How Facebook Turned a Big Risk into a Very Big Success
BY DAVID RADER
This is a story about risk. Everyone loves stories in which the hero takes a big risk, throws caution to the wind, and somehow finds a way to succeed. Will Smith and Tom Cruise are millionaires many times over because of our collective love of watching such fearless, daring escapades. The business world, of course, is no different. Everyone reads about the investor who puts a couple thousand dollars into some unknown company and is now rich beyond their wildest dreams, and who wouldn’t want to be that investor? But the frequency of those stories is incredibly rare. The business world is about taking smart risks and managing them carefully — it’s more Moneyball than Powerball.
This story begins with Facebook buying Instagram, a thirteen-person company with no revenue, for $1B. The acquisition was widely panned in the press and made some potential investors nervous that Mark Zuckerburg was too young and naïve to run a giant about-to-be-public company. It ends less than four years later with Instagram valued at $35B and Facebook stock nearly tripling. To us on the outside, that was all we could clearly see. The important part, though, is the middle — the part we couldn’t see. Facebook knew Instagram would be a risk, and they knew they had to approach it smartly in order to make it worth the investment. I’m no Facebook insider or expert, but I want to talk about the process that all smart companies go through in order to manage such risks — the part we outsiders don’t see.
Have a plan to make it successful
There are a lot of ways to grow as a company, all with varying degrees of associated risk. Improving your product is usually a low-risk method (just don’t tell that to the New Coke team), while acquisitions are typically very high risk (Steve Jobs famously made no acquisitions of more than $400M while he ran Apple, in spite of having billions in cash on the company’s income statements). When it comes to something as risky as an acquisition, it’s not enough to just say “that seems like a smart investment today; I’ll take the risk and see how it pans out.” Instead, a business must know in advance exactly what they intend to do after taking the risk in order to make it succeed. The higher the degree of risk, the more important it is to have a strong plan in place.
Facebook’s acquisition of Instagram met with negative reaction because analysts thought the company was overpaying and didn’t have a clear rationale. With the benefit of hindsight, we can see that Facebook wasn’t just buying Instagram as a lottery ticket that might develop into a great business; rather, they were buying it because they had a clear plan and knew what they could make it into.
A year and a half later, by integrating Instagram closely with Facebook, Instagram had grown its user base by 500% and was ready to start incorporating advertising. A year later, CEO Mark Zuckerburg announced plans to grow Instagram to a billion users and analysts now predict that Instagram will generate 10% of Facebook’s revenue within the next year — an increase from nothing to nearly $3B in just five years. Facebook bought Instagram with a detailed plan to grow the service. They succeeded not simply because they took a risk, but because they had an excellent plan, and executed it flawlessly.
Have a timeline and milestones to hit. Hold yourself accountable
Part of having a plan is knowing how to measure the success of that plan. It is not enough to just aim vaguely for “growth” or even to “grow revenues”. Smart businesses know exactly what sort of growth they are aiming for when they take on risk. They have milestones and individuals have responsibility for reaching those milestones. If they don’t reach them, those individuals need to either explain what went wrong and how they will improve, or the business shuts down. Google, the most valuable company in the world, has launched dozens of initiatives over the years that have failed to hit their milestones. When that happens, the company is merciless about terminating the projects.
A close reading of Facebook’s comments about Instagram shows how closely the company was tracking its progress and how hitting milestones led to the next phases for Instagram. Instagram started inserting advertising only after it had reached 150M users worldwide. In fact, the announcement that users might start seeing ads was within just a few sentences of announcing the 150M user milestone. This was no accident. Facebook most likely had that milestone in mind and hoped that they could first build a great product with loyal users, and would only attempt to turn Instagram into a money-making machine after it hit that goal.
Have an exit plan
Of course, not every risk is going to succeed — if there is no chance of failure, it’s not really a risk, is it? Accordingly, it is critical that businesses know what they will do if their risky initiative does not reach their goals. Notice how often Google had a “plan B” when projects failed: when Google Video didn’t work, they bought YouTube; when Notebook failed, its core functionality was built
into Google Docs. Google certainly would have loved to see their endeavors succeed, but when they didn’t, the company was ready to shut them down and adjust their strategy accordingly. The companies that struggle with risk are the ones that hold onto a failed experiment for too long, without any plan in place to wind it down. Yahoo, for instance, bought the rights to several original television shows but failed to turn any of them into successes. Worse, they didn’t have a backup plan for what to do if the experiment in original programming failed, and instead had to take huge write-downs with nothing to show for their efforts.
Facebook obviously has not had to implement an exit plan for the Instagram acquisition. What we can clearly see, though, is that they were not willing to change the new company until it was ready. Had Instagram failed to reach its milestones, we can assume that Facebook would have moved some of its best features onto Facebook’s own page (hashtags for instance, which gained popularity on Facebook long after their success on Instagram), and found a way to shut it down. Fortunately for the company, we never got to see what this plan would have looked like.
Hedging is okay, but don’t hedge away all your upside.
When it comes to large risks, human nature is to try to hedge. Usually, that’s a good thing — companies (and people in general) prefer the smoother, safer results that come from a hedged bet over the unpredictable and often disjointed results of an unhedged bet. But there needs to be a limit to that strategy or you may lose the potential for success. Even hedge funds are virtually never 50% long and 50% short, and smart companies are the same way. If you believe in your plan and are confident in your hypothesis, you must be willing to take the risk. The implementation plan that you have in place — and especially the exit plan — should allow for some hedging, but you can’t expect to dodge all of your risk.
When Facebook bought Instagram, a lot of people wondered if they might also buy Path or Pinterest, other image-centric social networks. Facebook could have hedged their Instagram bet by investing in those companies and knowing that, no matter who is the most successful, they would have some investment in that company. Instead, they remained focused on Instagram and only Instagram. That focus allowed them to receive all of the upside of Instagram’s success and avoid the downside when companies like Path later struggled. Facebook knew the risk they were taking, and they embraced it rather than trying to play it safe.
Acquisitions are just one example of a major organizational risk that needs to be carefully managed. Success in any risky endeavor, though, comes from taking similar steps. You need to develop a plan prior to launching the risky endeavor, complete with milestones and clear responsibilities. You should also always know your “Plan B” to withdraw if the risk doesn’t pan out. Finally, risks are most likely to succeed when they are taken boldly and confidently — don’t hedge too much, or you’ll lose the value that led you to the risk in the first place. Not every risk will result in Facebook’s runaway success, but by following these steps, your endeavor is more likely to look like Instagram than New Coke.
This article originally appeared on HourlyNerd