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Google’s looming hegemony

 

If we factor Google geospatial applications + its unique data processing infrastructure + Android tracking, etc., we’re seeing the potential for absolute power over the economy. 

Large utility companies worry about Google. Why? Unlike those who mock Google for being a “one-trick pony”, with 99% of its revenue coming from Adwords, they connect the dots. Right before our eyes, the search giant is weaving a web of services and applications aimed at collecting more and more data about everyone and every activity. This accumulation of exabytes (and the ability to process such almost unconceivable volumes) is bound to impact sectors ranging from power generation, transportation, and telecommunications.

Consider the following trends. At every level, Western countries are crumbling under their debt load. Nations, states, counties, municipalities become unable to support the investment necessary to modernize — sometimes even to maintain — critical infrastructures. Globally, tax-raising capabilities are diminishing.

In a report about infrastructure in 2030 (500 pages PDF here), the OECD makes the following predictions (emphasis mine):

Through to 2030, annual infrastructure investment requirements for electricity, road and rail transport, telecommunications and water are likely to average around 3.5% of world gross domestic product (GDP).

For OECD countries as a whole, investment requirements in electricity transmission and distribution are expected to more than double through to 2025/30, in road construction almost to double, and to increase by almost 50% in the water supply and treatment sector. (…)

At present, governments are not well placed to meet these growing, increasingly complex challenges. The traditional sources of finance, i.e. government budgets, will come under significant pressure over the coming decades in most OECD countries – due to aging populations, growing demands for social expenditures, security, etc. – and so too will their financing through general and local taxation, as electorates become increasingly reluctant to pay higher taxes.

What’s the solution? The private sector will play a growing role through Public-Private-Partneships (PPPs). In these arrangements, a private company (or, more likely, a consortium of such) builds a bridge, a motorway, a railroad for a city, region or state, at no expense to the taxpayer. It will then reimburse itself from the project’s cash-flow. Examples abound. In France the elegant €320m ($413m) viaduct of Millau was built — and financed — by Eiffage, a €14 billion revenue construction group. In exchange for financing the viaduct, Eiffage was granted a 78-year toll concession with an expected internal rate of return ranging from 9.2% 17.3%. Across the world, a growing number of projects are built using this type of mechanism.

How can a company commit hundreds of millions of euros, dollars, pounds with an acceptable level of risk over several decades? The answer lies in data-analysis and predictive models. Companies engineer credible cash-flow projections using reams of data on operations, usages patterns and components life cycles.

What does all this have to do with Google?

Take a transportation company building and managing networks of buses, subways or commuter trains in large metropolitan areas. Over the years, tickets or passes analysis will yield tons of data on customer flows, timings, train loads, etc. This is of the essence when assessing the market’s potential for a new project.

Now consider how Google aggregates the data it collects today — and what it will collect in the future. It’s a known fact that cellphones send back to Mountain View (or Cupertino) geolocalization data. Bouncing from one cell tower to another, catching the signal of a geolocalized wifi transmitter, even if the GPS function is turned off, Android phone users are likely to be tracked in realtime. Bring this (compounded and anonymized) dataset on information-rich maps, including indoor ones, and you will get very high definition of profiles for who goes or stays where, anytime.

Let’s push it a bit further. Imagine a big city such as London, operating 500,000 security cameras, which represent the bulk of the 1.85 million CCTVs deployed in the UK — one for every 32 citizens. 20,000 of them are in the subway system. The London Tube is the perfect candidate for partial or total privatization as it bleeds money and screams for renovations. In fact, as several people working at the intersection of geo applications and big data project told me, Google would be well placed to provide the most helpful datasets. In addition to the circulation data coming from cellphones, Google would use facial recognition technology. As these algorithms are already able to differentiate a woman from a man, they will soon be able to identify (anonymously) ethnicities, ages, etc. Am I exaggerating ? Probably not. Mercedes-Benz already has a database of 1.5 million visual representations of pedestrians to be fed into the software of its future self-driving cars. This is a type of applications in which, by the way, Google possesses a strong lead with its fleets of driverless Prius crisscrossing Northern California and Nevada.

Coming back to the London Tube and its unhappy travelers, we have traffic data, to some degree broken down into demographics clusters; why not then add shopping data (also geo-tagged) derived from search and ads patterns, Street View-related informations… Why not also supplement all of the above with smart electrical grid analysis that could refine predictive models even further (every fraction of percentage points counts…)

The value of such models is much greater than the sum of their parts. While public transportation operators or utility companies are already good at collecting and analyzing their own data, Google will soon be in the best position to provide powerful predictive models that aggregate and connect many layers of information. In addition, its unparalleled infrastructure and proprietary algorithms provide a unique ability to process these ever-growing datasets. That’s why many large companies over the world are concerned about Google’s ability to soon insert itself into their business.

frederic.filloux@mondaynote.com

 

Schibsted’s extraordinary click machines

 

The Nordic media giant wants to be the #1 worldwide of online classifieds by replicating its high-margin business one market after another, with great discipline. 

It all starts in 2005 with a Power Point presentation in Paris. At the time, Schibsted ASA, the Norwegian media group, is busy deploying its free newspapers in Switzerland, France and Spain. Schibsted wants its French partner Ouest-France — the largest regional newspapers group — to co-invest in a weird concept: free online classifieds. As always with the Scandinavian, the deck of slides is built around a small number of key points. To them, three symptoms attest to the maturity of a market’s online classified business:  (a) The number one player in the field ranks systematically among the top 10 web sites, regardless of the category; (b) it is always much bigger than the number two; (c) it reaps most of the profits in the sector. “Look at the situation here in France”, the Norwegians say, “the first classifieds site ranks far down in Nielsen rankings. The market is up for grabs, and we intend to get it”. The Oslo and Stockholm executives already had an impressive track record: in 2000, they launched Finn.no in Norway and, in 2003, they acquired Blocket.se in Sweden. Both became incredible cash machines for the group, with margins above 50% and unabated growth. Ouest-France eventually agreed to invest 50% in the new venture. In november 2010, they sold their stake back to Schibsted at a €400m valuation. (As we’ll see in a moment, the classified site Le Bon Coin is now worth more than twice that number.)

November 2012. I’m sitting in the office of Olivier Aizac, CEO of Le Bon Coin, the French iteration of Schibsted’s free classifieds concept. The office space is dense and scattered over several floors in a building near the Paris Bourse. Since my last 2009 visit (see a previous Monday Note Learning from free classifieds), the startup grew from a staff of 15 to 150 people. And Aizac tells me he plans to hire 70 more staff in 2013. Crisis or not, the business is booming.

A few metrics: According to Nielsen, LeBonCoin.fr (French for The Right Spot) ranks #9 in France with 17m monthly unique users. With more than 6 billion page views per month, it even ranks #3, behind Facebook and Google. Revenue-wise, Le Bon Coin might hit the €100m mark this year, with a profit margin slightly above… 70%. Fort the 3rd quarter of this year, the business grew by 50% vs. a year ago.

In terms of competition it dominates every segment: cars, real estate (twice the size of Axel Springer’s SeLoger.com) and jobs with about 60,000 classifieds, roughly five times the inventory of a good paid-for job board (LeBonCoin is not positioned in the upper segment, though, it mostly targets regional small to medium businesses).

Le Bon Coin’s revenue stream is made of three parts: premium services (you pay to add a picture, a better ranking, tracking on your ad); fees coming from the growing number professionals who flock to LBC (many car dealerships put their entire inventory here); and advertising for which the primary sectors are banking and insurance, services such as mobile phone carriers or pay-TV, and automobile. Although details are scarce, LBC seems to have given up the usual banner sales, focusing instead on segmented yearly deals: A brand will target a specific demographic and LBC will deliver, for half a million or a million euros per annum.

One preconceived idea depicts Le Bon Coin as sitting at the cheaper end of the consumer market. Wrong. In the car segment, its most active advertiser is Audi for whom LBC provides tailored-made promotions. (Strangely enough Renault is much slower to catch the wave.) “We are able to serve any type of market”, says Olivier Aizac who shows an ad peddling a €1.4m Bugatti, and another for the brand new low-cost Peugeot 301, not yet available in dealerships but offered on LBC for €15,000. Similarly, LBC is the place to go to rent a villa on the Cote d’Azur or a chalet for the ski season. With more than 21 millions ads at any given moment, you can find pretty much anything there.

Now, let’s zoom out and look at a broader picture. How far can Le Bon Coin go? And how will its cluster of free classifieds impact Schibsted’s future?

Today, free online classifieds weigh about 25% of Schibsted revenue (about 15bn Norwegian Kroner, €2bn this year), but it it accounts for 47% of the group’s Ebitda (2.15bn NOK, €300m). All online activities now represent 39% of the revenue and 62% of the Ebitda.

The whole strategy can be summed up in these two charts: The first shows the global deployment of the free classifieds business (click ton enlarge):

Through acquisitions, joint ventures or ex nihilo creations, Schibsted now operates more than 20 franchises. Their development process is highly standardized. Growth phases have been codified in great detail, managers often gather to compare notes and the Oslo mothership watches everything, providing KPIs, guidelines, etc. The result is this second chart showing the spread of deployment phases. More than half of the portfolio still is in infancy, but most likely to follow the path to success:

Source: Schibsted Financial Statements

This global vision combined to what is seen as near-perfect execution explains why the financial community is betting so much on Schibsted’s classified business.

When assessing the potential of each local brand, analysts project the performances of the best and mature properties (the Nordic ones) onto the new ones. As an example, see below the number of visits per capita and per month from web and mobile since product launch:

Source : Dankse Market Equities

For Le Bon Coin’s future, this draws a glowing picture: according to Danske Market Equities, today, the Norwegian Finn.no generates ten times more revenue per page view than LBC, and twenty times more when measured by Average revenue per user (ARPU). The investment firm believes that Le Bon Coin’s revenue can reach €500m in 2015, and retain a 65% margin. (As noted by its CEO, Le Bon Coin has yet to tap into its trove of data accumulated over the last six years, which could generate highly valuable consumer profiling information).

When translated into valuation projections, the performance of Schibsted classifieds businesses far exceed the weight of traditional media properties (print and online newspapers). The sum-of-the-parts valuations drawn by several private equities firms show the value of the classifieds business yielding more than 80% of the total value of this 173 year-old group.

frederic.filloux@mondaynote.com
Disclosure: I worked for Schibsted for nine years altogether between 2001 and 2010; six years indirectly as the editor of 20 minutes and three years afterwards, in a business development unit attached to the international division.
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It’s the Competitive Spirit, Stupid

 

Legacy media suffer from a deadly DNA mutation: they’ve lost  their appetite for competition; they no longer have the will to fight the hordes of new, hungry mutants emerging from the digital world. 

For this week’s column, my initial idea was to write about Obama’s high tech campaign. As in 2008, his digital team once again raised the bar on the use of data mining, micro-targeting, behavioral analysis, etc. As Barack Obama’s strategist David Axelrod suggested just a year ago in Bloomberg BusinessWeek, compared to what they were working on, the 2008 campaign technology looked prehistoric. Without a doubt, mastering the most sophisticated practices played a crucial role in Obama’s November 6th victory.

As I researched the subject, I decided against writing about it. This early after the election, it would have been difficult to produce more than a mere update to my August 2008 story, Learning from the Obama Internet Machine. But, OK. For those of you interested in the matter, here are a couple of resources I found this week: An interesting book by Sasha Issenberg, The Victory Lab, The Secret Science of  Winning Campaigns, definitely worth a read; or previously unknown tidbits in this Stanford lecture by Dan Siroker, an engineer who left Google to join the Obama campaign in 2008. (You can also feast on a Google search with terms like “obama campaign + data mining + microtargeting”.)

I switched subjects because something jumped at me: the contrast between a modern election campaign and the way traditional media cover it. If it could be summed up in a simplistic (and, sorry, too obvious) graph, it would look like this :

The 2012 Election campaign carries all the ingredients of the fiercest of competitions: concentrated in a short time span; fueled by incredible amounts of cash (thus able to get the best talent and technology money can buy); a workforce that is, by construction, the most motivated any manager can dream of, a dedicated staff led by charismatic stars of the trade; a binary outcome with a precise date and time (first Tuesday of November, every four years.) As if this was not enough, the two camps actually compete for a relatively small part of the electorate, the single digit percentage that will swing one way or the other.

At the other end of the spectrum, you have traditional media. Without falling into caricature, we can settle for the following descriptors: a significant pool of (aging) talent; a great sense of entitlement; a remote connection with the underlying economics of the business; a remarkably tolerance for mediocrity (unlike, say, pilots, or neurosurgeons); and, stemming from said tolerance, a symmetrical no-reward policy — perpetuated by unions and guilds that planted their nails in the media’s coffin.

My point: This low level of competitive metabolism has had a direct and negative impact on the economic performance of legacy media.

In countries, regions, or segments where newsrooms compete the most on a daily basis (on digital or print), business is doing just fine.

That is the case in Scandinavia which enjoys good and assertive journalism, with every media trying to beat the other in every possible way: investigation, access to sources, creative treatment, real-time coverage, innovations in digital platforms… The UK press is also intensively competitive — sometimes for the worse as shown in the News Corp phone hacking scandal. To some extent, German, Italian, Spanish media are also fighting for the news.

At the other end of the spectrum, the French press mostly gave up competing. The market is more or less distributed on the basis readers’ inclinations. The biggest difference manifests itself when a source decides to favor one media against the others. Reminding someone of the importance of competing, of sometimes taking a piece of news from someone else’s plate tends to be seen as ill-mannered, not done. The result is an accelerating drop in newspapers sales. Strangely enough, Nordic media will cooperate without hesitation when it comes to sharing industrial resources such as printing plants and distribution channels while being at each other’s throat when it comes to news gathering. By contrast, the French will fight over printing resources, but will cooperate when it’s time to get subsidies from the government or to fight Google.

Digital players do not suffer from such a cumbersome legacy. Building organizations from scratch, they hired younger staff and set up highly motivated newsrooms. Pure players such as Politico, Business Insider, TechCrunch and plenty of others are fighting in their beat, sometimes against smaller but sharper blogs. Their journalistic performance (although uneven) translates into measurable audience bursts that turn into advertising revenues.

Financial news also fall into that same category. Bloomberg, DowJones and Reuters are fighting for their market-mover status as well for the quality — and usefulness — of their reporting; subscriptions to their service depends on such performance. Hence the emergence of a “quantifiable motivation” for the staff. At Bloomberg — one of the most aggressive news machine in the world — reporters are provided financial incentives for their general performance and rewarded for exclusive information. Salaries and bonuses are high, so is the workload. But CVs are pouring in — a meaningful indicator.

Digital newsrooms are much more inclined to performance measurements than old ones. This should be seen as an advantage. As gross as it might sound to many journalists, media should seize the opportunity that comes with modernizing their publishing tools to revise their compensation policies. The main index should be “Are we doing better than the competition? Does X or Y contribute to our competitive edge?”. Aside from the editor’s judgement, new metrics will help. Ranking in search engines and aggregators; tweets, Facebook Likes; appearances on TV or radio shows; syndication (i.e. paid-for republication elsewhere)… All are credible indicators. No one should be afraid to use them to reward talent and commitment.

It’s high time to reshuffle the nucleotides and splice in competitive DNA strands, they do contribute to economic performance.

frederic.filloux@mondaynote.com

 

Minding The (Apple)Store

 

As I’ve written many times in the past, I’m part of the vast chorus that praises the Apple Store. And not just for the uncluttered product displays, the no-pressure sales people (who aren’t on commission), or the Genius Bar that provides expert help, but for the impressive architecture. Apple beautifies existing venues (Regent Street in London, rue Halevy near the Paris Opera) or commissions elegant new buildings, huge ones at times.

It’s a relentlessly successful story. Even the turmoil surrounding John Browett’s abbreviated tenure as head of Apple’s worldwide retail organization hasn’t slowed the pace  of store openings and customer visits. (As always, Horace Dediu provides helpful statistics and analysis in his latest Asymco post.)

It has always struck me as odd that in Palo Alto, Apple’s heartland and Steve Jobs’ adopted hometown, Apple had only a modestly-sized, unremarkable venue on University Avenue, and an even smaller store in the Stanford Shopping Center.

All of that changed on October 27th when the black veil that shrouded an unmarked project was removed, and the newest Apple Store — what some are calling a “prototype” for future venues, a “flagship” store — was revealed. (For the civic-minded — or the insomniac — you can read the painfully detailed proposal, submitted to Palo Alto’s Architectural Review Board nearly three years ago, here.)

I came back from a trip on November 2nd, the day the iPad mini became available, and immediately headed downtown. The new store is big, bold, elegant, even more so at night when the very bright lights and large Apple logo on its front dominate the street scene. (So much so I heard someone venture that Apple has recast itself as the antagonist in its 1984 commercial.)

The store is impressive… but its also unpleasantly, almost unbearably noisy. And mine isn’t a voice in the wilderness. The wife of a friend walked in, spent a few minutes, and vowed to never return for fear of hearing loss. She’d rather go to the cramped but much more hospitable Stanford store.

A few days later, I heard a similar complaint from the spouse of an Apple employee. She used to enjoy accompanying her husband to the old Palo Alto store, but now refuses because of the cacophony.

‘Now you know the real reason for Browett’s firing’, a friend said, half-seriously. ‘How can you spend North of $15M on such a strategically placed, symbolic store, complete with Italian stone hand-picked by Jobs himself…and give no consideration to the acoustics? It’s bad for customers, it’s bad for the staff, it’s bad for business, and it’s bad for the brand. Apple appears to be more concerned with style than with substance!’

Ouch.

The sound problem stems from a combination of the elongated “Great Hall”, parallel walls, and reflective building materials. The visually striking glass roof becomes a veritable parabolic sound mirror. There isn’t a square inch of sound-absorbing material in the entire place.

A week later, I returned to the store armed with the SPL Meter iPhone app. As the name indicates, SPL Meter provides a Sound Pressure Level (SPL) measurement in decibels.(Decibels form a logarithmic scale where a 3 dB increase means roughly twice as much sound pressure — noise in our case; +10 dB is ten times the sound pressure.)

For reference, a normal conversation at 3 feet (1m) is 40 to 60 dB; a passenger car 30 feet away produces levels between 60 and 80 dB. From the Wikipedia article above: “[The] EPA-identified maximum to protect against hearing loss and other disruptive effects from noise, such as sleep disturbance, stress, learning detriment, etc. [is] 70 dB.”

On a relatively quiet Saturday evening, the noise level around the Genius Bar exceeded 75 dB:

Outside, the traffic noise registered a mere 65 dB. It was 10 db noisier inside the store than on always-busy University Avenue!

Even so, the store on that Friday was a virtual library compared to the day the iPad mini was launched, although I can’t quantify my impression: I didn’t have the presence of mind to whip out my iPhone and measure it.

Despite the (less-than-exacting) scientific evidence and the corroborating anecdotes, I began to have my doubts. Was I just “hearing things”? Could Apple really be this tone deaf?

Then I saw it: An SPL recorder — a professional one — perched on a tripod inside the store.

I also noticed two employees wearing omnidirectional sound recorders on their shoulders (thinking they might not like the exposure, I didn’t take their pictures.) Thus, it appears that Apple is taking the problem seriously.

But what can it do?

It’s a safe bet that Apple has already engaged a team of experts, acousticians who tweak the angles and surfaces in concert halls and problem venues. I’ve heard suggestions that Apple should install an Active Noise Control system: Cancel out sound waves by pumping in their inverted forms — all in real time. Unfortunately, this doesn’t work well (or at all) in a large space.

Bose produces a rather effective solution…in the controlled environment of headphones.

This prompted the spouse mentioned above to suggest that Apple should hand out Bose headphones at the door.

Two days after the noisy Apple store opened its doors, Browett was shown the exit. Either Tim Cook is fast on the draw or, more likely, my friend is wrong: Browett’s unceremonious departure had deeper roots, most likely a combination of a cultural mismatch and a misunderstanding of his role. The Browett graft didn’t take on the Apple rootstock, and the newly hired exec couldn’t accept that he was no longer a CEO.

Browett’s can’t be scapegoated for the acoustical nightmare in the new Apple Store. Did the rightly famous architectural firm, Bohlin Cywinski Jackson, not hear the problem? What about the highly reputable building contractor (DPR) which has built so many other Apple Stores? Did they stand by and say nothing, or could they simply not be heard?

Perhaps this was a case of “Launchpad Chicken”, a NASA phrase for a situation where many people see trouble looming but keep quiet and wait for someone else to bear the shame of aborting the launch. It reminds me of the Apple Maps fiasco: An obvious problem ignored.

What a waste spending all that money and raising expectations only to move from a slightly undersized but well-liked store to a bigger, noisier, colder environment that turns friends away.

Having tacitly admitted that there’s a problem, Apple’s senior management can now show they’ll stop at nothing to make the new store as inviting as it was intended to be.

JLG@mondaynote.com

The Apple Tax, Part II

Once upon a time, Steve Ballmer blasted Apple for asking its customers to pay $500 for an Apple logo. This was the “Apple Tax“, the price difference between the solid, professional workmanship of a laptop running on Windows, and Apple’s needlessly elegant MacBooks.

Following last week’s verdict against Samsung, the kommentariat have raised the specter of an egregious new Apple Tax, one that Apple will levy on other smartphone makers who will have no choice but to pass the burden on to you. The idea is this: Samsung’s loss means it will now have to compete against Apple with its dominant hand — a lower price tag — tied behind its back. This will allow Apple to exact higher prices for its iPhones (and iPads) and thus inflict even more pain and suffering on consumers.

There seems to be a moral aspect, here, as if Apple should be held to a higher standard. Last year, Apple and Nokia settled an IP “misunderstanding” that also resulted in a “Tax”…but it was Nokia that played the T-Man role: Apple paid Nokia more than $600M plus an estimated $11.50 per iPhone sold. Where were the handwringers who now accuse Apple of abusing the patent system when the Nokia settlement took place? Where was the outrage against the “evil”, if hapless, Finnish company? (Amusingly, observers speculate that Nokia has made more money from these IP arrangements than from selling its own Lumia smartphones.)

Even where the moral tone is muted, the significance of the verdict (which you can read in full here) is over-dramatized. For instance, see this August 24th Wall Street Journal story sensationally titled After Verdict, Prepare for the ‘Apple Tax’:

After its stunning victory against rival device-maker Samsung Electronics Co., experts say consumers should expect smartphones, tablets and other mobile devices that license various Apple Inc., design and software innovations to be more expensive to produce.

“There may be a big Apple tax,” said IDC analyst Al Hilwa. “Phones will be more expensive.”

The reason is that rival device makers will likely have to pay to license the various Apple technologies the company sought to protect in court. The jury found that Samsung infringed as many as seven Apple patents, awarding $1.05 billion in damages.

The $1B sum awarded to Apple sounds impressive, but to the giants involved, it doesn’t really change much. Samsung’s annual marketing budget is about $2.75B (it covers washer-dryers and TVs, but it’s mostly smartphones), and, of course, Apple is sitting on a $100B+ cash hoard.

Then there’s the horror over the open-ended nature of the decision: Apple can continue to seek injunctions against products that infringe on their patents. From the NYT article:

…the decision could essentially force [Samsung] and other smartphone makers to redesign their products to be less Apple-like, or risk further legal defeats.

Certainly, injunctions could pose a real threat. They could remove competitors, make Apple more dominant, give it more pricing power to the consumer’s detriment…but none of this is a certainty. Last week’s verdict and any follow-up injunctions are sure to be appealed and appealed again until all avenues are exhausted. The Apple Tax won’t be enforced for several years, if ever.

And even if the “Tax” is assessed, will it have a deleterious impact on device manufacturers and consumers? Last year, about half of all Android handset makers — including ZTE, HTC, Sharp — were handed a Microsoft Tax bill ($27 per phone in ZTE’s case), one that isn’t impeded by an obstacle course of appeals. Count Samsung in this group: The Korean giant reportedly agreed to pay Microsoftbetween $10 and $15 – for each Android smartphone or tablet computer it sells.” Sell 100M devices and the tax bill owed to Ballmer and Co. exceeds $1B. Despite this onerous surcharge, Android devices thrive, and Samsung has quickly jumped to the lead in the Android handset race (from Informa, Telecoms & Media):

Amusingly, the Samsung verdict prompted this gloating tweet from Microsoft exec Bill Cox:

Windows Phone is looking gooooood right now.

(Or, as AllThingsD interpreted it: Microsoft to Samsung. Mind if I Revel in Your Misfortune for a Moment?)

The subtext is clear: Android handset makers should worry about threats to the platform and seek safe harbor with the “Apple-safe” Windows Phone 8. This will be a “goooood” thing all around: If more handset makers offer Windows Phone devices, there will be more choices, fewer opportunities for Apple to get “unfairly high” prices for its iDevices. The detrimental effects, to consumers, of the “Apple Tax” might not be so bad, after all.

The Samsung trial recalls the interesting peace agreement that Apple and Microsoft forged in 1997, when Microsoft “invested” $150M in Apple as a fig-leaf for an IP settlement (see the end of the Quora article). The interesting part of the accord is the provision in which the companies agree that they won’t “clone” each other’s products. If Microsoft could arrange a cross-license agreement with Apple that includes an anti-cloning provision and eventually come up with its own original work (everyone agrees that Microsoft’s Modern UI is elegant, interesting, not just a knock-off), how come Samsung didn’t reach a similar arrangement and produce its own distinctive look and feel?

Microsoft and Apple saw that an armed peace was a better solution than constant IP conflicts. Can Samsung and Apple decide to do something similar and feed engineers rather than platoons of high-priced lawyers (the real winners in these battles)?

It’s a nice thought but I doubt it’ll happen. Gates and Jobs had known one another for a long time; there was animosity, but also familiarity. There is no such comfort between Apple and Samsung execs. There is, instead, a wide cultural divide.

JLG@mondaynote.com

Apple: Three Intriguing Numbers

No Monday Note last week: I was in The Country of Sin, enjoying pleasures such as TGV trips across a landscape of old villages, Romanesque churches, Rhône vineyards — and a couple of nuclear power plants. All this without our friendly TSA.

Back in the Valley, Apple just released their latest quarterly numbers. They weren’t as good as expected, a fact that launched a broadside of comments ranging from shameless pageview whoring (I’m looking at you, Henry) to calm but worried (see Richard Gaywood’s analysis).

As I’ll attempt to explain below, Apple’s latest quarterly performance is unusual. But, stepping back a bit, the company’s numbers are nonetheless phenomenal.

Net sales, growing 23%, are more than three times larger than Amazon’s — and Apple’s net income is more than 1,000 times larger, $8.8B vs. a tiny $7M for the Seattle giant, whose shares went up after disclosing its earnings release anyway.

Turning to Google, Apple sales of $35B are more than three times Google’s $11.3B (including Motorola, for the first time), with net income numbers in a similar ratio at $8.8B and $2.8B respectively.

Ending comparisons with Microsoft, its revenue grew 4% to $18B, about half of Apple’s and, for the first time, the company posted a net loss of $492M, due to the huge $6.2B aQuantive write off, a one time event. Excluding that number, Microsoft net income would have been about $5.5B, two thirds of Apple’s. iPhone revenue at $16B for the quarter, approaches Microsoft’s number for the entire company, iPad, at $9B is about half.

For in-depth coverage of Apple’s Q3 FY 2012, you can turn to Philip Ellmer-DeWitt’s Apple 2.0 or Horace Dediu’s Asymco — possibly the best source of fine-grained industry analysis. I can also recommend Daring Fireball for John Gruber’s lapidary comments and carefully chosen links, and Brian Hall’s Smartphone Wars — vigorous commentary and insights, occasionally couched in NSFW language. Of course, you can always wade through Apple’s 10-Q SEC filing, if you have the time and inclination. Of particular interest is Section 2 MD&A, Management Discussion and Analysis, starting on page 21.

Out of this torrent of information and argument, I suggest we look at three numbers.

First, the 3% “Miss”, Wall Street’s term for failing to hit the revenue bull’s eye. I’m not referring to the guessing games played by Wall Street analysts, both the pros and the so-called amateurs. In the past, the amateurs have done a consistently better job of forecasting revenue, gross margin, profit, unit volumes, but this time, the pros won. Although almost everyone substantially overestimated Apple’s numbers, the pros weren’t nearly as optimistic as the amateurs.”

Instead of measuring Apple’s performance against the predictions of the traders and observers, we can recall what the company itself told us to expect. About a month into each quarter, management provides an official but non-committal estimate of the quarter’s revenue. This guidance is a delicate dance: You want to be cautious, you want to sandbag a little, but not so much that your numbers aren’t taken seriously. Unavoidably, a lot of second-guessing ensues.

Apple has consistently beaten its own guidance, by 19% on average over the past three years, and as much as 35% in Q1 2010. But in this past quarter, Apple “achieved” a historic low: Actual revenue came in at only 3% above the guidance number. Richard Gaywood provides a helpful graphic in his TUAW piece:

Apple management offered explanations during the conference call following the earnings release: The economy in Europe isn’t doing so well, “rumors” about the iPhone 5 have slowed sales of iPhone 4s… These might very well be the causes of the lackluster performance, but one has to wonder: Weren’t these issues known two months ago when the guidance number was announced? Apple is praised for its superbly managed supply chain, its global distribution network, its attention to detail. How is it possible that it didn’t see that the European economy was already cooling? How could management not have heard the steady murmur about an upcoming iPhone?

Put another way: What did you know and when did you know it? And, if you didn’t know, why didn’t you?

There is a possible alternative explanation: Samsung is making more substantial inroads than expected, as their impressive quarterly numbers just released would attest: 50.5M smartphones shipped, almost twice as many as Apple’s 26M.

Sharp-eyed readers may protest the comparison: Samsung reports the number of devices “shipped” while Apple reports units “sold”. But even if we allow for unsold inventory, Samsung’s performance is impressive.  (And, as circumstantial evidence, I noticed an unusually heavy amount of advertising for the Galaxy S III during my recent overseas trip.)

Samsung’s strong showing will almost certainly continue — so how will Apple react? A new product? Price moves? Both? In the conference call, Tim Cook assured his audience that Apple won’t create a “price umbrella” for competitors, that it won’t insist on premium price tags and thus leave small-margin money on the table.

Which leads us to the second number: Gross Margin guidance for the current quarter, ending September 30th, is 38.5%, down from 42.8% for the quarter that just ended. In consultant-speak, that’s an evaporation of 430 basis points (hundredths of percent) in just one quarter — and we’re already one month into it with no visible change in the product lineup other than the full availability of newer MacBooks (Air, Pro, Retina), and no evidence of heavy-handed discounting.

During the conference call, a Morgan Stanley analyst noted that Apple hadn’t shown Gross Margin numbers below 40% for the past two years. Would Apple care to comment?

We expect most of this decline to be primarily driven by a fall transition and to a much lesser extent, the impact of the stronger U.S. dollar.

The entire Gross Margin drop of about $34B of sales (the latest guidance) amounts to $1.5B, a sum that will shift in less than two months, and probably less than one as any momentous announcement is unlikely before Labor Day (the first Monday of September for our overseas readers). This could portend a strong price move in the “fall transition”. To put the $1.5B shift in perspective, imagine Apple dropping its “usual” Gross Margin by $100 per device (new or existing); this means 15M lower-margins devices in the three weeks of September after Labor Day. Or perhaps Apple’s CFO is sandbagging the guidance once again.

The third curious number is the most perplexing: While the entire company grew by 23% compared to the same quarter last year, Apple Store revenue grew by only 17% — and this in spite of adding 47 stores over the year, for a total of 372. Why would Apple’s much vaunted retail channel grow more slowly than the company? The weak Euro economy can’t be the explanation, there are relatively less Apple Stores there. The same can be said for “rumors” of newer devices, they impact all channels and not just company stores.

We’ll see if this last quarter was simply a manifestation of a natural “granularity” of its business (as opposed to the unnatural smoothing of quarter after quarter numbers favored by Wall Street), or if the company is entering a new chapter of the smartphone wars and, if this is the case, how it will change tactics.

JLG@mondaynote.com

Facebook: The Collective Hallucination

Facebook’s bumpy IPO debut could signal the end of a collective hallucination. Most of it pertains to the company’s ability to deliver an effective advertising machine.

Pre-IPO numbers looked nice, especially when compared to Google at this critical stage of their respective business lives:

Based on such numbers, and on the prospect for a billion users by the end of 2012, everyone began to extrapolate and predict Facebook’s dominance of the global advertising market.

Until some cracks began to appear.

The first one was General Motors’ decision to pull its ads off Facebook. This was due to poor click-through performance compared to other ads vectors such as Google. No big deal in terms of revenue: according to Advertising Age, GM had spent a mere $10 million in FB ads and a total $30 million maintaining its presence on the social network. But Facebook watchers saw it a major red flag.

The next bad signal came during the roadshow, when Facebook issued a rather stern warning about its advertising performance among mobile users.

“We believe this increased usage of Facebook on mobile devices has contributed to the recent trend of our daily active users (DAUs) increasing more rapidly than the increase in the number of ads delivered.”

If Facebook can’t effectively monetize its mobile users, it is in serious trouble. Numbers compiled by ComScore are staggering: last March, the average American user spent 7hrs 21 minutes on mobile versions of Facebook (80% on applications, 20% on the mobile site). This represents a reach of more than 80% of mobile users and three times that of the next social media competitor (Twitter), see below:

(source : ComScore)

More broadly, Facebook experiences the unlimited supply of the internet in which users create inventory much faster than advertising can fill it. This trend is known to push ads prices further down as scarcity no longer contains them. The reason why the TV ad market is holding pretty well is its lasting ability to create a tension on prices thanks to the fixed numbers of ad slots available over a given period of time.

Unfortunately for its investors, in many ways, Facebook is not Google. First of all, it has no advertising “killer format ” comparable to Google’s AdWords. The search engine text ads check all the boxes that make a success: they are ultra-simple, efficient, supported by a scalable technology that makes them well-suited for the smallest advertisers as well as for the biggest ones; the system is almost friction-free thanks to an automated market place; and its efficiency doesn’t depend on the quality of creation (there is no room for that). One cent a time, Google churns its enormous revenue stream, without any competition in its field.

By contrast, Facebook’s ad system looks more traditional. For instance, it relies more on creativity than Google does. Although the term sounds a bit overstated considering the level of tactics Facebook uses to collect fans and raise “engagement” of any kind. For example, Tums, the anti-acid drug, developed a game encouraging users to throw virtual tomatoes at pictures of their friends. On a similar level of sophistication, while doing research for this column, I landed on the Facebook Studio Awards site showcasing the best ads and promotional campaigns. My vote goes to the French chicken producer Saint Sever, whose agency devised this elegantly uncomplicated concept: “1 ami = 1poulet” (one friend, one chicken):

If this is the kind of concept Facebook is proud to promote, it becomes a matter of concern for the company’s ARPU.

Speaking of Average Revenue Per User, last year, Facebook made $4.34 per user in overall advertising revenue. A closer look shows differences from one market to another: North America, the most valuable market, yielded $9.51 per user vs. $4.86 for the European market, $1.79 in Asia and only $1.42 for the rest of the world. Facebook’s problem lies exactly there: the most profitable markets are the most saturated ones while the potential for growth resides mostly in the low-yield tier. In the meantime, infrastructure costs are roughly identical: it costs the same to serve a page, or to synchronize a photo album located in Pennsylvania or in Kazakhstan (it could even cost more per user in remote countries, and some say that FB’s infrastructure running costs are likely to grow exponentially as more users generate more interactions between themselves).

Facebook might be tempted to mimic a rather questionable Google trait, that is “The Theory Of Everything”. Over the last years, we’ve seen Google jumping on almost everything (including Motorola’s mobile business), trying a large, confusing array of products and services in order to see what sticks on the wall. The end result is an impressive list of services that became very valuable to users (mail, maps, docs). But more than 90% of Google revenue still come from a single stream of business, search ads.

As for Facebook, we had a glimpse already with the Instagram acquisition (see a recent Monday Note), which looked more like a decision triggered by short-term agitation than by long-term strategic thought. We might see other moves like this as Mark Zuckerberg retains 57% of the voting shares and as the company sits on a big (more than $6 billion) pile of cash. Each month brings up a new business Facebook might be tempted to enter, from mobile phones, to search.

All ideas that fit Facebook’s vital need for growth.

frederic.filloux@mondaynote.com

Decoding Share Prices: Amazon, Apple and Facebook

There are many religions when it comes to calculating the “right” price for the shares of a publicly traded company. At a basic level, buying a share is an act of faith in the company’s future earnings. The strength of this belief manifests itself in the company’s P/E (Price/Earnings) ratio. The stronger the faith, the higher the P/E, an expectation of increased profit.

Sometimes, an extreme P/E number beggars belief, it invites a deeper look into the thoughts and emotions that drive prices.

One such example is Amazon. On the Nasdaq stock market, AMZN trades at more than 174 times its most recent earnings. By comparison, Google’s P/E hovers around 17, Apple and Walmart are a mere 14, Microsoft is a measly 11.

This is so spectacular that many think it doesn’t make sense, especially when looking at Amazon’s falling profit margin (from this Seeking Alpha post):

Why do traders bid AMZN so high in the face of a declining .5% profit margin?

In his May 5th PandoDaily piece, “Nobody Seems to Understand What Jeff Bezos is Doing. Does He?”, Farhad Manjoo questions Jeff Bezos’s strategy and Amazon’s taste for obfuscating statements:

“Amazon is not merely “willing” to be misunderstood, it often tries to actively sow widespread misunderstanding. This works [to] its advantage; if competitors don’t know what Amazon is up to, if they can’t even figure out where and how it aims to make money, they’ll have a harder time beating it.”

…and he concludes:

“Is Bezos crazy like a fox? Or is he just plain crazy? We have no idea.”

He’s not alone: Year after year, critics have challenged Bezos’ business acumen, criticizing his grandiose views and worrying about the company’s bottom line. But the top line, revenue, keeps rising. See this chart from a Seeking Alpha article by Richard Bloch:

The answer to Farhad’s question, the cold logic behind the seemingly irrational share price is clear: Amazon sacrifices profits in order to gain size and, in the process, kill competitors.

That’s step one.

Step two: After having cleared the field, Amazon will take advantage of what is delicately called “pricing power”. As the Last Man Standing, they will raise prices at will and regain profitability. This isn’t Amazon’s only game. The breadth of their offering, their superior customer service and awesome logistics, make life difficult for poorly managed competitors such as Best Buy, or the undead Circuit City, to name but a few companies whose weaknesses where exposed by Amazon’s superbly efficient machine.

But traders recognize the wink and the nod behind today’s numbers, they are willing to pay a high price for a share of Amazon’s future dominant position.

Apple’s share price sits at the other end of the P/E spectrum. Revenue and profits grow rapidly: + 58% profit year-to-year, + 94% net income. “Normal” companies in their league are supposed to fall to the Law of Large Numbers: High percentage growth becomes well-nigh impossible when a company achieves Apple’s gigantic size. A $100B business needs to dig up $25B in new business to grow 25%. $25B is roughly half the size of Dell. When Apple’s revenue grows 58%, that’s more than one Dell on top of last year’s business.

Apple is the nonpareil of fast-growing, prosperous companies. They’re in a young market: smartphones and tablets. They can easily break the Law. With only 8% of the mobile phone market, the iPhone enjoys considerable headroom. And the iPad’s +151% year/year unit growth shows even greater potential.

So why isn’t Wall Street buying? Why do they think Apple has so much less room to grow than Amazon?

First, a big difference: Apple’s founder is no longer with us while Bezos is very much in command. This is no criticism of Tim Cook, Apple’s new CEO. A long-time Jobs lieutenant, the architect of Apple’s supremely effective Supply Chain, a soberly determined man, well liked, respected and healthily feared inside the company, Tim Cook is eminently credible. But traders are cautious; they want to see if the Cook regime will be as innovative, as uncompromisingly focused on style and substance as before.

Second, the much talked-about iPhone subsidy “problem”. The accepted notion is that Apple has strong-armed carriers into paying “excessive” subsidies for the iPhone, some say as much as $200 more than carriers pay other handset makers. (See “Carriers Whine: We Wuz Robbed!” of March 11, 2012.) Carriers rattle their sabers, they let everyone know they’re looking forward to the day when they will no longer be fleeced by the Cupertino boys.

The numbers are impressive. Take about 150 million iPhones this calendar year (37M units in the last quarter of 2011); assume that 80% of these iPhones are subsidized by carriers…that’s $24B in subsidies. For people who are betting on Apple’s future profits, these are big numbers that could go either way: Straight to Apple’s bottom line as they do today, or back to the carriers’ coffers “where they belong”. For Apple, with today’s P/E of 14, a swing of $24B in profits would result in a change of $336B in market cap. (Today Wall Street pegs AAPL at $525B.)

I’m not saying such a shift is likely, or that it would happen in one fell swoop. I use this admittedly caricatural computation to make a point: Carrier subsidies have a huge impact on Apple’s bottom line, and the perceived uncertainty over their future gives traders pause.

I’ll now take the opposite tack with this Horace Dediu tweet:

In my venture investing experience, it sometimes happens that the top salesperson makes more money than the CEO. In most instances the exec is happy to see big revenue come in and doesn’t begrudge the correspondingly large commissions. But, in the rare case of the CEO turning purple because a lowly peddler makes more money than him (it’s a male problem), we take the gent aside and gently let him know what will happen to him if he does it again.

Carriers sound like the bad CEO complaining about excessive sales commissions racked up by their star revenue maker. Carriers are contractually obligated to keep iPhone figures confidential so we can’t make a direct ARPU comparison — but we have anonymous leaks and research-for-hire firms, they’re curiously silent on the question of actual ARPU by handset. In the absence of a clear case made to the contrary, we’ll have to assume that the iPhone is the carriers’ top revenue generator, and that the subsidies will continue.

This said, if Apple comes out with a mediocre iPhone, or if Samsung produces a distinctly more attractive handset, the salesman’s commission will disappear, Apple’s revenue per iPhone (about $650 in Q1 2012) will drop precipitously, and so will profits.

That’s the scenario that makes traders cautious: Large amounts of profit are at risk, tied to carrier subsidies. They wonder if Apple’s lofty premium is sustainable and, as a result, they assign AAPL a lower P/E.

But “caution” may be too weak a word. In a May 7th 2012 Asymco post, Horace Dediu plots Apple’s share price as a function of cash:

This is troubling. It implies that cash is the only determinant of Apple’s share price.

Put another way, and recalling that share prices are supposed to reflect earnings expectations, it appears Wall Street puts little faith in the future of Apple’s earnings [emphasis mine]:

“Given this disconnect from the income statement, the pricing by balance sheet multiple seems to be a symptom of something deeper. Reasons vary with the seasons, but the company is not perceived to have sustainable growth.

Fascinating. The collective wisdom of Wall Street is that one of the most successful high-tech companies of all times, with three healthy product lines, strong management, generally happy customers and employees is not perceived to have sustainable growth.

We’ll see.

(In the interest of full disclosure, I’ll repeat something I’ve stated here before: I don’t own publicly-traded stocks, Google, Microsoft, Apple or any other. I consider the stock market a dangerous place where, across the table, I see people with bigger brains, bigger computers, and bigger wallets than mine. I can’t win. The casino always does…unless you don’t trade but, instead, invest–that is buy shares and keep them for years, the way Warren Buffet does.)

And Facebook?

I’ll wait for the dust of this botched IPO to settle before I try to figure out what Facebook’s share price reflects. I agree with Ronal Barusch in his WSJ blog piece: I’m not convinced that Facebook or its bankers will suffer irreparable damage.

Still, rumors and accusations are flying. Following Nasdaq’s disastrous handling of Facebook’s opening trades, we hear that the New York Stock Exchange is discreetly suggesting that the company move to a more sophisticated trading platform. This is a great opportunity for Facebook to change its FB stock trading symbol and adopt one that more accurately reflects its opinion of Wall Street.

I have a suggestion: FU.

JLG@mondaynote.com

California’s Financial and Cultural Deficits

I think I found a cure for both. First, the symptoms. Financially, California is close to being bankrupt, it spends more than it makes and runs a huge $361B debt, as illustrated by the online, live Debt Clock:

Unemployment is high; infrastructure is neglected; the pride of California, its UC Colleges, must raise tuition beyond the reach of the very people it was supposed to lift into higher education; California’s State Parks, another treasure, are neglected and being closed.

Fortunately, there’s a solution — and it’s right in our neighborhood. We’ve seen the wealth created by a flurry of recent Valley IPOs, and we’ve watched the rise in share price of more established companies. From Apple to Zynga, Facebook, and LinkedIn, we have a fresh crop of McBillionaires ready to help.

So, here’s what we’re going to do.

First, let’s all agree: $100K in monthly compensation is plenty. Beyond that, a 75% tax rate will help replenish the Golden State’s coffers.

Second, millionaires and billionaires won’t suffer much from a small yearly tax on their assets: 0.25% from $1.5M to $5M, half a penny on every asset dollar from $5M and up. Simplifying a bit, if you have $10M in assets you’ll pay about $50K in asset taxes every year, $100M yields $500K, $1B (think Facebook IPO) brings in $5M, and so on. A pittance for the great feeling of helping one’s fellow Californians.

Then there’s culture. Californians are perceived as a bunch of materialists obsessed with bling, cars, tans, IPOs, wineries, private jets, and various types of cosmetic augmentation and reduction. Outsiders deride our materialism, they call us nekulturny, they joke that the difference between yogurt and California is that yogurt has a living culture.

We can change all this by adding a simple clause to our asset tax code: Works of art are non-taxable. This would result in an explosion of art purchases and patronage. Sculptures, paintings, installations would grace every home and office of substance; artists from all over the world would flock to California, a Villa Medici for the 21st century.

Finally, we have to take care of our abused high-tech workers. Regard the poor Facebook programmers who had to spend yet another night in front of their computers before the IPO. Management profiteers attempt to ennoble this abuse by calling it a hackathon and parading the participants before the media, but we’re not buying it.

Let’s put an end to these destructive and demoralizing practices. Instead of a single 70-hour work week, we’ll create two jobs, hire two employees, each working 35 hours per week. And to promote a serene atmosphere, let’s agree that companies with 50 employees or more will have a “worker council” to oversee decisions such as staffing changes, compensation levels, group activities, layoffs, and the like.

Of course, as with any bold reform, some unintended, counter-productive side-effects may need to be considered.

Let’s start with the asset tax scenario. You work at a successful Valley company, you make good money and decide to help younger entrepreneurs by recycling your gains into their creations. You invest $1M in a startup and get 20% of its shares. As expected, you have to pay the asset tax on that investment, every year. The company attracts new investors at a higher valuation. Great, your initial $1M is now worth, say, $10M…on paper. You will now pay 10 times as much asset tax as before, $50K every year. Unfortunately, after years of valiant struggle, the company shuts down. You lose your investment — and the cumulated asset tax. You would have been better off buying art instead. Less angst, more civic pride (although, admittedly, less investment and innovation, fewer jobs).

You’ve long figured out I’m not serious. A 75% tax bracket, an asset tax, a 35-hour work week and worker councils — such naive measures would create a massive flight of money and talent out of California and into neighboring states that would be delighted to benefit from our boneheaded reforms.

And you’ve also figured out that the measures I’ve outlined, in a slightly oversimplified form, are or will shortly be in force in France. The asset tax is almost 30 years old and its current rate is likely to increase; the 75% income tax bracket is an election campaign promise and, believe it or not, the works-of-art exception is real.

This has resulted in a number of unfortunate countermeasures: High-tech execs pull up stakes and head to London or Brussels; European headquarters move out of Paris and Lyon or are created elsewhere. All because, to paraphrase François de Closets, French demagogues see no difference between Steve Jobs’ fortune and traders’ loot.

The 35-hour work week experiment failed to stanch French unemployment.  The code that complicates the management of companies employing 50 or more people, as Frédéric noted two weeks ago, has resulted in an abnormally high number of companies with 49 workers or less.

From the outside, this is puzzling: Instead of attracting talent and capital, France creates a combination of fact and perception working against the very interests it purports to protect. In addition to the flight of taxable assets, this will accelerate the Brain Drain French officials often rail against. In the US—and particularly in California—we welcome French entrepreneurs, engineers, business people—and money. Do French politicians understand the real world, or will they continue to closet themselves in the French Exception’s virtual reality?

JLG@mondaynote.com

Facebook in Frantic Mode

Facebook’s acquisition of Instagram — for one billion dollars — tells a lot about Mark Zuckerberg’s state of mind. Which is at least as interesting as other business considerations and was best captured by cartoonist Ingram Pinn in last week’s Financial Times comic. To illustrate John Gapper’s excellent Facebook is scared of the Internet column, Ingram Pinn draws an agitated Mark Zuckerberg frantically walking through a hatchery, collecting just hatched startup-chicks as fast as he can, while, in the background, AOL and Yahoo collect older chickens in larger carts.

In last week’s Monday Note, I hinted that I’d never put my savings in Facebook’s stock. (For that matter, I see writing on business and owning stocks as incompatible). When I read the news of the Instagram acquisition, I wondered: Imagine Facebook already trading on the Nasdaq; how would the market react? Would analysts and pundits send the stock upward, praising Zuckerberg’s swiftness at securing FB’s position? Or, to the contrary, would someone loudly complain: What? Did Facebook just burn the entire 2011 free cash-flow to buy an app with no revenue in sight, and manned by a dozen of geeks? Is this a red-flag symptom of Zuckerberg’s mental state?

Four things come to mind.

1/ Because he retains 57% of Facebook voting rights, Zuckerberg rules its board and can make any decision in a blink of an eye, no debate allowed. This can be a great asset in Silicon Valley’s high speed tempo, or it can stir up shoot-from-the-hip impulsiveness.

2/ Facebook’s founder attitude reminds one of Bill Gates during Microsoft’s heydays: no crack allowed in the wall of its dominance. The smallest threat must be eliminated at any cost. Where Microsoft used legally dubious tactics, Facebook unsheathes its wallet and fires a billion dollars round. In the startup world, this will have two side effects: For one, Facebook is likely to become the exit of choice Google once was. Two, the size of the Instagram transaction (some of it in stock) is likely to act as a beacon for any startup harvesting users by the millions. It sets an inflationary precedent.

3/ By opting for such a deal, Facebook’s management reveals its own feelings of insecurity. It might sounds crazy for a company approaching the billion users mark and providing an array of services that became a substitute to the internet’s basic functions. But, with this transaction, the ultra-dominant social network acted like an elephant scared of a mice. Instagram has 35 million users? Fine. But how many are using the service more than occasionally? Half of it? How many are likely to switch overnight to a better app? Most likely many will. Especially since Instagram is not a community per se, but a gateway to larger ones such as Twitter and Facebook.

4/ From a feature-set perspective, Facebook might find itself in a quandary. Kevin Systrom and Mike Krieger designed the ultimate stripped-down application: a bunch of filters and a few basic sharing features. That’s it. It is both Instagram strength and main weakness. Such simplicity is easy to replicate. At the same time, if Facebook-Instagram wants to raise the feature-set bar, it might lose some of its users base and find itself competing with much better photo-sharing applications already populating Apple or Android app stores.
To put it differently, Facebook photo-sharing model had been leaking for a while. Zuckerberg just put  a serious plug on it, but other holes will appear. A couple of questions in passing: Will Facebook continue to accept and encourage loads of third parties photo-sharing apps that connect to its network? Some are excellent — starting with Apple’s iPhoto, especially the iDevice version that will always benefit of an optimized hardware/software integration. How does Facebook plan to deal with that? And if it chooses to grant some level of exclusivity to the Instagram app, how will the audience react (especially when you read comments saying “We liked IG because it wasn’t FB”)?

Lastly, the bubble question. Again, three things.

First, let’s be fair. If indeed there is a new internet bubble, Facebook isn’t the only player to fuel it; investors who lined up at Instagram’s doorstep did it too. A few days before the deal, IG raised $50 million at a half billion valuation; Zuckerberg snatched the company by simply doubling the bet.

Two, comparing the FB/IG deal to Google’s in 2006 acquisition of YouTube for $1.65 billion doesn’t fly either. From the outset, everyone knew internet video was destined to be huge; it was a medium of choice to carry advertising. Therefore, the takeover by Google’s fantastic ad-machine was likely to yield great results. YouTube became a natural extension of Google services — just look at how competing services such as DailyMotion in France, or Vimeo are doing without the ad rocket-engine.

Three, the metrics used in an attempt to relativize the deal are dubious at best. Instagram had no monetization strategy–other that a lottery-like exit. This says applying any kind of cost per user ($33 for the theory in vogue) is bogus. Being unable to project any sustainable revenue mechanism makes such a valuation process completely pointless. In Instagram’s case, the only way to come up with a price tag was guessing the amount of money a small group of suitors–Facebook, Google and Twitter–might be willing to cough up for Instagram’s eyeballs.

If this deal shows one thing, it is the frenzied, cutthroat competition these three players are now locked in. Mark Zuckerberg is not through with collecting hatching eggs. He won’t be alone either.

frederic.filloux@mondaynote.com