META and Why Zuck is the King of Counter-Positioning

Praise for a sometimes unpopular business leader

META recently reported its Q3 2023 earnings result. While the strong result was insufficient to appease the market (the stock dipped after hours), there were some disclosures on the earnings call around Reels that were striking:

We estimate that with all the ranking and product improvements that we've made, Reels has now driven a more than 40% increase in time spent on Instagram since launch. We also reached a monetization milestone earlier than expected, and we estimate that Reels is now net neutral to overall company ad revenue. In many ways, Reels has now graduated from being an early initiative to now being a core part of our apps.

This follows on from commentary from the 2Q23 result that reiterated the success of Reels, with the product at that time exceeding a $10 billion annual revenue run rate (up from $3 billion last fall) and with more than three quarters of META’s advertisers using Reels (compared to 40% of advertisers using Reels in 4Q22). Even as far back as 3Q22, Reels was enabling META to gain market share in terms of time spent against competitors which included TikTok.

These data points for Reels are profound; they mark a highly successful business pivot and help dispel the prevailing narrative for META which existed just a year ago. Back then, there was immense doubt around: 1) the ability of Reels to defend against the user engagement threat posed by TikTok; and 2) whether the costs of building out the AI content-recommendation capabilities required to mount a defense against TikTok were temporary or structural.

META holders will no doubt remember the 25% share price decline following the 3Q22 earnings result, given the opex and capex guidance materially blindsided investors. Thankfully the preliminary 2024 outlook for META’s opex and capex provided in the 3Q23 result indicates a moderation in the company’s spend trajectory.

Rather than recap the earnings result for one of the most well-covered companies in the world, we instead wanted to point to past business pivots that in our view cement Mark Zuckerberg as one of the greatest strategic minds in business history. That sounds hyperbolic, but when you examine the three separate counter-positioning incursions META has faced in its history, the response to those threats mounted by Zuckerberg despite investor pressure and broader ridicule, and the resounding success of each of those pivots, we believe Zuckerberg deserves far more respect as a business leader than he gets. To our knowledge, there is no better example of deftly responding to potentially existential counter-positioning threats than what has been witnessed throughout Meta’s history.

Counter-positioning is difficult to respond to

The corporate graveyard is replete with examples of companies felled by the sword of counter-positioning, with countless strategic failings to respond to a threat that only grew stronger over time. Counter-positioning is defined by Hamilton Helmer as follows: “A newcomer adopts a new, superior business model which the incumbent does not mimic due to anticipated damage to their existing business[1]”.

This collateral damage often results in the incumbent firm either delaying the decision to adopt the new business model or doing so in a perfunctory manner. Counter-positioning is often characterized by David and Goliath dynamics: a larger incumbent with a profitable core business is being attacked by a fledgling startup that is pursuing a nascent, unproven business model. Counter-positioning threats are so difficult to respond to because of the difficulty in underwriting the financial success of that business pivot, with investor perceptions towards an incumbent’s response initially being marred by skepticism and disillusionment.

Source: Bristlemoon Capital

The perceived value and the actual value of the business pivot can, of course, diverge. The perceived value often succumbs to popular bearish narratives that get traction due to the paucity of data needed to formulate a view around the likelihood of that business pivot being successful.

For each chapter in META’s history when it was dealing with a strategic threat, the market very much did not give Zuckerberg the benefit of the doubt. And this is despite an enormous informational asymmetry that exists, with investors making their convicted judgments from an external vantage point that very much lacks the granularity of data and insights that informed Zuckerberg's strategic decisions. It is perhaps the ultimate form of investing arrogance to conclude that a management team is making poor strategic choices when you can only see a small fraction of what is informing their decisions. This is doubly so when Zuckerberg already had multiple highly successful strategic pivots under his belt.

Through a series of strategic movies, META fended off not one, but three separate counter-positioning attacks on its very profitable core business: 1) the shift of consumers from desktop to mobile; 2) ephemeral content from Snapchat; and 3) the threat of short-form video from TikTok. It is worth looking at the facts and context surrounding each of these sagas to show just how unclear it was at the time whether Zuckerberg’s strategic maneuvers would succeed.

The shift from desktop to mobile

Facebook recognized the growing trend of mobile usage – a threat to its primarily desktop-based business. It was late 2011 and the company was behind. It had chosen to build Facebook mobile apps for iPhones and Android using HTML5, a technology that was not optimized for building mobile apps. The result was mobile apps that were slow, buggy, and susceptible to crashes. Zuckerberg made the decision to quickly pivot the platform to cater to mobile users.

Zuckerberg did not waste time when responding to the threat: he abandoned his laptop and began working primarily from a mobile device[2]. Facebook product managers also had to disable their own desktop versions of Facebook and switch to the mobile version instead. The transition to mobile involved significant engineering efforts to overcome the technical challenges associated with mobile devices having different operating systems, screen sizes, and performance capabilities. There were also doubts around the ability of Facebook to monetize via mobile ads on a smaller screen.

The timing could not have been worse for making such a transition. Facebook had gone public on May 18, 2012, listing the company on the Nasdaq exchange at a price of $38 per share. By September of that year the stock was trading for less than $18 per share, prompted by investor concerns around how Facebook would make money from its increasing number of mobile users. However, Facebook’s transition to mobile proved to be one of the greatest pivots in business history. Facebook went from having zero mobile revenue to building a more than $100 billion mobile-advertising business ten years later. In the process, the company cannibalized its own desktop-based ads business. Zuckerberg recognized that mobile was the future and despite the near-term skepticism and damage to Facebook’s core desktop business, he leaned heavily into mobile and mounted one of the all-time great counter-positioning defenses against mobile-focused social media platforms.

The threat from Snapchat Stories

When Snapchat gained popularity with its ephemeral content feature called "Stories," Facebook responded swiftly by integrating a similar feature into the Instagram app (note that Facebook owns Instagram). It was a copy-cat move. This move, however, came at a cost. User engagement shifted from the highly profitable Newsfeed on Instagram to the lowly-monetizing Stories format. Newsfeed was a highly-optimized ad format that advertisers knew how to create content for. Stories, on the other hand, would take time for advertisers to experiment with ad campaigns to see what generated the best return on ad spend (ROAS).

There was enormous skepticism over the ability of the Stories ad format to reach monetization parity with Newsfeed. The Stories format was mostly comprised of lower-monetizing branded ads (compared to Newsfeed that was mostly performance ads which were much more profitable) and users consumed Stories content much more flippantly, with an average ad view time that was around one-third of an ad on the Newsfeed. The concern was that user attention was shifting to an ad property that was structurally lower-monetizing.

Two years after Stories launched on Instagram, advertisers were still seeing CPMs (cost per 1,000 impressions which is used to denote the price per ad) on Stories coming in at half the rate of Newsfeed. It took years for the monetization gap to narrow and for Stories to prove it was a monetizable format. The transition was painful and was an overhang on the stock. However, it also allowed Facebook to retain its user base by offering the same functionality that users found attractive on Snapchat. Facebook prevented users from migrating to Snapchat, effectively countering the competitive challenge and neutralizing what might have been an existential threat to its business.

The short-form video threat

It was 2019 and a Chinese video-making application called TikTok was soaring in popularity. In fact, TikTok gained 100 million users in just nine months following its global launch. Instagram, at the time the fastest scaling social app, took 2.5 years to reach the same milestone. TikTok was starting to steal user attention from Instagram, the lifeblood of the company’s ads-based business.

In response, Facebook introduced Reels in August 2020, a short-form video feature on Instagram. However, Instagram didn’t start monetizing this format until June 2021. Much like the Stories transition, the move towards Reels was highly dilutive and contributed to a large revenue growth deceleration that caused the stock price to crater. There were also investor concerns around the very high levels of capital expenditure required to support AI programs to train the Reels content recommendation algorithm, one that went from recommending content from just a user’s friends and family to recommendations sourced from the billions of users across META’s properties and across multiple modalities.

The fear, again, was that user attention was moving towards a new property that would not monetize well.  However, the move was the right one in stanching the competitive inroads being made by TikTok. META eventually reported that it was growing market share on a time-spent basis versus competitors such as TikTok, and that Reels was incremental to overall engagement across META’s properties. The stock price more than tripled from its lows and META proved for a third time that it could crush counter-positioned threats.

In each of these competitive attacks, there was great investor skepticism and the company’s share price suffered not only due to this uncertainty, but also due to the short-term damage inflicted on the business from mounting a response. These competitive responses would likely never have happened if it were not for the strategic genius of Mark Zuckerberg as well as the fact that he had voting control of the company via a dual class share structure. With Zuckerberg’s super-voting shares that carry 10 votes apiece, he was relatively unconstrained in his ability to make difficult strategic decisions. Zuckerberg was criticized heavily during each of these transitions. It was not at all clear at the time that they would prove strategically sound. However, in hindsight, each of these moves have been a resounding success, cementing Zuckerberg as one of the great business leaders.

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The information contained in this article is not investment advice and is intended only for wholesale investors. All posts by Bristlemoon Capital are for informational purposes only. This article has been prepared without taking into account your particular circumstances, nor your investment objectives and needs. This article does not constitute personal investment advice and you should not rely on it as such. This document does not contain all of the information that may be required to evaluate an investment in any of the securities featured in the document. We recommend that you obtain independent financial advice before you make investment decisions.

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Bristlemoon Capital Pty Ltd (ABN: 22 668 652 926) is an Australian Financial Services Licensee (AFSL Number: 552045). 

George Hadjia is associated with Bristlemoon Capital Pty Ltd. Bristlemoon Capital may invest in securities featured in this newsletter from time to time.

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[1] 7 Powers, pg 49.

[2] https://www.vox.com/2019/4/29/18511534/facebook-mobile-phone-f8