The Internet Revolution: It’s Not Social OR Mobile, It’s Apps

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SEE LAST PAGE OF THIS REPORT Paul Sagawa / Artur Pylak


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May 15, 2012

The Internet Revolution: It’s Not Social OR Mobile, It’s Apps

  • We believe that the Internet economy is in the midst of a revolutionary paradigm shift from the neutral browser of the PC era to the tightly managed App model. While the growth of social and mobile applications have spawned significant new businesses, the evolutionary pace of change has allowed nimble incumbents to adapt. The shift to Apps is more radical, allowing platform masters – Apple, Google, and maybe, Microsoft and Amazon – to manage their users’ web experiences by integrating functions into their platforms, setting default Apps and controlling the store through which Apps are distributed. We believe that the App model will allow the platform masters to co-opt much of the value as the web absorbs opportunity from the rest of the economy. 3rd parties will need critical mass and sustainable competitive barriers to thrive and, we fear many will not. Even well positioned Apps, like Facebook and Twitter, may find it difficult to monetize their business in adjacent opportunities due to the power of the platform owners.
  • We believe that the defining factor in the changing web paradigm is platform control. Many pundits divide Internet history into eras, asserting a “Web 2.0” era driven by the rise of collaborative social applications. While Web2.0 innovations spawned new businesses, they played out over years and nimble players easily navigated the changes. Mobility is also evolutionary, enabling new business models but not prohibitive to established franchises. However, the shift from a neutral “browser” model, to a platform owner controlled “app” model is revolutionary. Unlike PC browsers, mobile platforms push Apps for direct access, allowing the platform to manage the user experience via pre-loaded defaults, integration of certain apps to the use of the device itself and tight control of the App store. By this mechanism, platform owners can favor their own services and those from which they receive fees.
  • Cloud-based services are now the primary purpose of consumer computing, with trillions of dollars of opportunity addressable. Most major consumer applications– e.g. E-mail, search, e-commerce, media streaming, navigation, content sharing and social networking – are inherently cloud centered. Even traditional applications – e.g. office productivity, games, content creation/editing, and file archives – have cloud-based alternatives with functional and cost advantages. As platform owners push functionality to the web, they will disproportionately benefit as the Internet absorbs value from the rest of the economy. For example, Internet penetration into the huge global retail and advertising industries is small, but growing rapidly with enormous room for future growth.
  • Apple, Google, Microsoft and Amazon are in position to take the lion’s share of Internet opportunities. The iPhone’s intuitive and integrated user interface was ground zero for the “app” model, which has been emulated by Google, Microsoft and Amazon for their platforms. Statistics show that users of mobile platforms are far more likely to access internet-based services via apps than through their browsers, giving enormous advantage to integrated functions, default apps and apps favored in the platform owner controlled store. As smartphones and tablets overtake PCs as the primary mode of consumer web access, these platform owners have the first crack at serving advertising, selling services, and facilitating transactions to users, and can absorb opportunities targeted by 3rd party apps by integrating similar functionality into the platform or favoring an alternative app.
  • App driven companies must sustain differentiation, and circumvent the influence of platforms, or risk irrelevance. Stand alone applications have always been vulnerable to the power of platform integration – the DOJ famously forced Microsoft to disintegrate Explorer after it laid waste to Netscape and others. Apple’s tight integration of iTunes stymies other media distribution solutions on its devices. Google’s integration of its own apps – Search, Maps, Places, Google+, Play (books, music, movies, apps), Talk, YouTube, Drive, Voice, etc. – into Android attacks a wide swath of web-based businesses. Amazon, fearing eventual disintermediation, built its Kindle interface over Android and moved its own e-store to unavoidable prominence. Against this tide, independent app companies must differentiate themselves with their target customers, build critical mass and establish sustainable barriers to competition from platform integrated alternatives. Examples of well positioned App companies with scale and barriers include Amazon, Facebook, OpenTable, Twitter, and Hulu.
  • Even successful, differentiated, sustainable apps, like Facebook, may be stymied in addressing adjacent opportunities without a platform. Facebook’s revenue projections assume that it can lever its 900 million users to capture advertising and sell web-based services – e.g. media streaming, games, e-tail, etc. However, in the emerging platform dominant model, the platform owner will have first crack at serving advertising and selling services before the user hits the app, and can be expected to relentlessly move to break competitive barriers and siphon value into their platforms. As Amazon felt it necessary to establish its own platform, Facebook may need to gain greater integration into a mobile platform to achieve its manifest destiny. We remain intrigued with the potential for co-operation with Microsoft, and its Metro-based Windows Phone and Windows8 platforms.

Major Web-based Mobile Applications, Market Share versus Barriers to Entry

Cut to the Chase

The Internet blogosphere is nothing if not self reflective. Over the past several years of staring at its collective bellybutton, a rough consensus on the development of the web emerged, codifying a transition from the communication and transaction oriented “information superhighway” of its birth to the communal, cloud-based resource “Web 2.0” of more recent vintage. Now, pundits are touting an emerging third era, driven by mobile, location-aware applications. While this widely accepted framework is a convenient tool for accessing the growing functional capability of the Internet, it obscures the revolutionary impact that the predominance of “apps” over “browsing” is having on the competitive balance of the whole internet economy.

The App model yields considerable competitive power to the owner of the software platform through which the user reaches the Internet. In the browser era, users approached the Internet through a neutral window, choosing their own home page and entering their own URLs or clicking on hyperlinks. Microsoft had been forced by the DoJ to unbundle its browser from its Windows operating system, and was thus, hesitant to show significant favoritism to any of the various sites vying for consumer attention. In contrast, Apple’s iOS integrated many web apps directly into the operating system, privileged some with prominent positions on its default screen, and favored others in recommended lists on the Apple curated App store.

With Google’s Android, Amazon’s Fire and Microsoft’s Windows Phone and Windows8 platforms mimicking Apple’s App model, a new platform dominated era has begun. We believe that this era will see enormous swaths of value co-opted into the Internet economy from the worlds of advertising, retail, media, consumer services, and transaction processing. The power of the App model means that the owners of the major platforms will get first crack at these opportunities, serving some user needs with integrated functionality before they can even hit an App, favoring affiliated Apps, and extracting fees from Apps in the store. As value concentrates toward the platform owners, the share for 3rd party App players will be under pressure, compromising their ability to monetize their positions. This is obviously good for Apple, Google, and, probably, Amazon and Microsoft.

It is not good for most App companies, including Facebook. To survive, much less thrive, Apps will have to achieve critical mass and build considerable barriers to competition, such as proprietary technology, scale advantages, infrastructure investment, brand, and unusual operating skills. Otherwise, the platform masters will integrate interesting business opportunities into their platforms for their own benefit. Even well positioned applications, like Facebook or Twitter, may find their opportunities for extending their businesses into adjacent areas stymied by restrictive platform rules or due to the substantial advantages of the platform masters. For investors, we favor the platforms – Google, Apple, Microsoft and Amazon, probably in that order – and App stalwart Open Table, which has substantial barriers to competition in its widely deployed software systems. We are less enthusiastic about Facebook, which may have greater obstacles to achieving the growth that many expect, and most of the recent Internet IPOs, including Groupon, Yelp, Zynga, and Pandora.

In the Beginning…

As the Internet has evolved from its start as a Defense Department project in the 1960s, it has been through many phases. Its first two decades were largely anonymous, a nerd’s paradise of interconnected academic and government computing centers, used primarily for passing files and messages. In the 1990’s, awareness of the Internet passed into the public domain, with Al Gore leading the cheerleading and coining the term “information superhighway” – even if he had nothing to do with its creation. By then, the internet was widely used for commercial purposes, a trend that was supercharged by the introduction of the HTML page specification and the browser. This is generally marked as the start of the user friendly “world wide web” that now comprises the large majority of the Internet that we all know and love.

Usage in the first decade of the world wide web era was largely static, mostly users browsing fixed web pages by typing in URLs preceded by “WWW dot.” These Web 1.0 pages were hyperlinked and it was not unusual for a site to have multiple links to content on other sites and servers.  In 1995, there were some 39 million internet users browsing some 100,000 web sites via dial-up connections with 28.8Kbps and 33.6Kbps modems (Exhibit 1). Content creators were few. Most internet users were using desktop PCs with CRT displays and maximum resolutions of 800 x 600. Photos posted to a web page were of poor quality and video was extremely rare.

Exh 1: Global Internet Users, 1996-2011

It Got Better

Over time, two important things happened. First, the performance of the Internet improved. Standard PC configurations began to include faster processors, ample memory and higher quality displays. DSL and cable modems proliferated, bumping access speeds by a factor of 100. By 2004, half of all US users accessed the Web via broadband. Second, the community of Internet users grew exponentially. By January 2004; there were over 700 million internet users globally, or just over 10% of the world population, and by May, there were over 50 million websites on the Internet.

The steady improvement in the performance and penetration of the Internet started to support more advanced and interactive applications and the critical mass of users fostered the development of valuable on-line communities for sharing and collaborating. This emerging environment led to the rise of a new set of Internet businesses, like Facebook, YouTube, Flicker, MySpace, Friendster, sites that allowed users to create profiles, connect and interact with other users, and upload user generated content revolutionizing the way users engage with the internet. Websites evolved from being simple repositories of hyperlinks and text files, and began to focusing on user stickiness, offering features and content that would keep users on a site for a longer period of time and allowing the site owner to monetize by serving advertising. Pundits labeled this the Web 2.0 era, and while it obviously nurtured the growth of a new set of businesses, it was not necessarily an obstacle for the established Internet leaders of the era. While “Web 2.0” was, arguably, the beginning of the end for Yahoo – Google, Amazon, Apple and Microsoft navigated the change easily, with many of the era’s darlings failing to live up to their early expectations.

The progression of the performance and penetration of the Internet have continued apace. At the beginning of 2012, there were over 2.2 billion internet users globally about half of which have a broadband connection. Broadband speeds often top 10Mbps, and typically support high quality streaming video, aided by the widespread adoption of Content Delivery Network architecture, which distributes servers into geographically dispersed sites, thus minimizing the delay between server and user. However, while the changes to the Internet economy have been extraordinary, these changes have be evolutionary rather than revolutionary, and the basic paradigm of the PC browser as a neutral window to web based services remains sacrosanct on the desktop.

You Say You Want a Revolution

Over the last 4-5 years, we have seen the rise of the mobile Internet, prompting pundits to call out the beginning of another new era. The data speeds available on wireless devices have been gaining on those offered on fixed broadband networks, with 3G WCDMA and CDMA offering better than 1Mbps widely available in all major US markets by multiple carriers and HSPA+ and 4G LTE are being rolled out with peak download speeds greater than 10 Mbps (Exhibit 23). The addition of mobility adds several wrinkles for the Internet economy. Applications are available over longer intervals of the day and from more convenient locations, enabling users to access the Internet as a supplement to another activity, such as watching television or shopping. The applications may also be fully aware of the user’s physical location and use that to provide additional value, pointing to nearby locations, providing directions, or noting the proximity of other users. Consumers can now watch HD mobile videos while on public transportation, view restaurant reviews and get directions while deciding, comparison shop between brick and mortar and online retailers, and also post their own content on the go. A user can upload a high resolution photo or HD video while on the go, provide real time feedback on a restaurant, or review a daily deal.

This adds significant value to the on-line experience for users and creates incremental opportunities for web-based businesses to exploit, but like Web 2.0, the changes created specifically by mobility appear more evolutionary than revolutionary, even though we believe that mobile platforms will become the dominant mode of web access in the relatively near future. Rather, the real game changer is the shift from the neutral browser to platform controlled Apps.

Exh 2: Wireless and Wireline Advances, 2000-2012

Exh 3: Projected Average Mobile Network Connection Speeds, Global

There’s an App for That

The launch of the iPhone in 2007 introduced the App. Now familiar to mobile internet users world-wide, the App was game changer, though few observers appreciated the power of the new paradigm upon its introduction. Basically, Apps bypassed the neutral browser, offering a shortcut to commonly used functions via easily accessible icons on the main screen. For users, apps are a considerable convenience, particularly on a small smartphone screen, obviating multiple steps and the nuisance of typing addresses. For Apple, it allows it to control its users Internet experience to an unprecedented degree. The default applications – Messages, Safari Browser, Mail, App Store, Camera, Photos, Maps (Google), Weather, iTunes, Music/ Videos, Calendar, YouTube (Google), Reminders, Clock, Contacts, Notes, Calculator, Stocks, Voice Memos, Newsstand, Face Time, Compass, Game Center, Photo Booth and Siri – are given prominent real estate and are difficult to change or even move. The distribution of new applications is restricted to the App Store, which is tightly curated by Apple, which recommends favored Apps and takes a 30% swipe of any fees generated. Furthermore, Apps are prohibited from prompting additional transactions unless the publisher pays a further 30% on the revenues generated.


Exh 4: Top Mobile Properties and User Engagement (Browser versus App), March 2012

While users can still access alternatives via the browser, the advantages of the App are compelling. Smartphone owners rarely access web sites with the browser if an app is available, and few users bother to seek alternatives to the default applications. A study by Comscore released earlier this month found that 82% of time spent on mobile media happens via apps versus browsers (Exhibit 4). Over 80% of time spent on Google, Facebook, Amazon, Apple, eBay, and Twitter was spent via an app. In this, the bar for establishing a new web business serving iPhone users is very high, as is the toll to be paid to Apple, particularly in competition with a default app or one well recommended in the App Store. We also note that the number and scope of default Apps has increased with every iteration of the iPhone, gradually squeezing more and more of the air available for 3rd party providers.

This is also true of the Android platform, although to a lesser degree. Google has integrated its Search, Voice Commands, Gmail, Google+, Play, Maps, Places, Talk, Navigation and Calendar products tightly to its platform. OEMs licensing Android may also add 3rd party default applications in the initial configuration. While it is not complicated for users to change default applications, the interplay amongst them adds value to the user experience, and few users would be likely to change to alternatives. Google does allow alternative App Stores, it does not take a share of App proceeds and it does not prohibit Apps from prompting further transactions or take a cut. Similarly, Microsoft and Amazon also pre-load default Apps and run their own Apps Stores.

Exh 5: U.S. Web Browser Market Share Trends – 1996-2011

In Bill Gates’ Dreams

Back in the day, Microsoft envisioned something similar. In 1996, startup Netscape’s browser application, Navigator dominated the browser market with over 70% share of Internet users (Exhibit 5). Netscape’s business model allowed Internet users to download the browser for free while corporate customers had to pay license fees for its suite of Internet software. Shortly thereafter, Microsoft pounced. It leveraged its then 90%+ share of the PC operating system market to bundle a browser into its OS and not charge additional fees. With its deep pockets and leverage over PC makers, Microsoft was able to quickly wrestle share away from Netscape. By the end of 1998, Internet Explorer had slightly over 50% market share. The Department of Justice took Microsoft to Federal Court in 1998 accusing the company of monopolistic behavior with its bundling of Internet Explorer. An initial judgment in September 2000 found Microsoft guilty and Judge Thomas Penfield Jackson ordered the company to be broken up, only to have the order reversed by the DC Circuit Court of Appeals. Microsoft then settled with the DOJ in November 2001, agreeing to sever the tight integration of browser and OS and allowing third-party access to its source code for five years.

Had the ruling gone the other way, Microsoft would have been free to inextricably bond Internet Explorer into Windows, and then begin integrating various web-based functions into the browser, all in the name of creating a more seamless experience for users. Arguably, Microsoft could have exerted the same influence over the browser internet that Apple wields over its iOS environment, and in doing so, it could have thwarted the rise of many of the stalwarts of the consumer Internet, such as Google, Amazon, Apple iTunes, and even Facebook by forcing desktop browser users to use Microsoft provided alternatives as their default choices.

After the Gold Rush

Apple’s App model has achieved what Microsoft could not. Over 80% of the Fortune 500 companies maintain a downloadable app to communicate with customers. Instragram, an app startup that did not exist two years ago, commanded a $1B valuation in a cash and stock takeover by Facebook announced in April. The company built a user base of 30M in just over a year and half after launching its photo-editing app. Rovio’s Angry Birds has become an international phenomenon, ready to spin out feature films and theme parks from a start as a simple App. Today in tech corridors around the globe, venture capitalists no longer hear pitches about building websites, rather about cloud-based Apps.

Despite the enthusiasm of entrepreneurs and financiers, we are skeptical that many will find gold at the end of their rainbows. To be successful on their own, independent app companies must differentiate themselves with their target customers, build critical mass and establish sustainable barriers to competition from platform integrated alternatives.  Otherwise, Apple, Google, Microsoft and Amazon will simply roll over them, integrating similar functionality into their platforms. While daunting, the circumstances are not hopeless. Companies like Amazon, Facebook, OpenTable, Twitter and Hulu have managed to establish differentiated App-based franchises that have reached critical mass and demonstrated resiliency against competition.

Exh 6: AdMob Survey – Tablet Usage Versus Other Entertainment Forms

Every Cloud Has a Silver Lining

We believe that mobile platforms – smartphones and tablets – are well on their way to becoming the predominant mode of internet access for consumers. Smartphone and tablets substituting for traditional PCs has become apparent with Nielsen finding in a survey last year of new tablet owners that over 30% were less likely to buy PCs. A Google/AdMob survey found that 59% of respondents would prefer to use a tablet to read a book, 52% would prefer the device to a radio, and 34% would use it to watch TV (Exhibit 6). Dovetailing with this paradigm shift is the rise of cloud-based applications. Unlike PCs which have vast storage options, mobile devices have fairly limited storage and depend on an internet connection to the cloud for content. Most of the applications that dominate consumer IT use – e.g. E-mail, search, e-commerce, media streaming, navigation, content sharing and social networking – are inherently cloud centered.  Even traditional applications, such as office productivity, games, content creation/editing, and file archives, now have cloud-based alternatives that offer real functional and cost advantages.

Exh 7: Market Sizes of Industries Threatened by Technological Disruption

With the cloud also comes trillions of dollars of opportunity addressable by Internet businesses (Exhibit 7).  As platform owners push device functionality to the web, they are also in position to disproportionately benefit as the Internet continues to absorb value from traditional industries across the rest of the economy.  Several large industries present near term opportunities for web based players. Though internet penetration into the $14T global retail industry is in the single digits, e-commerce has been growing at nearly a 15% CAGR since 2006. The global advertising, marketing, and promotions market is about $1.0T, while Google which is estimated to control half of the online advertising space had almost $40B in online ad revenue from the last twelve months. Online video ads command a CPM 2x greater than traditional broadcast since many ads can’t be skipped and consumers can be targeted (Exhibit 8). Combine that with over 20% annual growth in total online advertising and nearly 90% growth in mobile advertising, the opportunity is tremendous (Exhibit 9). Other large industries exposed to disruption from technology and the cloud include Higher Education ($250B), Retail Banking and Credit Cards ($159B), Multichannel Video ($175B), Consumer Electronics excluding smartphones, tablets and PCs ($140B), Television Hardware ($130B). More than likely some less obvious industries will be disrupted with a simple app yet to be conceived and deployed.

Exh 8: Advertisement CPM Ranges by Media, 2011-2012

Exh 9: Mobile Advertising Revenue, Worldwide, 2008-2015

Manifest Destiny

Currently, Android powers 50.1% of US Smartphones and iOS 30.2%, with Research in Motion’s Blackberry hemorrhaging share with a further 13.4% to lose (Exhibit 10). Microsoft is in a distant 4th place, with just 4.4% share but hope for the future as new models built on its critically praised Windows Phone OS roll out and gain synergy with the upcoming launch of Windows 8 for tablets, notebooks and desktops. Apple’s iPad currently dominates the tablet market that it began just two years ago, with better than 70% share (Exhibit 11). We expect Android, Microsoft’s Windows 8 and Amazon’s Android-derived but distinct platform to grab over half the market during the next 3-4 years of hyper-growth, but expect Apple to remain dominant at the higher end for the foreseeable future.

Exh 10: Smartphone Operating System Share

This scenario portends enormous power for Apple and Google in competing for the value created by the shift to the cloud. Both companies have been aggressive in adding new products and capabilities in anticipation. Apple’s iCloud and AppleTV are squarely aimed at streaming media and centralized storage opportunities, with the 2010 acquisition of Quattro and the subsequent launch of iAds clear signs that Apple does not intend to let Google run away with the on-line advertising market. Siri, the voice activated assistant launched with iOS 5, is an attempt to de-value Google on Apple’s platform, as is a rumored new mapping product based on technologies from the recently acquired C3 Technologies and Poly9. Apple has also taken its shot at Amazon, with its controversial e-books entry currently under DoJ scrutiny for alleged price fixing. Finally, Apple’s ambitions for the TV market have been the subject of daily conjecture for a long time.

Exh 11: Global Media Tablet Shipment Forecast, Worldwide, 2010-2015

Meanwhile, Google has not been sitting on its heels. Android already benefits of Google’s dominant position in on-line advertising, Search and Maps. Google Places, tightly integrated with its dominant Maps product, has been building content and momentum, nudged along by the recent acquisition of Zagat. This squeezes a range of other businesses similarly predicated on providing information and reviews of restaurants and businesses – e.g. Yelp, Urban Spoon, and Trip Advisor. Google’s acquisition of ITA positions Google to offer travel services directly from search queries, potentially cutting out travel specialists like Expedia, Orbitz, and Priceline. Google+ aims to steal some of the thunder from social networking leaders Facebook and Twitter, although early results have been largely uninspiring. The expansion of the Play store moves Google more resolutely into e-books and streaming music and video, with rumors that the company plans to expand its e-tail activities further into traditional Amazon territory. Google Wallet is an Android play for the credit card market.

Amazon sees the writing on the wall. The launch of the Kindle Fire was an acknowledgement that sitting behind Apple and Google at the device level had left Amazon vulnerable to the ambitions of the platform owner. Amazon licensed Android, but completely rewrote the user interface to excise the Google influence, featuring instead, its own App Store and its e-commerce platform center stage. Thus far, the Kindle Fire has been a success, the clear number two tablet during the last holiday season, but it will be incumbent on Amazon to build on the momentum with new products and innovations. The rumors around Amazon hint at a move into the smartphone arena, a significant opportunity to expand the company’s reach but one that would likely require the cooperation of wireless carriers, with whom Amazon has had little experience.

Microsoft’s current share of the smartphone and tablet markets is anemic, but its assets are intriguing. After a decade of blunders, Windows Phone is finally a worthy platform. Based around the “Metro” user interface with active application tiles, Windows Phone is differentiated from iOS and the similar Android, with many reviewers enthusiastically praising its advantages. These advantages will be multiplied with the introduction of the Windows8 operating system in the fall. Windows 8 is intended to be Microsoft’s flagship OS for both PCs and tablets, and features the very same “Metro” user interface. With expected enterprise adoption, the growing familiarity of users with “Metro” should raise Windows Phone’s appeal. Moreover, Microsoft also brings cloud-assets that it can integrate into its experience, such as Xbox, Skype, Hotmail, Outlook, Office365, SkyDrive, and Bing. Nonetheless, Microsoft must begin its run from the back of the pack.

I Will Survive

As mobile platforms displace the traditional PC architecture and as the mobile platform owners absorb opportunity, independent web-based businesses will feel the squeeze. Companies that fail to establish critical mass and build sustainable barriers to competition from the platform owners will be at the greatest risk. Arraying web application players according to their estimated share of their addressed market and a subjective assessment of their barriers to entry suggests that well positioned companies are outnumbered by those in jeopardy (Exhibit 12).

Exh 12: Major Web-based Mobile Applications, Market Share versus Barriers to Entry

Amongst the best positioned App players, Facebook and Amazon are obvious. Each dominates a well established corner of the web ecosystem with extraordinary scale and first mover advantages. While they have tried and will continue to try, Apple and Google have not been able to make more than a small dent in either social networking or e-tail. Twitter may be less obvious, but its growing domination of news dissemination makes it nearly impossible to supplant. Open Table is even less obvious, but its web restaurant reservations service is supported by reservations management software deployed at each of the tens of thousands of restaurants affiliated with the service. 40% of US reservations taking restaurants are on board, with 20% of all reservations taken through the on-line system. Rolling over Open Table involves not just enticing the consumer to consider a new App, but also convincing a critical mass of restaurants to shift their on-site software system. Finally Hulu, the TV streaming App, has a significant barrier to entry owing to its exclusive access to content controlled by its co-owners, Disney (ABC), NewsCorp (FOX) and Comcast (NBC).

Exh 13: Performance of Select Tech Companies with IPOs in last 2 years

Less well positioned are the companies to the lower left of the chart, including a number of companies that had launched widely hyped IPOs over the past two years (Exhibit 13). Most of these companies have performed very poorly since coming public, in part, a reflection of the obstacles these Apps face in an increasingly mobile platform dominated market. Companies like Yelp, Groupon, Zynga, Pandora, and Expedia must differentiate their offerings vs. similar services tied tightly or favored by iOS or Android while attempting to build critical mass. The degree of difficulty is very high.

I Said Stay in Your Room!

Unable to eliminate the influence of well positioned Apps, platform owners can look to minimize their presence and thwart their ability to address new business areas. Facebook is a good example of this. On the desktop, users often keep a browser tab open to Facebook, allowing easy access for occasional forays into the social network. Neither iOS nor Android supports this paradigm – users must launch the Facebook App each and every time they want to use the service for more than a narrow glance. While Facebook remains wildly popular, even on mobile platforms, its ability to monetize its position is fundamentally compromised. Apple’s iron clad revenue sharing policy for App revenues essentially means that any auxiliary business Facebook were to launch on the iPhone or iPad would have to tithe 30% to Apple if the access point were through an App.

Moreover, the fact that iOS and Android get first crack before the customer even selects the Facebook App icon may squeeze opportunities for advertising, e-commerce and other services. For example, a search for a video on Siri or Google search would push to an iTunes or Google Play transaction rather than a sale through Facebook. Apple and Google also can capture a far richer picture of user activity for advertisers and serve those ads more naturally and directly than can Facebook on a mobile platform. Social games – a considerable revenue source for Facebook – may find it enticing to deploy directly to the device platform as Apps.

Amazon has confronted this problem by launching its own platform. Thus far, Facebook has been resistant to a similar direction, but has acknowledged the challenges it faces in monetizing its position on mobile devices. With Facebook on the eve of its IPO with an historically rich valuation on offer, its vulnerability to the whims of the dominant platform owners is a considerable risk factor that could play very badly for investors with aggressive expectations for long term revenue growth from outside its core application.

Looking further at Facebook’s circumstances, we remain intrigued about the potential for co-operation between the company and Microsoft. The tile-based Metro interface would be far more conducive to maintaining the “always on” Facebook tab, while tight Facebook integration could be an attractive draw for the consumers that Microsoft has struggled to reach. Microsoft has also demonstrated less ambition to squeeze incremental advertising and e-commerce opportunities from its App partners, making it likely to be more amenable to a Facebook friendly arrangement. We note that we have no information that any such relationship has ever been contemplated, but the potential fit does seem serendipitous

Exh 14: Winners and Losers


The advent of the App era gave enormous power to mobile platform owners, who have significant advantage in addressing the enormous value being created by cloud-based applications. These platform owners – most significantly Apple and Google, but also Microsoft and Amazon – are also in position to squeeze independent web businesses, taking fees and co-opting their business models by integrating them into their own default Apps (Exhibit 14). Web apps that are able to establish critical mass and build sustainable competitive barriers may survive or even thrive these conditions, but even successful Apps, such as Facebook, Amazon and Twitter, may find routes to auxiliary revenue opportunities blocked by the platform owner. We believe this environment greatly favors the platform owners. App vendors can be very successful within the narrow bounds of their core service if they reach critical mass with sustainable barriers to competition – Facebook, Amazon, Twitter, OpenTable and Hulu come to mind. However, those companies whose valuations depend on levering their core franchises to new opportunities – Facebook – may face more difficult obstacles than most observers surmise.

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