News headlines have been made with the purchase by Facebook of WhatsApp? for $19 billion.
Journalists looking for story lines from this have certainly not been short-changed. For example, the human story: there is the fascinating history of Jan Koum, a Ukrainian who has become a multiple billionaire at age 37. Or, if you prefer, the business model story: a questionably high price is being paid for a company that has no profits and refuses to accept advertising revenues. Alternatively, what about the industry competition story: angst is emanating out of the telecoms industry about huge revenue losses as their users may migrate to Internet-based mobile services like WhatsApp? and away from their cellular networks.
So, is this the moment that mobile apps businesses are starting to “come of age” ? Or is it another “tech bubble”, like the one that blew up the Nasdaq back in year 2000 ?
To assess which of these scenarios is likely, it is helpful to consider the component parts of the techno-commercial evolution on top of which the mobile apps business is dependent: respectively, ICT1/-based product/service innovation; network-based positive externalities.
These components may be examined under four headings:
(a) product/service innovation in the ICT 1/ sector,
(b) network-based positive externalities,
(c) supply-demand fundamentals; and
(d) new “digital age” business models that fuel Internet-enabled start ups such as WhatsApp?
ICT-based Product/Service Innovation
In the second decade of the 21st century, “ICT” is seen as a highly integrated global industrial complex. That was not the case 30 years ago. From the early 1980s, forward-thinking specialists and business executives understood that “ICT” was a potential only. Its realisation would be a process of convergence based upon rapidly-evolving technology and massive capital investments.
That convergence was driven in part by deliberate efforts to design and adopt open network communications standards. The then prevailing proprietary internetworking protocols generated high operations costs; whereas open standards dramatically accelerated network externalities (see next section).
Open standards were also premised on the expectation that network operators would be building fast, high capacity digital communications networks.2/
From a business/commercial perspective, traditional fixed network operators were amongst the least dynamic players in the market process of industry convergence. Not only did they suffer from the curse of a monopolist’s management culture. They focused almost exclusively on their networks as a “pipe” for voice telephony, doing little to innovate new products and services.
This relative absence of entrepreneurial culture left the field open for competitive newcomers whose approach was to provide fixed network-delivered, innovative products and services to consumers and businesses. Information content and delivery began to take precedence over network engineering. The first wave of these businesses were the cable companies, delivering telephony, data, video and tv programming in high density metropolitan areas.
The old monopoly – recently privatised – fixed telcos had a reprieve from this onslaught by the cable companies through the introduction of 1st and 2nd generation (mainly GSM) mobile services mainly during the 1990s. Here they learnt about the need for innovation in products and services, tailored to create and serve customers’ demand.
But cellular mobile networks, although compatible to interoperate from the outset, were still analogue outside of the core network. Products and services were overwhelmingly limited to voice telephony, SMS and a few unsophisticated “value added” services using limited bandwidth and usually accessed from 3rd party service providers via “gateways”.
In parallel with the telco industry’s diversification into mobile networking and services, powerful competitors were constructing fast high capacity fibre optic fixed networks targeting large corporate customers with demand for transactions-based processing of data. Data services became a huge growth market, particularly for services industries like the financial and banking sectors.
While in the consumer sector, two complementary software innovations came together -the creation of effective database search engines and the use of hypertext – to enable end users to access remote information using standard user interfaces. These complementary software technologies were rapidly adopted by service developers worldwide, leveraging the underlying open Internal Protocols for network transport. Companies like Google and Yahoo grew quickly out of this fertile technological complex, using business models that did not require the consumer to pay anything other than the network access fees, since these companies revenues relied instead on advertising.
Last but not least, learning from the commercial success of global GSM network expansion and the associated astonishing speed of penetration of mobile handset sales, major consumer electronics companies quickly adopted the latest generation of miniaturised integrated circuits, touch screen technologies and OS platforms during the first decade of the 21st century to roll out smartphones, tablets, ipads etc on a global scale. For the 2nd quarter 2012 global sales of smartphones was around 160 million devices, and the trend increasing. Critical mass had already been achieved.
Network-based Positive Externalities
There is a universal and fundamental characteristic of all networks: their utility grows exponentially as their user numbers grow arithmetically. This truth became a commonplace with the arrival, and subsequent diffusion, of telephones and telephone networks. So long as a user can identify who is on a network (eg. through directory services), the value to each and all increases dramatically as more people (and devices) connect.
In economics this characteristic of networks is referred to as a “positive externality”, because it is an added benefit to each and every user arising independently of any individual. It is embedded instead in the growth of potential connections of devices and people.
In an “Information Age”, where information services are delivered over networks, there is a now a combined effect of, on the one hand, network-based positive externalities and, on the other, the socioeconomics of crowd behaviour.
Socioeconomics is a new field. It uses advances from behavioural economics and related disciplines to explain individuals’ psychological responses in (mainly) financial markets. These responses are aggregatively measured as “sentiment”. There is a pervasive tendency either towards “bullishness” (over-optimism; over-buying) or “bearishness” (over-pessimism, over-selling).
Generalising this pattern to consumer markets, we have the phenomenon of “best sellers” in publishing and Internet-accessed videos “go viral” – both expressions of the same “winner takes all” rewards as psychology drives different groups of consumers into a mania of “must-have” buying.
When this psychological behaviour pattern plays out over an open, global network (the Internet), then the speed of adoption/diffusion is indeed “viral”. More importantly, the demand economics of this type of information exhibit not diminishing marginal utility, but the opposite. Perceived value to the individual is increased by belonging to the group who identify with the brand/product/image.
The supply side of this demand-supply relation is equally important: massively increasing returns to scale since the production costs of the information service do not grow proportionately to the increased quantity of demand.
Furthermore, there is a valuable bi-product for the supplier: a rapidly growing database of the transactions history of all its users’ purchasing, calls, and web-accessing history, providing the input for conducting data mining and profiling of consumers preferences which can either be sold to third parties and/or leveraged for developing new information services offerings (in the marketing jargon: “improving the user experience”)
By the middle of the first decade of the 21st century, the business opportunities to leverage the Internet and associated mobile device operating platforms to supply service innovations to consumers and business were at a “take off” stage. The knowledge of how to capture “winner takes all” returns from such service innovations was widely understood. The challenge was to design and push new generations of network-ennabled products and services that users (particularly consumers) would desire to adopt as must-have mobile services.
“Take off” is reflected by the facts that, by 2013, there were over 300,000 mobile apps software developers working in the 28 countries of the European Union 3/; while by July of that year over 1 million applications had been written for the Android platform. The latter number reflects both the low costs of entry into the sector for suppliers, as well as the “mania” of demand from consumers and businesses to use and/or offer such capabilities to their customers. What remains to be seen over the long term is how many of these service propositions make money and develop into market leaders.
Which returns us to the question of WhatsApp ? Has it, with its current mobile app offering – which is essentially an Instant Messaging service – found the Holy Grail for profitability ?
“Information Age” Business Models
Under a capitalist economic system, private enterprises either make profits or else they eventually go bust. However, today’s advanced capitalist economies form a complex globalised whole characterised by an unprecedented social division of labour as well as centuries of accumulated wealth embodied in a dynamic capital structure. Two aspects merit highlighting about this, both essential to understanding how today’s business models are changing.
One of those is the existence of specialist venture capitalists focus on identifying private start ups that need capital (eg.to fund R&D, product development and organisation expansion). Young small tech-based companies that are unprofitable yet have promising product or service innovations are frequently targeted and offered huge sums of money for investment by such venture capital firms.
Innovative software companies are frequent beneficiaries. Whether these capital injections aide or hinder their progress towards profitability is contingent on many factors, not least whether or not the original innovators remain at the company and in the driving seat as concerns product innovation. However, this venture capitalist segment of the capital markets is almost synonymous with the emergence of a dynamic ICT complex from the early 1980s. In providing previously undercapitalised start ups with additional funds for product development, this sourcing potentially cushions the innovators from the immediate risks of negative cash flow and too few customers.
The second reality that requires attention is not new, at least from the perspective of economics. It entails the operation of Say’s Law, which states that supply generates demand, which creates the income to purchase the new supply’s products and services. The fundamental truth and importance of this economic law is that it demonstrates there is no such thing as either “underconsumption” or “overproduction” at the aggregate level.
But in the context of the evolution of the global ICT industry, it also explains that, although revenues and profitability are ultimately dependent on consumers’ demand and preferences for products and services, there are also important ‘intermediate’ goods and services that are created/innovated as the dynamic structure of the ICT sector evolves and matures.
One example of such an intermediate product is a network-enabled customer base. Another is a data repository of your customer bases’ call behaviour couple with a complete directory of all their call numbers. As of December 2013, WhatsApp?? claimed to have 450 million active users. It also had downloaded from all its customers their entire contact databases off their smartphones.5/
WhatsApp?? currently charges their customers a mere US$1 per year to use their Instant Messaging Service. The company has stated, in a press conference call subsequent to the announcement of their purchase by Facebook, that they have no plans yet to introduce a fee-paying subscription, nor to allow paid-for advertising onto their application. All of which has generated provoked critical ripostes from business journalists and commentators, dismissive of their lack of revenue-generating capability.
Yet Facebook, or any other market leader in the Internet-based information industries for that matter, does not spend US$ 19 billion with having done due diligence and financial forecasting (net present value calculations of break even and beyond). They will have run scenarios of future growth of WhatsApp??’s customer base and messaging volumes. They also will have plans for further product development and cross-fertilisation of Facebook’s capabilities with those of WhatsApp?? And they will have estimated the US$ value of the potential global market, taking account of the opportunity to in the meantime kill off the telco operators’ SMS market. The possibilities of advertising and subscriber revenues as options for the future will be held in abeyance.
The $19 billion price tag for WhatsApp?? translates into $42 per current WhatsApp??? service user. That may turn out to be a very cheap price viewed 10 years hence. Alternatively, it might be turn into an exceptional accounting write down, due to risks unfolding which today are not known.
Regardless, Say’s Law applies. There is a market demand for WhatsApp??. It is an input product for Facebook’s own enterprise expansion which includes leveraging the positive externalities of the Mobile Internet and the returns to scale of monetising customer data.
1/ “ICT” stands for Information, Communications and Telecommunications industries.
2/ In 2014 it is easy to forget that even in the early 1980s, most telecom network operators across the globe were public sector monopolies and that digital lines available to businesses were of no more than 2 Megabits capacity
3/ “Mobile applications development”, Wikipedia