This last year has proven to be considerably difficult for FANNG businesses, which were largely responsible for a majority of the economic growth in 2020 and 2021. During that period, however, Facebook made a defining choice in its business model by prioritizing Metaverse products in their business model. In October of 2021, they leaned heavily into this new segment and restructured their business entirely around it, with the most prolific change being their name change from Facebook to Meta. However, as economic policy shifted towards a more constrained environment, the company found itself ensnared in what was once its most promising venture. Recently, the Metaverse has been faltering due to the lack of regulation, fraudulent activity, and wavering demand. If this pessimistic outlook on an integral part of Meta’s expected future success doesn’t change, this may lead to a failure to realize the potential of their Metaverse investment and bring the business to its demise due to an adjacent lack of priority in their social media segment which is facing monetization and competitive headwinds.
However, before we go into the company's troubling situation, it helps to know how it got there in the first place and this requires some context.
The Pre-Meta Period:
In its early years, Facebook was an app solely targeted to college students, but this model shifted once Facebook saw incredible traction within a short period; the app reached 1 million users in ten months. The company had a mission to connect people and communities by taking the social experience online. Over the next 14 years, growth was defined by a combination of user growth and key acquisitions which have played a defining role in their business to date. Targeted advertising became their key driver of revenue, as they provided much higher engagement metrics than traditional advertising solutions would at the time, thanks to their data collection.
Beginning of the End:
That brings them to a fundamental problem. What happens if people don’t want to join the platform anymore or potentially even leave? The threat of obsolescence is especially prevalent in industries experiencing intense competition. They could fight this by acquiring businesses which complement their main platform, which worked with Instagram. Well, that's exactly what they did, and this resulted in two important events to bring them to where they are today. It first gave them the first taste of what the Metaverse had to offer through their acquisition of Oculus in 2014, and second, it began a long and winded string of antitrust issues with regulators which hindered their ability to remain acquisitive in a timely manner.
Eight years after Facebook acquired Instagram, the Federal Trade Commission announced that they were suing Facebook for “illegally maintaining its personal social networking monopoly through a years-long course of anticompetitive conduct.” They requested an injunction to force the divestment of Instagram and Whatsapp, pitching that it occurred due to the existential threats they posed to the Facebook-Messenger monopoly. The case is on-going with a trial expected to begin sometime by the end of 2023 to 2024 which puts a potential countdown on the businesses performance. Regulatory headwinds were further exacerbated one year later as in 2021, as a product manager at Facebook named Frances Haugen came forward and released confidential documents to whistleblow malpractice within the business. These documents revealed troubling information about both Facebook and Mark Zuckerburg, with topics including societal and political ailments inflicted in the name of profitability. The senate demanded Zuckerburg appear before them and address the issues and were not impressed with how it was handled, making mention of their favor towards the break-up of the monopoly.
On top of that, the industry was rapidly changing as fierce competition ripped away market share, most notably being TikTok. The proliferation of short-form content was something they fought against through the implementation of Reels. While the reels segment lags behind TikToks engagement rates, Instagram overall has a mature and robust advertising infrastructure with better conversion, click-through, and return on ad spend. This exemplifies their importance in Facebook's portfolio holdings, since the ability to copy competitors only works due to their large user-base and preferable advertising infrastructure. What does all this mean? Facebook is on a countdown to a trial which could result in the divestment of their most productive segment and main defense against competitors. Their acquisitive nature cannot sufficiently cushion the risk they face since every acquisition they pursue is under intense regulatory scrutiny to ensure competition remains unhindered. This leaves just one option still open.
This brings them to a pivotal moment in their life cycle, where they began betting on the idea of the Metaverse. The Metaverse is a virtual world accessible through the internet where users can do things like go to an office and work, hang out in a park, and other things that are normally done in person like going to a concert. Second Life, one of the most popular realized Metaverses, allowed characters to do these things while playing as cartoon versions of themselves and even let users speculate on their digital real estate. People were spending ~$100M per year on purchases within the world with some having well over $1M worth of virtual real estate holdings. The rationale for the Oculus acquisition was to make it applicable to more social gathering like what was mentioned above, a far cry from their initial value proposition of gaming. However, competition from the broader gaming segment like Sony’s VR headset which was made for Playstation and lackluster demand for online social gathering applications like mentioned above made it difficult for their products to gain any traction.
When all hope seemed lost for their VR vision, the pandemic presented a unique opportunity for the business. Speculative trading activity was at its highest through a swift recovery in the markets, after the blow dealt by lockdown led people towards making money from home. At the same time, cryptocurrency was in the greatest bull run in its history and everyone was trying to get out ahead of any new trend which could make money. These tailwinds put Oculus at the forefront of their new envisioned future. In 2021, Facebook committed itself to this shift by changing the parent company name to Meta Platform. The shift was a big piece of news to take the heat off and put them in a new light. Google did the same thing in 2015 by restructuring themselves under a new parent company called Alphabet to differentiate its search engine from the multitude of other ventures it has underway. The Facebook name change is indicative of a fundamental shift towards their prioritization of the Metaverse within their business model.
While their Metaverse plans were in development, new headwinds came along with Apple's new privacy laws taking a bite into the Facebook social media segment projected advertising revenue. At the time, this was a massive deal for the entire app store with nearly every company losing 15% to 20% of their total advertising income and Facebook losing over $10B of revenue. The tracking came in the form of collecting user data on other websites to determine search patterns to help optimize targeted ads but Apple implemented an update in iOS 14 which forces the apps to ask permission in whether they would like to be tracked and people turning it off created overall lower quality targeted ads. Zuckerberg publicly denounced the new policy implementation in a press release but mentioned that the company would be able to navigate the challenges due to their long-term investments. The company had been recently testing out a new application which was invite-only for a period in which users who had VR Headsets could collaborate with other users in practical manners (I.E. having virtual meeting rooms, whiteboards, etc.) and after some fine-tuning, the app known as Horizon Worlds was released to the public.
That brings us to today, where Meta Platforms is facing one of its biggest dilemmas with its foundational and growth-oriented value propositions, and is now on the clock to find a way to innovate or fall victim to their headwinds. These significant investments into the Metaverse and fundamental shift towards the prioritization of its success needs to work out for the company because the Facebook and Instagram services still are facing massive pressure to be broken up by the FTC. With Instagram being the leading service provider among the two with the greatest amount of growth and composition of total revenue, this would leave the parent company in practically irresolvable turmoil without anything to fall back on. With the potential loss of their flagship social media staples, we need to understand better what it is they’re falling back on and the feasibility of their vision in the Metaverse.
The Vision & Goal
Meta’s goal with this shift is pursuing what's called the Infrastructure Control Model, where they essentially control the hardware infrastructure as a proprietary entry point for users but can easily shift to other content providers, just like an iPhone. On top of that, they’re looking to develop a creator economy to attract and retain users in the application which cannot be accessed anywhere else due to its tech specifications with their headsets. In an ideal world, demand for the various services and products would be similar to that of the in-real-life alternatives and they would make a fee on every single transaction that occurs (on those concerts, real estate purchases, etc.).
No long-term outlook as to what they consider success has been provided beyond short-term guidance for 2022 and their results. At the beginning of the year, Horizon Worlds hit a 300,000 user milestone and by the end had only 200,000 Horizon Worlds hit a 300,000 user milestone and by the end had only 200,000 Monthly Active Users (MAU) with the projected users being 500,000. They also found that only 9% of the 10,000 built worlds were ever visited by more than 50 users. These statistics show that while growth is a big part of their problem, retention of users needs to be considered as well. The marketing for the product has also seemingly been unsuccessful since there's a large disparity between groups of internet users who’ve have heard about horizon worlds and those who haven’t:
The underperformance is attributable to their value proposition. While other successful VR/M-World companies tend toward the gaming experiences, Meta’s betting on the social first vision tethered to real-world experiences which allows other companies like Sony to penetrate the market deeper as they capitalize off their gaming infrastructure. On top of all this, the biggest reason investors are against the venture is their inability to monetize Horizon World which makes it a cash-burner with bad unit economics and generally no robust demand. Back in 2021, they had broadly defined what success looked like to them with their Metaverse expansion:
The goal of hosting $100B+ of digital commerce and 1B people on their platform helps to define what their idea of success looks like, but can they achieve this? To understand that better, it makes sense to define some of the market's current dynamics, how those are expected to evolve over time, and where Meta fits into that bigger picture. Within the Meta Platforms realm, the Metaverse can be defined as the cumulation of three big drivers; the AR/XR utilization, the 3D elements, and the infrastructure required to host successful metaverses.
The AR/XR application has been pursued through the creation of their Meta Quest 2 headset. While it isn’t necessary to purchase the Meta Quest headset to access Horizon Worlds, that is a significant driver in the advancement of monetization through targeted advertising. By tracking user movements, Meta Quest users can be identified with 95% accuracy. In the capturing of this biomechanical data, it can near instantaneously create equivalent ROAS metrics for applications with access to it. Furthermore, it can predict your habits, understand your vulnerabilities, and create a much more granular marketing profile with the sole intent of attention gatherings, all of which can easily attract and retain new advertisers.
The 3D elements of the Metaverse bifurcate the different existing types of metaverses and are complemented with the AR/VR capabilities. Games like Minecraft and Roblox can be defined as Metaverse in-themselves, yet are fundamentally different as they operate in a 2D world. They’re economic success can be attributed to their prioritization of the experiential layer. User experiences are the biggest drivers of a successful 3D World and without it, capitalistic interests cannot be pursued. Meta significantly lacks from this perspective since Horizon Worlds is reportedly filled with bugs, low quality visuals, and an overall lacking things to do. The experiential layer is only successful thanks to Meta Quests ability to connect to PC games, which are third-party developed and released.
The most complicated piece of them all is the infrastructure layer of Metaverse development. The existing technology stack is too underdeveloped (or nonexistent) to help developers build more scalable and overall better AR/VR applications. In the same way that cloud libraries filled with photos or work is stored on a server owned by a large company, the Metaverse is going to require the same thing except will need over 1000x more computing power, speed, and storage than currently being used. With the industry being in its early stage, one way Meta’s addressing the issue is through perusal of strategic partnerships. For example, Meta partnered with NVIDIA to expand their technical infrastructure and components required to sustain the M-World.
The industry is highly fragmented and that opens the door to consolidation as large players' roles become more defined. They’ll have the capital to either commit to companies who will lead the creation of these specialized projects or acquire them as a means to penetrate the market. There are a few issues which arise with Meta Platforms doing this; namely their time constraint due to the lawsuit with regulators, the specialized nature of the industry conflicting with their vision, and major ethical and regulatory implications.
Their value proposition being oriented towards connecting communities conflicts with other industries like infrastructure development or medical simulations where that is not a priority. For Meta Platforms to succeed, they may need to broaden their vision and their shift towards the Metaverse and away from social media. The development of infrastructure is expected to decrease in cost thanks to newer technologies like AI (and is something the company has begun to develop). Companies with the technical capabilities to complete the project could be acquired by Meta Platforms to bring these projects to life.
The one piece which will play a much bigger role as things progress is the ethical and regulatory considerations. Currently, the regulatory environment is heavily lagging but research is being done regarding policy to determine the best next steps. Meta Platforms has historically had issues regarding data trading and access to more sensitive information through AR/VR headset usage. Global regulatory organizations deal with these dilemmas differently, some on a continent-wide basis and some down to local levels, but the consensus is that if the ethical dilemmas aren’t considered seriously, irreversible damage can be done. With increasing fraudulence on the Facebook website, a lack of priority towards the ethical considerations would open the company to new headwinds going forward if they don’t find a way to align shareholder, customer and their own values.
The future of Meta Platforms and its various services is hazy at best but this transitionary period will be one that defines them going forward. In the short-term, their focus should be on refining the experiential layers of their product offering since this is the easiest to implement. They could also continue developing partnerships among industry leaders and smaller players to get their foot into the doors of sub-niches they expect to grow and can serve through resource provision or through an acquisition. The issue with this is the amount of time it would take to acquire and integrate the company and realize synergies which would conflict with the count-down of their lawsuit with the FTC.
While the business historically has been considered a social media company, this situation may give them the chance to reorient themselves in a different direction. If the business walks away from the lawsuit unscathed, they could see unequivocal success thriving in two industries with significant markets. If they fail to integrate the Metaverse solutions in time and the lawsuit forces a divestment in Instagram, Meta Platforms would remain a shell of its former self. Only time will tell the results, but one thing certain is that these next couple years will define the company going forward.