Microsoft made quite some big news last week acquiring LinkedIn for 26.2 billion dollars. In order to understand this deal, I find very useful to have a deep dive into LinkedIn’s business model.
Of course, the professional network had seen its stock slide during the last six months, making the price tag look like a good deal. Such a big acquisition raises two questions:
- Why is the acquired company selling?
- Why is the acquiring company buying?
I will try to answer both of them with this article where we will have a look into LinkedIn’s business model.
LinkedIn’s business model, a deep dive into its financials
LinkedIn’s net revenue for 2015 is almost 3 billion dollars, or about one sixth of Facebook’s. LinkedIn has always enjoyed healthy revenue growth. Taking into account that it is always easier to grow something from a relatively low absolute base, the fact that LinkedIn has managed to keep it above 30% for some time now is quite a feat.
But there are some indicators that point to a problematic future for this social network.
As we will discuss along this article, I think LinkedIn’s business model hit some kind of ceiling growth. Several metrics point in this direction, which is why the Microsoft deal starts making more sense than what I previously thought.
Net revenue seems to be doing fine. Net income gives us a clue as to what is going on within the professional social network:
Despite increasing YoY revenue growth about 30% each quarter and being marginally profitable, LinkedIn started losing money in the last five periods. Nothing serious, anyway. About 46 million dollars from more than 860 million in Q1 2016.
But costs have been growing at a faster pace than revenues and recently have started to catch up, eventually surpassing them.
The cost structure shows us the growing importance of Sales and marketing within the company:
While, at the same time, LinkedIn is growing its R&D budget but at a lower pace than the overall cost structure. The social network has started to focus more on pushing its products than finding out what products to build in the long term.
Which, of course, is a good idea for short term growth and a terrible one for future growth. Both variables affect the user experience in a negative way, since LinkedIn has been accused of going too far in its monetisation efforts.
LinkedIn’s unengaged user base
LinkedIn is one of the biggest social networks in the world. It has more than 430 million registered members as of march 2016. That makes it second only to Facebook, which has more than 1.5 billion (if we leave aside a handful of messaging apps).
Despite this strong user base, LinkedIn’s business model is suffering from lack of engagement of its user base.
The graph above shows a comparison of LinkedIn’s user base. Most social networks tend to show off their big numbers first and their not-so-good ones are buried within the report. When they are not good at all, figures like this one aren’t showed at all.
LinkedIn may be second to Facebook in user base, but the number of users that come back every month is much smaller. Ever since the company started to disclose its user numbers, the ratio has declined from over 30% to just below a quarter in Q1 2016.
This gives us some kind of measure of the engagement LinkedIn members have towards the network. Barely 100 million users visit the network’s premises at least once per month.
Despite this, LinkedIn’s business model has been able to grow its revenue per registered member. From 0.90 dollars in 2010 to more than double that in 2016, as the graph above shows.
Of course, the low engagement of LinkedIn’s user base can also be seen as an opportunity for growth in the future. But given the last quarterly results, investors are not buying into that narrative anymore.
LinkedIn lost about 50% of its stock value back in February, making the acquisition deal a bargain for Microsoft.
LinkedIn’s business model had hit a ceiling and it started to become clear that a change in strategy was needed. It was time for the social network to look elsewhere for help to support scaling its business beyond its current possibilities and fixing the user experience.
Microsoft’s pivot towards business services
Few people know that Microsoft is one of the early investors of Facebook. And still owns 1.6% of the company. This stake has to be seen as a way for the Redmond based company to counter Google’s growth back in 2007.
Steve Ballmer pushed for this deal to happen, convinced on its importance to fight the search giant. But the reasons for buying a stake in Facebook then and the ones that support the acquisition of LinkedIn’s business model now are very different.
Microsoft is not the same company it was almost ten years ago. The web and mobile wars are lost with Android and iOS on the winning side, effectively creating a new set of problems, like the ones we saw in the App Store strategy.
Microsoft is winding down its mobile division. The Nokia investment has been crushed and there is no sign of Microsoft branded phones in the near future. Satya Nadella has seen to that.
The new CEO’s plan is to pivot Microsoft into a corporate services company, instead of a software licensing one.
We can see this strategy pouring through the last moves Nadella has made with Microsoft. Quite a few acquisitions in order to strengthen its software portfolio in competing platforms (iOS and Android). As well as the pivot of Windows and Office to a SaaS model.
Microsoft is changing from a company where all its profits and opportunities come from one platform (Windows) to one where cloud and cross platform services play the central role.
This is where LinkedIn’s business model comes in. Despite the engagement problems we saw earlier, LinkedIn is still one of the most solid social networks out there. The data it has about professional users and their connections is second to none.
Given the renewed focus of Microsoft with the corporate market, LinkedIn is a great fit for its ambitions. Ben Thompson argues that:
with LinkedIn Microsoft can form a direct relationship with its end users that goes far beyond the CIO and opens up a huge array of opportunities that not only were unavailable previously, but are also critical in a world where CIO’s matter less than they ever have previously, and where employees change jobs constantly. Instead of starting from scratch with every new hire, it is Microsoft that is positioned to provide the glue that connects enterprise workers no matter where they are.
In other words, cloud and mobile have broken the old Microsoft’s advantages, making its relationship with corporate CIO’s less important. Ballmer thought that what Microsoft had to do was chase Apple and Google in the consumer markets, forgetting that corporations were the raison d’être of Microsoft in the first place.
With LinkedIn, Satya Nadella’s new Microsoft hopes to marry both markets in a different way by catering end users as well as corporations. And now, with LinkedIn’s business model in their hands this task seems much more feasible.