsApp’s rationale will be abandoned.

I think it is safe to say that absent some crazy abandonment of net neutrality to an extreme and some monopolisation of mobile networks, that SMS money has gone and isn’t coming back. Instead, WhatsApp and its ilk are just part of the transition of carriers to pure mobile internet access providers. That is all they are going to be in the end and that is the future state that we should consider this in. Thus, WhatsApp simplifies that movement and unbundles what people are paying for.

In which case, how will WhatsApp monetise? I think the likely incredible thing here is that it has already succeeded. WhatsApp experimented with various paid models from a paid up to a paid subscription to its now, try before you buy, option. Basically, after a year you pay $1 per year. It is dead simple and quite lovely. There are no gimmicks there either. You have to initialise the paid version. It doesn’t just kick in. There is something so refreshing in a service that just gets people to pay for it if it is worth something to them rather than exploit some failing in their rationality. Again, this is built into the company:

“The F-word here is focus,” Koum says. “All software bloats to the point when it sends and receives email. Jamie Zawinski said that. The difficult part for us is adding features without making the product more complicated.” Acton adds: “People ask for a desktop version, for user names — but we focus on the utility of the app, its simplicity, the quality of the service. Ads, games, gimmicks — that stuff gets in the way. We don’t want to build a hookup app so you can find someone weird to talk to. It’s not what we’re about. We’re about your intimate relationships.” When they add new features, it is only after intense discussion and experimentation, and a conviction that execution will simplify rather bloat the service. For the recently rolled-out push-to-talk voice messaging, it takes a single tap to record and send a voice message; to play it, a phone will automatically switch from speaker-mode to soft volume when its proximity sensor detects that it’s being held near an ear.

But there is more going on here and here is where it links in with Facebook. Facebook’s hallmark has been “trusted social.” That means that connections between individuals are by mutual assent. Facebook does that by default even if there are no variants. A few years ago, Facebook looked like it was moving into email. Again, its focus was on a platform that would have no spam, no unwanted interactions. As it turns out, no one cared about email but many do use Facebook’s messaging as a substitute. Indeed, get a message from someone else and you have to struggle to find it. It is completely buried. Facebook don’t want to give you a tool to “get in touch” with someone but to “stay in touch” with them. There is a big difference.

WhatsApp, more than any other service, adheres to this philosophy. To message someone, they have to be on the platform. If they are not there you can’t connect with them. It is basically a Facebook like curation of who can contact you. Thus, unlike iMessage or SMS, there’s no spam, no unwanted texts.

What Facebook bought was that: the messaging platform most compatible with their own core philosophy of trusted communications. They know that “getting social” means getting activity and that means only granting access to people you trust. WhatsApp is founded on the same principle. They want those lasting relationships. They want weak ties to interact with more strength. I suspect there was a meeting of the minds that led to this merger. If you are on a Facebook product, everyone you know is already on the “do not call” list.

Moreover, there is strategic compatibility on another dimension. WhatsApp is not a “get big quick” company. It was about acquiring users for the long term in an environment where, by creation, there are strong network effects — only people on the platform can communicate — there are no cross-platform options.

“We’re the most atypical Silicon Valley company you’ll come across,” says Acton, a clean-cut, red-faced 42-year-old from Michigan, whose appearance contrasts markedly with Koum’s 188cm-tall, dark, unshaven look. “We were founded by thirtysomethings; we focused on business sustainability and revenue rather than getting big fast; we’ve been incognito almost all the time; we’re mobile first; and we’re global first.” He and Koum, he adds, are “the yin and yang — I’m the naïve optimist, he’s more paranoid. I pay attention to bills and taxes, he pays attention to our product. He’s CEO. I just make sure stuff gets done.”

This is not a company focussed on execution in a way that they have to be the best out there right now and earn money by being superior now and into the future. Instead, they opted for a closed network and a stealth strategy that allowed them to build a sustainable but ultimately locked in user base. That is, they used network effects — except like Facebook these were a feature rather than a bug. To do this they made promises on monetisation but in the end if all goes well, they grow, have a large user base and don’t need to do that much to live off them into the future. Others have tried for this — like Blackberry Messenger (who pioneered this years ago — the whole package and let it slip by) — but they were artificially tied to another platform or hardware. WhatsApp is software and each user is an annuity. That sort of thing makes you valuable.

Finally, it goes without saying that Jerry Seinfeld anticipated all of this.

3 Responses to WhatsApp to Facebook? Strategic compatibility, that’s What

  1. John G. says:

    good article, but i was just talking to a younger cousin who uses this app like crazy in a developing country (which is whatsapp’s forte) and he said that basically once the 1 year was done and they were required to pony up the $1 (the cost of 2 macdonalds burger in this country) they essentially deleted their app and reinstalled it, giving them another year. so i wont count on that annuity being 1 for 1 for each user.

    • Oupoot says:

      Lets not forget that in many countries, mobiles change every 2 years, if not sooner. Thus, a new phone, a new digital ID and a new WhatsApp application – seriously raising the question of continuing perpetuity. Maybe the tie-up with Facebook will overcome this feature?

  2. […] Joshua Gans attempts to explain WhatsApp, the small text messaging service that was acquired by Facebook for a combination of cash and stock reported as $19 billion. He writes, […]

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