“We didn’t build services to make money”

One of the most notable things about Facebook’s early years as a public company was the cool efficiency it showed in its earnings report.

Quarter after quarter, year after year, revenue and net income have steadily risen and grown to the right. The company has deftly pivoted to mobile, riding the wave of smartphone adoption and replacing desktops with mobile ad revenue at a manageable pace.

That history is part of what made the rebranded company’s third-quarter earnings report so impressive.

Facebook (now called Yuan) has had bad earnings reports before — in its second-quarter earnings report in July 2018, it warned of slower revenue growth and tighter margins. Investors dropped the stock 24% in one day. Likewise, gloomy forecasts and misses led to single-day plunges in February (Q4 2021) and July (Q2 2022) earlier this year.

But until this year, the company has more or less reined in spending. Revenue is usually tied to operating income growth.

For example, in that troubling 2018 interim earnings report, annualized quarterly revenue growth of 42% translated into a 33% increase in operating income.

For the full year 2021, a 37% increase in revenue translates into a 43% increase in operating income.

Things began to change in the fourth quarter of that year, with a 20% year-over-year increase in revenue translating into a 1% decline in operating income. This trend got worse as each quarter progressed, culminating in the disastrous results of the most recent period. Revenue fell 4%, a decline the company knew was coming and warned it last quarter. This translates to a staggering 46% drop in operating income.

Spending continues to balloon — up 19% from last year — even as Facebook knows revenue is falling.

The reason for this is an existential bet on the company’s future. CEO Mark Zuckerberg has said the company is willing to spend $10 billion a year to build virtual worlds, investing in virtual reality headsets that bring people there, and Horizon Worlds virtual universes that they can explore once they arrive . They will also inspire developers to create their own worlds.

Shareholders began to question the payout, and Altimeter Capital’s Brad Gerstner suggested the company cut its annual payout to $5 billion while also cutting headcount by 20%.

There’s no reason to expect Zuckerberg to take his advice. The CEO owns super-voting shares, which makes a hostile takeover impossible. He reportedly packed the board with loyalists and urged anyone who questioned him. And his longtime No. 2, Sheryl Sandberg, who helped turn Facebook into an ad-selling juggernaut and an inefficient business machine, left earlier this year.

A decade ago, when Facebook was preparing to go public, Zuckerberg wrote a letter to investors explaining his vision for the company. Back then, it was all about helping people connect. The details have changed a bit over the years, sometimes incorporating private one-to-one communication through apps like Messenger and WhatsApp, and more recently through the Metaverse to immersive 3D interactions.

But the more important part of the letter is Zuckerberg’s warning to investors that Facebook isn’t here to make money. It’s here to change the world, and making money is one means to help make it happen:

…Facebook didn’t start out as a company. We’ve been primarily concerned with our social mission, the services we’re building, and the people who use them. It’s a different approach for public companies, so I’d like to explain why I think it works.

I started writing the first version of Facebook myself because it was something I wanted to exist. Since then, most of the ideas and code that have come to Facebook have come from the great talent our team has attracted.

Most great people are primarily concerned with building great things and being a part of great things, but they also want to make money. Through the process of building a team — and building a developer community, ad market, and investor base — my understanding of how to build a strong company with a strong economic engine and strong growth is a matter of coordinating many people to solve important problems.

Simply put: we don’t build services to make money; we make money to build better services.

We think it’s a great way to build something. These days, I think more and more people want to use the services of companies that believe in going beyond simple profit maximization.

By focusing on our mission and building great service, we believe we will create the greatest value for our shareholders and partners over the long term – which in turn will allow us to continue to attract the best talent and build even better service. We wake up in the morning not with the main goal of making money, but we understand that the best way to achieve our mission is to build a strong and valuable company.

Facebook still generates a lot of money — its operating margin remains at a healthy 20%, and it reported $4.4 billion in net income for the quarter and $9.6 billion in net cash from operating activities. Those numbers are worse than they looked a year ago, but they’re enough to fund Zuckerberg’s vision for the next 10 years.

On the earnings call, he said, “I think those who are patient and invest with us will be rewarded.”

Investors who disagree with this vision should exit. Many have already done so — Facebook’s stock has lost about two-thirds of its value in the year leading up to Wednesday’s earnings report. A few hours later, it was down by nearly 20%.

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