Microsoft Acquires LinkedIn: Separate or Together?

Chris O'Brien has written a thought-provoking piece for Venture Beat about the Microsoft acquisition of LinkedIn.  O'Brien has a bearish outlook on the deal.    In his article, he cites many reasons why the deal may not work out, including the fact that Microsoft has had a less-than-stellar record of making major deals (Skype, Nokia, Yammer).    I don't know if I'm quite as bearish as O'Brien on the deal, but I certainly have some doubts.   What I found most interesting, though, was O'Brien's take on the issue of how Microsoft will manage LinkedIn going forward.  Here's an excerpt, in which O'Brien describes the "acquisition double-talk" taking place at Microsoft:

Acquisition double-talk, part 1: On the one hand, this deal is all about the oft-vaunted idea of “synergy” (even if that word is not used). The idea is presumably to build LinkedIn into all sorts of Microsoft products. Great! But, does this mean I’m going to get all sorts of messages suddenly asking if I want to share my Word doc through LinkedIn or have some LinkedIn integration with an Excel spreadsheet…or…what? There’s a lot of talk today about how this is going to broaden Microsoft’s reach into all sorts of new channels for selling stuff like cloud services. But does one of the largest tech companies in the world really need to spend $26 billion to reach new customers?

Acquisition double talk, part 2: Structurally, LinkedIn is going to remain independent. Per the Nadella memo:

“LinkedIn will retain its distinct brand and independence, as well as their culture which is very much aligned with ours. Jeff (Weiner) will continue to be CEO of LinkedIn, he’ll report to me and join our senior leadership team. In essence, what I’ve asked Jeff to do is manage LinkedIn with key performance metrics that accrue to our overall success. He’ll decide from there what makes sense to integrate and what does not.”

So, we will all work together. But we will work together while remaining separate. We call it: Separate Togetherness. (I’m going to copyright that and write a book on it one day.)

O'Brien raises an interesting issue that arises in many acquisitions.   On the one hand, the acquirer wishes to realize substantial synergies.  After all, those synergies are the very reason why the acquirer pays a large premium to purchase the target firm.  On the other hand, the acquirer does not want to spoil all that is good about the target firm.  Thus, they promise to provide the target firm a great deal of autonomy moving forward.  They promise to keep it separate.   You can see the conundrum here.  Keeping it separate means probably forgoing key synergy opportunities.  Pressing for too many synergies too quickly might alienate employees at the target firm, infringe on the innovative culture of the target, etc.   One also has to raise a broader question though:  If you are going to manage the target separately, then could you have achieved many of the collaborative benefits without actually acquiring the firm.  Could you have pursued some other organizational arrangement, such as a strategic alliance?  Could you collaborate, but without the risks and costs associated with a merger?   

Networking Leads to Job Growth?

Michael Mandel, president of South Mountain Economics and former chief economist at BusinessWeek, has conducted an interesting new study about job growth.   Using data from LinkedIn, he found that, "the most connected metro regions had more than double the job growth of the least-connected metro areas.” Does that mean networking leads to more economic activity and more jobs?  Not necessarily.   Correlation does not equal causation.  Perhaps, a high growth economy in a region causes professionals to connect with one another more often. The chart to the left summarizes Mandel's findings. 

Why Lock-In and Switching Costs are More Substantial at LinkedIn than Facebook

Network effects exist when the value per user rises as the number of users increases.   In a situation where strong network effects exist, we often see high switching costs and a lock-in effect.  Take eBay, for example.  Why has eBay remained so dominant for so long in the online auction market?   Well, compare the value per user at eBay to the potential value per user at a startup that might challenge them.   Users place a high value on eBay because the existence of many fellow buyers and sellers makes it likely that they can find someone with whom they can engage in a mutually beneficial transaction.   They would have a much harder time making that match on a new auction site with  a limited number of users.  For that reason, the network effects create switching costs for users, and a lock-in effect emerges.   That's all good news for an incumbent player with high market share, such as eBay.

Ok, so clearly LinkedIn and Facebook benefit from strong network effects.  Does that mean that they will remain as dominant for as long as eBay has in the auction market?  I would argue that Facebook and LinkedIn face quite different levels of switching costs and lock-in effects.   Consider the cost of switching from Facebook to Instagram or Twitter.  What's keeping you on Facebook?  Well, it's probably that circle of fairly close friends and relatives with whom you keep up to date and exchange photos and messages via the social network.  Suppose that a critical mass of that small circle of friends defects from Facebook to another social network such as Snapchat or Twitter.  Would it be costly for you to switch as well?   Well, as long as a critical mass of friends has left, then your switching costs are rather low.  Yes, you have other acquaintances who might still be on Facebook, but are they really going to keep you there?  Perhaps not. 

Now compare Facebook to LinkedIn.  What's keeping you from potentially switching from LinkedIn to another prospective professional social network?   You should recognize rather quickly that your small circle of close friends is not what is keeping you on LinkedIn.  Instead, you derive value from a much wider range of users on LinkedIn.  Many of those folks are not people with whom you communicate often.  They might be former classmates, co-workers, and the like.  They are people with whom you share weaker ties, but maintaining a connection to them has potential value to you professionally.  Now suppose that a few close friends defect from LinkedIn. Would you consider defecting?  Well, the problem, of course, is that all those acquaintances and former associates remain on LinkedIn.    In short, the switching costs are higher on LinkedIn.  The lock-in effect is stronger.   You would be much more reluctant to abandon that expansive "rolodex" that LinkedIn has become for you professionally.  

Why the discussion today about LinkedIn vs. Facebook?   Consider the latest news from an iStrategyLabs report.  It found that the number of Facebook users ages 13-17 have declined by 25% in the past three years.  The number of users ages 18-24 has declined by 7.5%.   These young user defections show that Facebook's lock-in effect may not be as strong as people once thought.  We've seen the story before of a social network losing traction; remember MySpace?  I'm not saying that Facebook will face that fate, but it's worth noting that network effects don't guarantee that an incumbent will remain on top forever.