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Facebook’s $19-billion WhatsApp bet is about to pay off

Anthony Mouchantaf is co-founder and president of Toronto-based Rthm Technologies Inc.

Last month, WhatsApp's new privacy policy took effect, allowing the messaging app to begin sharing data with Facebook. The new policy garnered condemnation, and has already been challenged by German regulators. While WhatsApp users are understandably upset, they shouldn't be surprised.

Facebook's $19-billion (U.S.) acquisition of WhatsApp in 2014 had raised a few eyebrows; Facebook already had a messaging platform and more than a billion users. However, to those privy to Facebook's core business model, it was immediately clear that WhatsApp would be immensely valuable in improving ad delivery on Facebook, as well as Instagram, and Facebook's Audience Network. Facebook's first step to monetize WhatsApp is, and always has been, to leverage its bank of user information and behavioural data to better target advertisements across Facebook's other platforms, thereby improving return on investment (ROI) for advertisers and improving the experience of its users.

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This is particularly crucial to Facebook's long-term growth in light of its recent third-quarter results. Despite beating revenue targets, the stock fell in light of CFO David Wehner's announcement that ad load – the volume of ads the company can show users – could "come down meaningfully" after mid-2017. Now unable to rely on ad volume to drive growth, unlocking new efficiencies in advertiser ROI and user engagement will be critical.

Facebook is finally putting its plan for WhatsApp in motion, and if successful, it will be worth well more than $19-billion.

In a 2011 Wall Street Journal article, investor Marc Andreessen famously declared that "software is eating the world." In short, modern Internet companies have become the primary driving forces of economic growth, creating what Mr. Andreessen refers to as "real, high-growth, high-margin, highly defensible businesses."

This has created a momentous shift in capitalistic methodology, as traditional economies of scale have taken on a new and enhanced form. For software products, costs per unit of output not only decrease as scale is reached, but the cost per unit for every additional unit of output beyond the first unit is effectively zero. Examples of this phenomenon include mobile gaming and entertainment, digital media content, and enterprise software.

When it comes to digital technology, there are no production-based efficiencies to be had. Once a company has invested the requisite capital and human resources to produce one unit of a product, it can reproduce an indefinite amount of that same product, at almost no additional cost. Where then might capitalistic efficiencies still be found in a modern, software-based economy?

In the 21st century, economic efficiencies will be found in the reduction of frictional and monetary costs in the delivery of goods rather than in their production. In other words, marketing. Consumption has become overwhelmingly non-essential in nature. We purchase products because we want to, not because we have to, and when we do purchase essentials, such as food and clothes, we are given many choices, such that even these essential purchases are coloured by our idiosyncratic preferences. Companies must therefore invest significant capital to better understand consumer preferences and customize their products to cater to those preferences.

For many infant industries, this creates a Catch 22: Investors will not fund otherwise great products until market traction is shown, but in order to show market traction significant capital in the form of marketing is required. Solving the marketing problem will thus be the ultimate source of economic growth and innovation in this century. This is where Facebook and Google have built their core businesses, and where companies like Snapchat and Pinterest are poised to follow.

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The development of the Facebook and Google advertising networks, and the real-time bidding (RTB) apparatus that underlies them is potentially the most significant economic development of the past decade. The methodology here is relatively simple: Publishers offer web page or mobile app inventory to these networks, and the networks sell the inventory to advertisers, who bid for the impression, wherein an advertiser's bid will be coloured by the demographics of the user viewing the advertisement. An advertiser may be willing to pay 20 cents to show an ad to a teenager in New York, but only five cents to show the same ad to a retiree in Arizona.

These technologies have created immense economic efficiencies. By tracking user behaviours, controlled for demographics, interests, locations and browsing history, these networks present data-driven solutions to the problem of identifying a target market.

Vendors are able to pinpoint which discrete groups react most positively to their product, and are thus most likely to make a purchase. With a target market identified, these networks provide granular ad delivery to ensure that vendors are only reaching their most valuable prospective customers in the most cost-effective way possible. For Facebook users, adverts need not be a nuisance, but can instead be a process of discovery – discovery of interesting content, products, services, or apps, curated to their unique likes and interests.

Despite these impressive leaps, advertising technology has only scratched the surface of its ultimate potential. In this century, digital and social media technologies will be the engines of economic growth in the consumer space. Integrating WhatsApp data into Facebook's advertising network is just one $19-billion bet that Facebook is making on that growth. Expect many more of these bets in the years to come.

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