Competitive Advantage of FACEBOOK

With more than 1 billion users, Facebook is the world’s largest social network. Founder Mark Zuckerberg started Facebook in 2004 while he was an undergraduate computer science student at Harvard University.

Facebook (NASDAQ: FB) has the highest market share amongst all social networking sites, averaging ~60% of all visits in 2013. At this stage in its development it boasts a respectable return on capital, exceeding 10%. A business with a competitive advantage has both a stable market share and a return on capital substantially exceeding its cost of capital, and these measures persist into the future. The question is: Does Facebook have a sustainable competitive advantage, and if so, what is it?

Facebook design and develop websites and apps that allow millions of people around the world to communicate and share information. When you look closer at what the Facebook platform actually does, it is simply an amalgamation of existing applications like email, messaging, contact book, photo sharing and a message board. The key achievement of the founders, managers and associates of Facebook was becoming the dominant social network by gaining acceptance in the mass market. However while currently #1, they were not the first, and won’t be the last social network.

If Facebook is in the process of developing a competitive advantage, their dominance of general use social networking points to the potential source of their competitive advantage: network effects. Facebook is well known but probably in an industry where brand name matters for little. MySpace was once the dominant social network and is now almost unheard from. The switching costs are very low for users of these platforms. They can easily move to another platform with a minor loss of data, like photos, which are in all likelihood already backed up on a personal hard drive.

Platforms such as Facebook benefit from network effects that can create a captive audience. The addition of a new user adds value to existing users of the platform because it creates a richer experience, as each user can more easily connect and share with more people. It reaches a tipping point where all new users looking for this experience have one obvious choice, and this system ensures users remain on the same platform. Therefore it is obvious that Facebook possess a network effect, as they have the highest number of users on their platform.

However the shortcoming of the Facebook platform compared to other platforms is the value that a user gains. On other platforms with network effects like stock exchanges and online marketplaces like eBay, users get additional monetary benefits by using one platform. There is more liquidity and this leads to lower transaction costs or higher bids. On Facebook the value gained is less material, it doesn’t have a dollar value.

Facebook’s network effect has a lower value. Social networks and other communication platforms have a fickle history – once prominent platforms like MySpace, Friendster, Hotmail, MSN Messenger and ICQ have over time lost most of their active users. Given these observations it is the sustainability of Facebook’s network effect that is the sixty-four million dollar question.

Social media companies are built on technology and it is an industry with a significant amount of ongoing innovation. Replicating Facebook would mean hiring skilled engineers, writing the code and building data centres required to deliver the service. In one form or another there are currently thousands of entrepreneurs around the world working on creating these platforms. Viber, SnapChat come to mind and Facebook has already acquired Intagram and WhatsApp to strengthen and defend their platform. As Facebook can be viewed simply as an amalgamation of existing web applications, the major hurdle is not innovation but rather, convincing internet users to move their social networking over to a new platform.

So with enough capital the platform could be easily replicated. There is a long history or migrating to new platforms. With this in mind it is vital that Facebook prove their business model over time and show that they can attract sticky users. The early stage of a potential network effect is shown by the high market share of Facebook in the product space, but it is a developing rather than existing competitive advantage. Its sustainability remains questionable. User numbers in various important demographics must be watched carefully.

However if Facebook do build and maintain a competitive advantage based on a network effect, given the economics of the industry as seen in the Research Factors Business Ranking, the rewards will be immense.

references:
 http://www.researchfactors.com/does-facebook-have-a-competitive-advantage/
http:// www.wikipedia.com/facebook