Facebook And Apple Know Their Users Will Stick Around

(Bloomberg Opinion) -- Facebook has faced so much criticism lately that it's tempting to see its unexciting earnings release as another sign of trouble. More likely, however, the company is merely turning into an Apple lookalike, profiting from network effects rather than from disruptive innovation or any kind of residual positive vibe from its brand. It's no accident that on the earnings call, Facebook Chief Executive Officer Mark Zuckerberg named an Apple service as Facebook's main competitor.

On the earnings call, Zuckerberg said usage of his company's products was shifting from the Facebook and Instagram news feeds to ephemeral “Stories” and private messaging. On the latter, he said,

We are leading in most countries, but our biggest competitor by far is iMessage. And in important countries like the U.S. where the iPhone is strong, Apple bundles iMessage as the default texting app and it's still ahead. In countries where there's more competition between iOS and Android, like much of Europe, people tend to prefer our services.

We don't often think of Apple as a Facebook competitor; that's a role we reserve for various parts of Google parent Alphabet (especially YouTube), Snapchat, Twitter and various other dedicated social and messaging platforms. Perhaps it's time, however, to look at Apple and Facebook as companies with broadly similar sources of market power, which would explain their squaring off in the messaging space.

Apple grew extremely fast on the back of its explosive innovations, the iPod, the iPhone and, briefly, the iPad. It reported 68 percent revenue growth in 2005 (peak iPod) and 66 percent in 2011 (when Android wasn't yet the powerful competitor it has since become and Nokia gave up on its own software, getting into an ill-fated partnership with Microsoft). Now, Apple's growth is far less impressive; its 2017 revenue was lower than in 2015. Though Chief Executive Officer Tim Cook still touts fast growth of the company's installed base – it has reached 1.3 billion devices, he said in January, 30 percent more than two years before – it's not clear how many of these devices are actually in constant use; the relatively flat iPhone unit sales over the last three years show the user base isn't growing by much as people mostly replace their old devices.

Facebook's user base growth is also largely in the past. It has all but stopped in Europe and the U.S., and it's barely noticeable overall. Zuckerberg talks about 2 billion daily users for all of the company's services combined, and that's likely to plateau. So, another year like 2009, when Facebook's revenues grew 186 percent, is extremely unlikely.

Both companies' giant user bases, however, are powerful moats against competition (in messaging, that means against each other, too). Whisper it, but neither Facebook nor Apple needs to do much innovation these days: Facebook can copy its trendiest services from SnapChat (Stories) and YouTube (Watch), while Apple feels comfortable aping the moves of Samsung and other Android phone makers (bezel-less screens, dual cameras). With captive users, experimentation is a needless risk – let rivals try things out first, then Apple and Facebook can come in and capture the profit.

Samsung will be the first to release foldable screens, but so what? Apple captures 86 percent of all global smartphone profit because its user base isn't going away, held back by the Apple universe of apps, services and cross-product convenience, which Samsung can't match because it's merely a part of the Google universe, within which users feel free to switch among producers. It's the same with Facebook: Even as its user base has stopped growing, its profit is healthy enough to outperform market expectations, as it did in the last quarter; one look at Snap and Twitter for comparison purposes is enough to understand who really owns the users. 

Google and Amazon, two other powerful platforms, aren't protected by network effects in the same way Apple and Facebook are. Google wanted the power that comes with owning people's contact networks but failed with Google Plus, the social network it recently closed to outside users. Its operating system universe, open to multiple manufacturers, is a means of collecting data, not of tying users to the company. Amazon's network effects largely come from its recommendation and reputation systems, but these are a secondary factor in choosing where to buy stuff online – price and convenience are more important. Apple and Facebook, for their part, really own their audiences.

The ways in which Apple and Facebook exploit network effects are different, however, and Apple's model, at least for now, is more secure. Apple is great at harnessing what are known as cross-group external effects: App developers and content providers are welcome members of the ecosystem along with users, all of them together enrich the universe and therefore Apple. Facebook runs on within-group external effects – its users value interactions with each other – but its monetization model is cross-group: It sells the captive audience to advertisers, whose intrusions generally only create negative value for users. 

That doesn't mean Facebook can't eventually move to a somewhat happier monetization model. It's trying that with messaging: When businesses pay Facebook to communicate usefully with customers – for example, send them boarding passes, tickets and delivery notifications rather than ads – cross-group external effects come into play.

Facebook may be more vulnerable after all its recent scandals – my Bloomberg Opinion colleague Shira Ovide makes a compelling case for that viewpoint. But it's possible that the company will find better ways to exploit its network effect advantage while exposing itself less to public anger. Messaging and Stories, where content is private or disappears before anyone can make a fuss, are two areas Zuckerberg appears particularly to like. Confident Apple-like milking of the user base is a more likely scenario for Facebook going forward than any cataclysmic losses; it won't be about explosive growth, but it'll be reliable.

To contact the editor responsible for this story: Therese Raphael at traphael4@bloomberg.net

This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.

Leonid Bershidsky is a Bloomberg Opinion columnist covering European politics and business. He was the founding editor of the Russian business daily Vedomosti and founded the opinion website Slon.ru.

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