When AOL announced that it was being sold to Verizon, many speculations started to fly around about consumer Internet companies. Why? Because as they become public and need to keep up with the expectations of their users on mobile, it becomes increasingly difficult for them to innovate. They’re shooting themselves in the foot, in a way. In this article, which I wrote for the Harvard Business Review, I outline what their options are.
A growing number of publicly traded consumer internet companies are making the choice to “go private” which is creating a wave of consolidation. The most recent example is AOL, recently acquired by Verizon — but this merger won’t be the last. So why is this happening, and what happens next? Based on my experience going through three mega-mergers, at Trulia, Nokia, and Siebel, and on dozens of interviews with industry insiders, I see two major reasons for the trend, and three ways companies are likely to respond to it in the future.
First, consumer internet companies tend to go public too early.
Since the last financial crisis, many new regulations have been implemented to protect shareholders, increasing the pressure on management to meet earnings expectations by prioritizing short-term over long-term. For many consumer tech companies, this post-IPO pressure on financial returns is too high.”
Because they are innovative by nature, consumer tech companies need to invest heavily in research and development, which could be done if they had a portfolio of products at different stages of maturity, with some of them being established cash cows. However, many of them go public at a point when they only have one product, even if it’s still unrefined. Some of them go public before even turning a profit.
What compels these companies to IPO prematurely is that they need to provide a liquidity event for their institutional investors, and sometimes for their founders or early employees. A soaring stock price is one of their strongest employee retention tools, especially right now, when there is a war for technical talent in booming Silicon Valley. Facebook tried to ignore Wall Street pressure in 2012 upon its IPO, but quickly decided to shift course after experiencing attrition.
The impact of going public too soon is “a death by a thousand tweaks.” Left with the only option to show revenue growth by milking a single product, many consumer tech companies resort to tactical optimization which delivers very little value to their consumers, if any. The extra revenue that these tweaks generate gives the impression of momentum but only the market leader in any category has a real chance at surviving too many of these cycles.
Because of the post-IPO pressure, many emerging tech companies like Uber are trying to stay private at all costs (this is what resulted in the term “unicorn” for startups that raise over a billion dollars in investment without going public). However for the companies that are already public and don’t have a dominant position in their category, they have become acquisition targets. The good news is that there are many buyers out there.
The second major reason this is happening now is that the economic recovery has strengthened two currencies: cash and stock.
Just like people do, companies tend to buy more when they feel rich. With interest rates at an all-time low, investors have turned to Wall Street for higher returns, so stock prices are climbing. As a result, a number of companies find themselves in a position where they can afford to make a large acquisition because they can use their stock, which is trading high, as a currency. This timing is especially of interest to telecom and media incumbents, who are now ready to place their bets in the Internet space, now that it has matured and that the survivors like Yahoo and AOL are struggling.
In addition to stock, cash is another widely available currency at technology giants like Google, which is not ready to give its cash back to shareholders in the form of dividends, as Microsoft recently started doing. It wants to continue to fund innovative projects, particularly in connected car and local businesses, both of which are natural complements to its Maps business. Besides, the internet giant recently missed the boat on critical innovation sectors, one of them being social. This is one of the reasons for the recent rumors of a possible acquisition of Twitter by Google.
It’s chess time. Companies who have the currency to buy and a strategic reason to do so are the most likely to make a move.
With consolidation ahead, the consumer internet space is going be very dynamic over the coming months. There are three types of moves we can expect:
• Defensive move: A few years ago, Microsoft acquired Nokia as a way to enter the mobile market after it had missed its window. Today, telco market leaders like Verizon and Sprint are in a similar position. They need to maintain their leadership in the mobile space. In the last era, they spent most of their energy creating walled-gardens to protect their position on the voice segment, while new entrants carved out a position for themselves in the data segment. Now that the battle for voice is over, telcos are turning their focus to data. Because they struggle to drive innovation internally, they look to buy an internet brand, like Yahoo or AOL. Other rumors of defensive moves include Google trying to acquire Twitter, and YellowPages.com trying to acquire Yelp.
• Offensive move: In 2014, Facebook purchased WhatsApp when it realized that it needed to have a dominant position in the messaging segment. Marc Zuckerberg seems to have an incredible talent for timing the acquisition of winning consumer services like Instagram and WhatsApp. Had he bought them later, he may have had to pay a much higher price; had he bought them sooner, he would have taken the risk to make the wrong bet. Today, companies like Apple and Google are ready to make similar bold offensive moves in the connected car market. Rumors of a Tesla acquisition have been heard, Lyft could be another candidate.
• Portfolio approach: The two previous types of moves demonstrate how hard it is even in bleeding-edge companies to drive innovation continuously. Hard but not impossible for someone like Barry Diller. His internet conglomerate, IAC, which owns Match.com and OKCupid among others, has recently launched a new dating service called Tinder, which is taking over the world of young singles. IAC is taking the same approach to dating as most traditional consumer packaged goods companies do to products like dishwashing powder. Instead of making costly acquisitions to expand their portfolios, they constantly launch new products at small scale, in what is called a test market, until it has been optimized enough to be broadly rolled out.
What’s exciting about the upcoming wave of consolidation in the consumer internet space is that there will be many winners. Acquirers will survive and strive, targets will be able to innovate again, and consumers will get a better product. The danger would be if monopolies start to emerge as a result — but there is still some time for regulators to think about how to prevent this from happening.