Sunday, March 25, 2012

The facebook singularity at $1,000,000,000,000

The entry below is just a 'blogification' of comments I made on this article:

From the article: "My internet guru just sent me the arithmetic that shows without any doubt that Facebook  can’t be worth $75 billion in market cap– much less $100 billion. At that crazy valuation, it might be the short of 2012."

There follows after that quote an argument, indeed using arithmetic, that is childish in its simplicity. Here is my response to that article:

Facebook is worth *more* than $75 billion and if I could purchase the whole shooting match and had the $75 billion I would put it down in a heartbeat.

Your Internet guru sent you arithmetic. Sometimes, it *is* just a simple matter of arithmetic. Sadly, this is not one of those times. This is a question of mathematics. Facebook has gone well beyond the critical mass necessary to be virtually impossible to beat. As a matter of fact, the only thing that can beat Facebook now is Facebook. It is theirs to lose.

Right now, Facebook is capable, free and it has my data, my linkages with friends and family and their data and their linkages with friends, family subjects, companies and people of interest. It knows a ton about me personally, can triangulate even more using information about my friends and other associations and has a certain level of trust that it continues to consolidate. In some instances, I can communicate more easily via Facebook than any other way. Some of the people I can contact on Facebook I don’t even have any other contact information for and for reasons too involved to go into here, contact information I would never otherwise have and could only ever obtain from Facebook or a rich, competent populated surrogate if it existed. It does not, by the way exist and it shows no sign of coming to exist.

If any player is going to defeat Facebook globally, they will have to invest an enormous amount of money, correct the few (though still highly vulnerable) deficiencies it has, improve upon its services and tie up Facebook with the ugliest of regulatory hurdles and lawsuits.

Were I in charge of a Microsoft, Apple, Google, Yahoo, IBM, HP or similar large and powerful player, I would be scrambling right now to *partner* with Facebook while there is any entre left. People in charge of Facebook might be willing to lay off some of their risk by partnering at this point, but that window is rapidly closing.

Were I in charge of competitors, particularly Google, I would be very worried right now and dealing with the challenge presented by Facebook would be priority number one, with all others a very distant second. Unless Google can respond to the threat posed by Facebook, Facebook will almost entirely cut off its oxygen supply. It is a Google killer; perhaps the only one.

Advertising is the lifeblood of a company like Google. They make eyeballs available to advertisers and as long as the advertiser can find a way to make those eyeballs into conversions that pay more than the cost of advertising, they will advertise with Google. Thus far. Even if $100 into Google Adwords yields $110 in net revenue, that $100 will go elsewhere if it produces *more* than $1,000 in the competing system.

The competing system is Facebook and it will soon become an unbeatable competitor. They will soon be in a position to guarantee a return on advertising for most things sold on the Internet. They will be the advertiser’s partner and the partnership will make money for both partners. They will also, by virtue of their place in the middle, be able to tell which ultra-high margin products are being brokered and they will be able to replace the broker.

Because Facebook is in such a strong position to know *what* I will buy, when and why, it is much more likely to be able to place an ad that successfully converts into a sale. The experience on Facebook will be much more likely that you do not see an advertisement for something until you want to buy it. Because Facebook has an intense ongoing relationship with you, it will not attempt to fool you into taking inferior deals. Its best option is to make sure it only shows you stuff you want, when you want it and for a price and conditions that make you happy to buy again.

There is, at this time, no player anywhere that can even come close to challenging Facebook. The closest any entity came was MySpace and Facebook crushed them.

Unless they mess it up, and they have shown little sign of doing so, Facebook will be the first Trillion Dollar company. In fact, there is every possibility that Facebook is a singularity and will largely redefine commerce. Knowledge is power, especially now, and Facebook has more relevant knowledge than any other entity, no matter how you measure it and that knowledge is growing and consolidating at an exponential rate.

If you put down $75 billion today and capture a company whose market cap exceeded a trillion dollars in ten years you would have made a cool Trillion on your investment. There is no other place you could put $75 billion dollars and hope for such a return.

Fire your Internet guru or at least stop using him for investment advice.

Just a hint, if there are not exponents in the numbers being used to describe Facebook, the analysis is fundamentally wrong. This is not about a collection of servers and linear growth or even ordinary exponential growth. It is not about past performance, traditional ways of calculating investment, cashflows, etc.

The only relevance that traditional figures have to Facebook is to determine whether or not it can keep its infrastructure alive. It is very much well beyond that point and hence any traditional measure will not be relevant until either there is a serious competitor, some unusual and costly obstacles or it has grown so large it is no longer growing *and* it has finished ‘consolidation’. By ‘consolidation’, I mean that it has only made an initial engagement with users and there are many more to come.

The one thing with the most significant value going forward is the client relationship. One company dominates this entirely and that is Facebook. Should Facebook be able to make available, on a competitive basis, certain products (and a broad range is suitable), it will rapidly dominate that market.

Siphoning users off of Facebook is not, at this point easy to do. A competitor would have to not only offer significant incentives to users that demand an enormous infrastructure, it would have to somehow offer incentives to entire communities and communities of communities and hold them in thrall long enough to establish some permanence.

While competitors are attempting to make sense of Facebook, Facebook continues to extend its hold and each addition creates exponentially stronger bonds. Whisper-thin connections between teenagers create networks of connections among their adult relatives stronger than the mightiest ropes in a smaller and less integrated network. In a new network, the bond between lovers is not as strong as the bond between a person and a photo of their dog.

I have not made a tally, but I would bet money that in one way or another, every single one of the fortune 500 companies are represented on Facebook and I would be surprised if the vast majority did not have their own page. This one network connects the entire world and with every passing day those connections increase in number and strength.

Again, if someone is coming to you with the arithmetic of financial information, they have no idea what they are talking about. The value of Facebook is in the network of relationships that it mediates and the value of such a network grows, not with the number of people N or even some power like N squared or N^10. It grows at the rate of 2^N:

Not ….. N = 0 – 1 – 2 – 3 – 04 – 05 – … 50 …
Not . N^2 = 0 – 1 – 4 – 9 – 16 – 25 – … 2,500 …
But . 2^N = 1 – 2 – 4 – 8 – 16 – 32 – … 1,125,899,906,842,624 …

In the case of Facebook, N (above) is equal to more than 800 million and is not just quantitatively different from smaller networks. It is qualitatively different in fundamental ways we have yet to discover. Any attempt to squeeze an analysis of something like the value of social networks into simple arithmetic misses the point entirely and is guaranteed to be wrong.

It is possible that Facebook will reach a value of $100B, stall and fall to earth, but it is hard to imagine how that would happen if they do not either shoot themselves in the foot or come under concerted attack by very powerful forces.

Two other clues for the thoughtful.

1) Wall street has not even been that good at historical review, let alone prediction.

2) If Facebook started eight years ago in 2004 (it did) and it was worth a million dollars then (it was almost certainly worth less), and it is worth $10 billion dollars today (even the author above thinks it is worth more) it would have had to increase roughly ten times in value every two years since then. By that reckoning, it would be worth $10B in 2012, $100B in 2014, $1T in 2016, $10T in 2018 and $100T in 2020. I would say that grabbing that tiger by the tail at $75B would be a fantastic bargain.

I *do* expect Facebook (or an incumbent that manages to replace it) to be worth more than a trillion dollars over the next five to ten years, possibly even sooner. Beyond that, I am not sure that type of measurement keeps its meaning. It is conceivable that an operation like Facebook could begin pulling in $25 to $50 billion dollars per quarter and given its commanding position in the marketplace it is conceivable that margins would be wacky.

Update 2015-09-08: Facebook currently has a market cap of 0.25 trillion dollars. My purchase at 0.075 trillion dollars would have paid off handsomely at a bit over 3:1 by now.

Update 2016-03-08: Facebook currently has a market cap of 0.32 trillion dollars. My purchase at 0.075 trillion dollars would have paid off handsomely at a bit over 4:1 by now.

Update 2017-06-28: Facebook currently has a market cap of 0.44 trillion dollars. My purchase at 0.075 trillion dollars would have paid off even more handsomely at more than 5:1 by now. To be honest, even though I was confident enough in my reasoning, I am a bit surprised that they currently are heading for a half a trillion dollars and show no sign of slowing. They now have 2 billion users. At this point in time, Mark Zuckerberg is personally worth an astounding $65B -- nearly double the $35B the Forbes author thought Facebook was worth and more than 80% of the way to the $75B the Forbes author thought Facebook could not possibly be worth. I don't know how things will unfold from here because Mark Zuckerberg is calling the shots and that puts him under intense pressure as the vast Facebook enterprise becomes ever more complex. It's easy to see him stumbling. If not, though, Facebook's currently strong $3B per quarter profit through ad sales should increase and could spike dramatically at any time.

Update 2017-12-15: Facebook continues to climb and has established a clear pattern.The chart below is based on Facebook's market cap at mid-year from 2013-2017. Barring some unusual event, I see no reason why it would not continue with that growth pattern. It has not come close to maxing out monetization of its site. I have been meaning to write an article about all the 'low-hanging fruit' that Facebook has still not reached for.

Update 2019-02-04: Facebook's market cap stalled around the half-trillion point. Part of the halt is due to investor reliance on MAU growth as a measure, which at the now 2.2 billion user point is hard to sustain. However, I think that Facebook has failed to capitalize on obvious paths to further growth in penetration and revenue and they have failed to capitalize on key assets.
Below are some of the largest companies by market cap along with important profit centers. Facebook, by virtue of its combination of capital, infrastructure, global reach and engaged users is able to move into their profit areas. All of these companies, Facebook included, have a couple of critical weaknesses in common that Facebook is singularly able to correct and then exploit. All of these companies are highly vulnerable to rapid takeover of some of their revenue sources. Oddly enough, because of some major structural shifts affecting these companies, all of them are vulnerable to attack from a novel new competitor emerging from the very environment they have created.
Microsoft 780,520<< Cloud
Apple Inc. 748,680<< Ecosystem+Hardware 735,900<< Cloud, Brokering Sales
Alphabet Inc. 728,360<< Search, Cloud
Berkshire Hathaway 499,590<< Reinsurance
Facebook 375,890<< Social Networking
Tencent 375,110<< Cloud
Alibaba Group355,130<< Cloud, Brokering Sales
Johnson & Johnson 346,110<< Pharmaceuticals 
JPMorgan Chase 324,660<< Financial Services
Total >>5,269,950

Update 2020-08-07: Facebook currently has a market cap of 0.77 trillion dollars. As I write this, that is now over the Trillion mark in Canadian dollars. My purchase at 0.075 trillion dollars would have paid off more handsomely still at more than 10:1 by now.
At this point in time, Mark Zuckerberg is personally worth $100B. More than the $75B the Forbes author thought the whole company could not be worth ($75B). To be honest, I thought that Facebook would be well past this point. There have been missteps. Unfortunately, they have had trouble holding on to their position with certain demographics as some platforms with new use cases draw users away -- Instagram, Twitter, TikTok, etc.
Facebook still has an enormous audience. They can essentially reach every person on the planet if their news is interesting enough. Facebook could beat Google by offering actual sales in localized marketplaces rather than just advertisements. They have enough data to mine to allow them to determine who is looking for what. Facebook should pivot so that it is buyer-centric, offering as much assistance to buyers as possible so that they can buy what they want, when they want, at a price that makes them happy about the sale. By monitoring what people are looking for (here's an idea: ask them), Facebook can present only advertisements that are of genuine interest to people at the time they are going to purchase anyway. There are numerous ways to increase user engagement in ways that don't waste their time. One huge hurdle that needs to be dealt with is to restructure to gain and keep user trust. That means putting users in charge of their data, putting in place some governance that disallows the company breaking important promises, monetizing user content for the benefit of the user, putting in place privacy mechanisms that make it impossible for bad actors like states to pierce certain veils without genuine community oversight. At this point, Facebook is an enormous ship to steer. I would give thought to splintering into separate focused entities that have a covenant to share common services and infrastructure. I would set up competitors to things like Twitter and Youtube, offering better monetization, privacy, data security and a mutually beneficial covenant going forward. I would start by creating an internal organization whose sole purpose is to examine other entities whose growth is exponential, determine the cost/benefit of duplicating and folding it in and fast track a credible pilot.

Update 2021-05-02: Facebook currently has a market cap of 0.923 trillion US dollars. As I write this, that is now over 1.1 trillion in Canadian dollars. As incredible as it seemed when this was first posted, it seems reasonable to expect Facebook to crack the $1T USD mark, and to do it sooner than predicted from the graph I posted in 2017. This is despite what I would consider to be missteps on their part. Despite effectively saturating penetration on users (approximately 1/3 of the world's population), they are still riding the wave of GFN math because of unrealized synergies. When I originally posted this article, Facebook was not even on the FT 500 list. It made it on to the list in 193rd place the following year. As of this writing it is the fifth largest publicly traded company in the world by market cap. Ahead of Facebook are Apple, Microsoft, Amazon, and Alphabet (Google). All of these have essentially monopoly positions in incredibly lucrative areas. All of them are uniquely vulnerable to competition from Facebook. Of the group, only Facebook still has a steep upside. However, Facebook also has a weak underbelly being attacked by competition. They have been good at buying or out competing emergent competitors, but they have, in my opinion, failed to capitalize on their unique position with respect to the most important thing in today's what I call the 'attention economy'. Were they to buy DuckDuckGo and pour their time, money, and data into it, they would have a Google killer engine. Were they to have a compelling offering to replace iPhones, they could out compete Apple. Were they to provide compelling user and corporate office functions, and a smooth on-ramp and workstation with Linux, they would be able to shift users permanently from Microsoft. Were they to put in place or buy a package distribution network and court third party sellers, they would be able to move users off of Amazon. Amazon Prime dollars across more than a billion users would make that one aspect of the company worth more than a trillion dollars. Because of their incredible reach and central place in the emerging attention economy, Facebook is the only company uniquely positioned to make a clean sweep of the most lucrative markets, and plant immovable global roots. One of the tools that Facebook needs to gain mastery of quickly is AI. In this area, too, they have an almost insuperable advantage. One of the crucial bottlenecks for capitalizing on emerging AI is training data, and Facebook has extraordinary access to existing data and a unique pipeline for mining additional high quality data. 

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