Facebook's Competitive Advantage
Simon is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
When considering a new position, I typically put stocks through a three-step analysis:
1 - Competitive Advantage - to assess if there is a moat, that will enable the company to become or remain profitable.
2 - Quantitative Metrics - to determine whether or not the price is right to buy.
3 - Sector Specific and Red Flags - to ensure the company is hitting the important metrics and that there are no potential landmines.
With all of the hype surrounding Facebook (NASDAQ: FB) lately, I thought it would be a prime contender to run through the paces. We'll assess the competitive advantage of the social media giant by looking at four distinct areas:
1 - Intangibles: Brand recognition, Patents, Leadership and Vision, and Culture
2 - Stickiness: Recurring/Habit Forming, High Switching Costs, Distribution Network
3 - Customer Experience: Network Effect, Word-of-Mouth Advertising, NPS Positive
4 - Cost Advantage: Resource Location, Process/Scale
Each identifiable sub-component is worth one point, so there are 12 points possible to score (I have yet to find a company that scores a perfect 12). I generally consider a company that scores at least 3 points to qualify as having a competitive advantage, and at least 5 points to have a strong competitive advantage.
That said, let's see how effectively Facebook has used its online picks and shovels to dig out an economic moat.
Looking first at intangibles, it is hard to argue that Facebook is not a well-known and popular brand. There is also a case to be made that their brand is increasing their customers' willingness to pay. The average cost per impression on Facebook is up 41% over the past year, and up 15% over the last quarter alone (http://www.searchenginejournal.com/facebook-ads-cost-increasing/42658/)
One of Mark Zuckerberg's biggest criticisms is that he's only 28 years old and doesn't yet have an established level of experience or business acumen. However, he is relentless in his dedication to perfecting every Facebook experience and has a vision for what it is to become.
Having personally visited the Facebook building, I don't believe the company has yet established a strong culture amongst its employees (most just sit at their desks and play strange music), nor are there patents that are protecting any IP.
Facebook scores 2 of 4 possible points for Intangibles.
Facebook is incredibly habit-forming for both its users and for advertisers. It has embedded services to optimize ad performance and to best reach target audiences. This makes advertising more effective over time and creates switching costs if advertising elsewhere. Users and advertisers do not want to re-learn how to use a second social network once they have gotten used to Facebook's features. There is no distribution network that blocks out competitors, as all content is provided online.
Facebook scores 2 of 3 for Stickiness.
Possibly Facebook's biggest strength is its mastery of the Network Effect. There are now 900 million users worldwide that are continuing to send friend requests, 'like' content, and post updates. The rule of large numbers reminds us that eventually this growth will slow down, but the network effect is alive and well.
This also lends to another source of advantage: Word-of-Mouth advertising. Because Facebook has an army of users and advertisers promoting it, it doesn't have to pay significantly to attract new users -- which continues to strengthen its network. Lastly, Facebook is receiving positive feedback from those that advertise on it. As of this morning, their Facebook Marketing page (which guides new businesses on how to set up accounts) has nearly 1.5 million "likes" and is full of success stories of people bragging on it.
Facebook rakes in 3 of 3 for Experience.
There are no cost advantages in Facebook's location or process, so no points are awarded for Cost Advantage.
Summing up all of the tallies, Facebook scores 7 points for Competitive Advantage:
Brand - 1
Vision/CEO - 1
Habit Forming - 1
Switching Costs - 1
Network Effect - 1
Word of Mouth - 1
NPS Positive - 1
Total Points = 7
Though creating a competing online social network is not terribly difficult, it would be very difficult at this stage to match Facebook's user base and customer experience. Users have gotten accustomed to the features of Facebook - sharing pictures, tagging friends, etc - so I don't see them jumping ship immediately if a competitor (ahem, Google) were to offer a similar service.
Though the 2011 dot-com bubble taught us that there are plenty of risks involved with investing in internet startups, Facebook remains the best-in-breed of social media. In Step 2 (soon to follow), we will look at valuation and determine what price is right to jump in at.
Simon has no position in Facebook, but is interested in the potential of the social media juggernaut. TXinvestor82 has no positions in the stocks mentioned above. The Motley Fool owns shares of Facebook. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.If you have questions about this post or the Fool’s blog network, click here for information.