With Mobile Messaging, It’s Easier to Build a Castle Than a Moat

What Facebook will do to protect WhatsApp, and why many more WhatsApps will keep popping up

Facebook’s $19bn acquisition of WhatsApp is the largest ever for a venture-backed company.

WhatsApp was able to build a castle of hundreds of millions of users faster than any company ever before. This post explores how WhatsApp’s growth was possible, why more messaging services will grow like it again, and how the incumbent messaging services will try to erect moats around their users to prevent that from happening.

Moat strength: Linear vs. Quadratic Network effects

Network effects and Metcalfe’s Law are related, but distinctly different.

For services with a network effect:

“The value of a product or service is dependent on the number of others using it.”

Metcalfe’s law, which was used to describe telecommunication networks, describes a particular variant of network effects where:

The value of a network is proportional to the square of the number of connected users (n) of the system: n^2.

Network effects can be linear. Metcalfe’s law describes network effects that are quadratic. The difference is important.

1:1 messaging services have linear network effects

Snapchat, Whatsapp, Facebook Messenger, Line, and other messaging apps are all useful if you have one friend on the service. That’s part of why so many of these services get started: they’re still useful when small.

Messaging services are better with a hundred friends than ten friends. Assuming those are all equally good friends, those extra friends make the service 10x better for users since you’re communicating pairwise with each of them.

If these services followed Metcalfe’s Law, then the the service with n=100 friends vs. n=10 would be 100^2/10^2 more valuable: 100x. But we know that isn’t true, since when you’re interacting 1:1 with friends, the incremental friend joining doesn’t make those existing conversations better.

Castle building: consumer services have never grown this fast

Mobile in the 2010s is making the web of the 2000s look puny as a growth channel.

Frictionless mobile growth

Benedict Evans lays out a few of the core reasons why mobile services can grow so much faster:

  • Address book access to bootstrap a social graph.
  • Push notifications, so services don’t need to build habits like visiting a website daily. It’s pull, not push, engagement.

Combined with undercutting onerous SMS fees (over $100bn/yr, still), mobile presents the perfect storm of growth for communication apps.

Mobile vs. PC market size

The mobile market is already much larger than PCs: 3.2bn mobile users vs. 1.6bn PCs in use. And the growth rate is tremendously higher for mobile: 1.7bn phones sold in 2012 vs. 350m PCs.

The result: mobile consumer services grow faster than and have bigger addressable market than those on the web.

WhatsApp grew 3x faster than the previous fastest growing social network in its first 4 years: Facebook (source: TechCrunch)

Mobile messaging lacks moats

Because the network effects are linear, the size of a messaging services’s castle —its hundreds of millions of users—doesn’t create a huge moat compared to equally sized castles at Facebook or Twitter, which follow Metcalfe Law services. With services growing faster than ever in a bigger consumer market than ever before, it looks like we’ll continue to see new mobile messaging services grow at astonishing paces to unheralded sizes.

Facebook probably won’t want to pay 10% of its market cap for all of them.

Protecting the castle

So what are messaging services to do once they’ve grown so big, so fast, to preserve their value? What will Facebook do to make sure Whatsapp stays the market leader? Some possibilities:

  1. Leverage consumer scale to create defensible two-sided marketplaces: getting users is hard for most non-messaging services. Building commerce businesses—deals, transacting for services, transportation, and so on—require lots of consumers and suppliers. Messaging services can attract suppliers with their huge audiences. Building marketplaces with supply-side network effects can serve as both a big moat and big new non-advertising revenue channel. WeChat and Line are leading the way here in Asia.
  2. Make users invest more: if users have more ways to invest in the service — building an identity they care about, creating a history they don’t want to give up—it increases the switching costs of leaving. This strategy is antithetical to ephemeral services like SnapChat and anonymous services like Secret.
  3. Multi-player games: fit perfectly into the messaging app container with hundreds of millions of users. Having the largest set of games, some potentially exclusive, can create network effects in terms of inventory.
  4. Reduce fees: in the case of WhatsApp, it’s obvious Facebook will want to reduce all growth friction. Collecting a tariff from every user will not last.

Up next: incumbents invest in moats, upstarts build new and bigger castles faster

Mobile penetration is still growing. The address book and push notifications aren’t going anywhere. Startups will build bigger castles faster than ever before.

Messaging incumbents will look to protect their castles with new, defensible moats to try to keep their users from promiscuously trying new services. Some of these moats will be entirely new monetization models for consumer services beyond traditional advertising.

Finally, expect more big acquisitions from the largest tech companies. Google missed out on WhatsApp ($10bn wasn’t quite enough), but their $400bn market cap and $50bn in cash will be in play. Eventually Apple, with its $475bn market cap and $160bn in cash, will likely realize it needs to build social services beyond its iOS platform. Tencent and Baidu will be the major players outside the US — Tencent has already taken an equity position in Snapchat — and domestically, Facebook, Twitter, and Yahoo will likely continue to be active.

After spending $19bn on WhatsApp, though, Facebook may take a breather.

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