Facebook’s Acquisition of WhatsApp is Bigger than You Think

Facebook rocked Silicon Valley with its $19B of messaging app WhatsApp, with tech writers, leaders, and investors debating the massive purchase price. Wall Street seemed less than enthusiastic, dropping Facebook shares slightly after the announcement.

The deal price is certainly staggering, and we can debate whether Facebook paid a reasonable price. While this is an aggressive bet, it provides Facebook with the opportunity to hit another moon shot of the same order of magnitude as Facebook itself and has the potential to change the way the software industry works.

Let’s start with the potential economics.

WhatsApp has about 430 million users, and is adding one million users per day. It’s growing faster than Facebook, and has better reach in developing markets. It could have over one billion users in a year or two, and could get to 5 billion in the next few years, probably faster than FB. Not all of those users will be paying, at least initially, but even at the current $1/year rate, WhatsApp is on its way to being a $1B company with very high profit margins. Suppose WhatsApp wants to become a $2B company. They can raise prices to $2/year, or differentiate pricing by charging say $20 per year in some markets, $5, $2, and $1 in others. This would still be a bargain compared to common cellular text message plans and would let WhatsApp become a multibillion dollar company, before it even gets into voice and video messaging.

This brings us to the second aspect of the business- the dagger aimed at the heart of the telecommunications industry. I don’t want to trivialize the challenge of delivering billions of text messages, but this is a lot easier than conducting live voice calls. Cellular companies have spent many billions of dollars building out the infrastructure to support voice, and they rely on the high margin texting business to make those investments profitable. This market has been ripe for “disruption” for some time, but other companies have been stymied by annoying advertising supported revenue models and the lack of phone penetration. Now that billions of phones are in circulation, including a majority of phones that would not be labeled as “smart”, but can still run WhatsApp, and you have a free distribution network, aided by WhatsApp’s ability to pull in your contacts and link up contacts who also use WhatsApp. It’s viral growth in the mobile era, not the ancient history of Facebook’s web/email-based growth 5-8 years ago.

So, will the deal make sense financially for Facebook? It’s tough to say, but it certainly could, just in terms of cash flows, without considering the importance of swallowing the biggest threat to Facebook’s growth, and a nice ability to hedge Facebook’s ad-supported business with an ad-free subscription business (and keeping all of this away from Google).

Perhaps more importantly in the long run, WhatsApp turned the technology adoption model upside down. Traditionally, technology started with businesses and wealthy “westerners” (quoted to include Japan and Korea) and trickled down to smaller businesses and less wealthy individuals. I don’t think this was a deliberate attempt to avoid the developing world or less wealthy customers, it was just too hard to make money any other way. With mobile distribution possible at a scale in the billions of users, it’s now viable to target huge markets of people at low price points, even by the standards of India, Kenya, and other countries where WhatsApp is the default messaging platform. This allows software companies to target these markets directly, not as trickle down afterthoughts, which I hope will open up creative floodgates to addressing the needs of people who have, well, actually “needs” and not simply “wants”.

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