Snapchat’s Biggest Mistake: Rejecting Facebook’s $3 Billion Offer?

Context: Facebook recently tried to acquire Snapchat, the latest teenage app craze which is experiencing explosive growth for $3 billion. That’s roughly thrice the $1 billion prize tag for which it acquired Instagram last year (which had roughly 30M users then, and has since grown to more than 150M users).

Snapchat declined the offer, and is apparently trying to raise more money at a higher valuation (Tencent, the Chinese giant is trying to invest $200M at a $4 billion valuation)

There has been a massive debate on whether Snapchat should’ve sold out to Facebook or not.

My 2 cents: It should have. Here’s why.

No Social Graph Lock-in

On the web, you could have a significant network lock-in once you gained critical mass. No one can replace Facebook on the web very easily because no one on the web can create your social graph for you again with no effort from you, and once you have all your friends on Facebook, you’re not going to make much of an effort to recreate it again unless there is something very compelling.

On mobile, for the new breed of messaging and social apps, the phone book is the social graph. This not only reduces the barrier to entry significantly, but also kind of nullifies the advantages that used to come with network effects. Once your app has had some initial traction, for every new user that comes in, the app will automatically connect him with friends on his phone book who is already using the app.

No History

For you as a user to go back to a social network/app, you need either one of two things there.
1. Friends (your friends should be on the network) so you’d think twice before moving away from it.
2. History (you should have a lot of content on the network) so there is a shifting cost if you decide to move on.

On Snapchat, you have neither. If you do decide to move on to a new popular app, you’ll find your friends there because the new app will likely leverage your phone book to quickly create a social graph for you.

And because the ephemerality of the app – self destructing messages – is its key defining feature, it cannot have a history.

Without these two, it becomes much easier for any user to ditch Snapchat for the next cool app than it is to ditch something like Facebook into which a user’s whole identity and network is tied in.

Snapchat is trying to create history for its users, adding some stickiness to its app, with features like Snapchat Stories, but it might never work because the reason its core audience loves Snapchat is because they don’t want to deal with the pressure of maintaining a social history.

Fickle-Minded Teens

Teens are too fickle-minded and their behavior too capricious. You never know what they’ll like next. Right now, it seems to be exploding, ephemeral messaging (Snapchat), but just some months ago, it was a persistent image-focused social network with a social feedback mechanism (Instagram), and before that, Twitter and Facebook.

The rate of disruption in the mobile space is really fast because of reasons I already mentioned (no social graph lock-in, fickle-minded teens who make it hard to predict what the next big thing is). Just a year ago, no one could’ve seen Snapchat coming and possibly displacing Facebook/Instagram as the ‘cool’ private messaging app for teenagers. 6 months from now, who’s to say that Snapchat won’t be replaced by some completely new app?

Tencent’s Pony Ma put it across perfectly when he said: “I’m facing a crisis in this industry. Young people, the things they like on the Internet, increasingly I don’t understand it. This is my biggest worry.”

And it’s not just Pony Ma, it’s just incredibly difficult to understand what the next big thing will be in the hotly contested mobile social/messaging space. If I had to bet, I’d wager that Snapchat is likely not going to be the one to bring the next big product innovation which clicks with the teens.

Snapchat is peaking?

In hindsight, it seems to be clear that Instagram saw a massive growth spurt right after it sold out to Facebook, and if it had just held out a bit more, it could possibly have had a much higher valuation.

Snapchat is apparently at 5M monthly active users (or 26M depending on who you believe), so there is still room for growth. But most of the potential growth has already been factored into the $3B offer from Facebook.

Snapchat may or may not have peaked, but at a $4B valuation in less than 2 years, with no other information at my disposal, I’d hazard the guess that it possibly has.

By rejecting Facebook’s $3 billion bid, Snapchat has effectively positioned itself for an IPO some years down the line. There are hardly many other players who would be able to pony up more than what Facebook offered – possibly Google, Apple, Microsoft, Amazon (or Line or Tencent). My perception is that Snapchat’s founders (who’ve partially cashed out and hence have no pressure to make some immediate money) and its VCs are not going to settle for a valuation less than $5-6 billion now, and if they do get the rumored Tencent $200M investment at a $4B valuation, they’re not going to settle for anything less than a $15-$20 billion IPO after 2-3 years.

To go public, it’ll have to demonstrate significant revenue potential by then, assuming it’ll still be as hot as it is now.

That’s quite unlikely given that most ways in which it could potentially monetize would destroy the very reason why its users love Snapchat – extremely private, ephemeral messaging. Instagram has seen a massive backlash following its bid to monetize, with corporate accounts being bashed by its loyal users. Snapchat’s user base will likely revolt even more.

High levels of engagement don’t always mean that it’ll be monetized with the same level of success. The very reason for the former might be the reason why the latter may never work out. And given that Snapchat has no real lock-in (social graph or history), if users do get pissed, there isn’t much of an exit barrier for them; they could very well move on to some other app which in a bid to grow aggressively, wouldn’t be monetizing then.

Having said that, it’s very likely that Snapchat’s founders have some strategy in mind, and have definitely thought about all of this.

When Facebook declined Yahoo’s $1B offer back in 2006, it turned some heads, but it turned out to be the right call. For reasons I’ve mentioned above, I believe that Snapchat made the wrong call by rejecting Facebook’s generous offer.

I may be wrong.

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