Microsoft, Facebook, and the shift of the platform to social networks

I was just interviewed on ABC Radio about Microsoft’s mooted acquisition of 3-5% of Facebook for US$500 million or so, as written about by the Wall Street Journal today. I’m severely jetlagged and it’s well past my bedtime, but I thought I’d make a few quick notes on points I raised in the interview that are relevant to this story.

Value is increasingly seen as shifting to social networks. When News Corp bought MySpace 2 ½ years ago for $580 million, I pointed out that what it was buying was the positioning at the interstices of people’s relationships. Media – as in the flow of information – is increasingly between people rather than in a hub and spoke arrangement, which makes social networking platforms central to value creation.

Social networking platforms have figured out what works. Since 2000 when sixdegrees.com made the first bold attempt to create a system to create value from linking people and subsequently failed, social networks have gradually improved to the point where they are drawing in a massive number of participants. MySpace was the first true success story, and in absolute numbers is still far larger than Facebook. However Facebook has translated MySpace’s success to a professional and arguably more diverse demographic, through different positioning and features. Social networks are rapidly becoming central to people’s interaction with the online world.

Valuation reflects potential future value and position, not the current asset. A social networking platform on its own will very likely never be worth $10 billion, which is what Microsoft appears to think Facebook could be worth. However Facebook has extraordinary latent value in its positioning as a platform. From its current form it could branch out to become a strong or conceivably dominant position in the online world. Just as Google started with the platform of a good search engine and used that to move into other domains, Facebook could well shift into a wide variety of online applications and monetization mechanisms. Microsoft, Yahoo!, or Google are far better to exploit this potential value than Facebook as a stand-alone company. The obvious and much-discussed valuation alternative is an IPO, which would give a very high valuation to Facebook given its popular appeal and recognition. This means that the $10 billion figure is in fact not unrealistic.

This is all about the platform of the future. The computing platforms of the past have been dominated by Windows. More recently the level of the dominant and meaningful platform is the web-based application. It is quite likely that the level of the platform that can extract the most value in the future is at or close to the level of the social network. If this is true, the implications include 1. that these valuations are entirely in order; and 2. that the key issue for the major players or aspirant players in the online world is how to parlay their existing assets into the new spaces in and around that platform. Given the current landscape, there is no question that Facebook has to be at the center of strategic discussions.

The value of Facebook could quickly erode. Facebook has swiftly both built a new market and acquired a large chunk of the existing market, primarily boosted by opening its application to developers. In the same way, this predominant position could as quickly go to another competitor, for example Google if it plays its cards right. Two things will be required for this: first, openness in how data can be used across social networking applications, meaning that individuals would feel absolutely no lock-in in using the system; and second, complete user control of that data, and user trust in how this works. If those criteria are in place, and the functionality of a new or evolved system continues to build on what we have learned so far, it could gain users very quickly, significantly at the expense of Facebook, once it gained momentum.

Noteworthy commentary:

24/7 Wall St: Competition for Facebook could push up prices.

Read/Write Web: Facebook could use the money to make acquisitions.

Rob Hof: Where is Facebook’s ad strategy?

Allen Stern: Microsoft and Facebook may not be a good fit

Dan Farber: Google aren’t likely to slow down Facebook