Might Zuckerberg’s gamble on the metaverse turn into Facebook’s ruin?

Photo by Jezael Melgoza on Unsplash

Last week Meta, Facebook’s holding company, published its third quarter results and shocked investors across the world. In October 2021 Mark Zuckerberg had announced he wanted to forcefully steer Facebook, WhatsApp, and Instagram into the next generation of social media: the metaverse. He foresaw a radical shift, thereby not just changing the name of the company but pledging to build 10,000 metaverse-related jobs in the EU alone. Since last year $15bn have reportedly been pumped into the metaverse project without investors knowing where exactly they ended up. After the latest earnings call, however, many wonder whether that was a grave strategic blunder.

Compared to last year the Q3 revenue fell while the expenses rose by 19%. Most concerning to shareholders is that $3.67 billion of the losses were caused by Reality Labs, the unit seen as the main engine to Meta’s metaverse ambitions. And the picture is not getting rosier any time soon: “We do anticipate that Reality Labs operating losses in 2023 will grow significantly year-over-year,” the CEO Outlook read. Upon the news the stock price plummeted and was down by 70%, multiple times worse than the beating the average tech company’s stock price took.

Of the many skeptic investors, Altimeter Capital has been one of the most outspoken. In an open letter to Mark Zuckerberg, their CEO Brad Gerstner has called to slash expenses for staff by >20%, reduce CAPEX by >$5bn and above all to cap the metaverse investment at $5bn per year. The focus of the company needs to pivot away from the metaverse to more tangible things such as the core business – advertising – and to more applicable technology such as AI. Those returns are immediate or near-term, whereas the metaverse might gobble north of $100bn before producing any return, if there is one at all. In comparison, Gerstner mentions that AWS, i.e. Amazon’s highly-profitable cloud computing arm, had cost Amazon less than $5bn.

But it is not just investors that are rejecting Zuckerberg’s metaverse narrative. A recent report in The Verge described employee resistance to the new strategic direction, as well as the company’s VR/AR products. Hence, the question becomes ever more pressing about how many people will actually pay $1,500 for a VR-headset to play poker with legless avatars.

Was the initial reasoning wrong?

This is not to say that setting sight on the metaverse was a mistake. Facebook has grown into a behemoth thanks to the triumphant march of the smartphone. Social media is primarily used on mobile devices. And the data generated through the ever-increasing number of sensors built into the devices has enabled a highly-precise targeting and highly-profitable ad-sales. But a look at the technology life-cycle shows that the smartphone has reached the saturation phase. Even in developing countries the phone proliferation is grinding to a halt and the new features of current models are hardly worth mentioning. This heralds the rise of a new technology. The only possible contender are virtual reality (VR) and augmented reality (AR) glasses.

Zuckerberg understood that a number of key technologies that enable the metaverse – especially blockchain – were starting to take shape. This, he surmised, would expand the concept of VR/AR from gaming to social networking. Everybody that wanted to fully connect to this new era of digital networking would have to enter via the new device – the smart glasses. Focusing on those would guarantee Meta an edge over Apple and Google who dominate the smartphone operating systems. It would sell hardware, run the operating system, and earn 30% from sales via its Meta Quest Store. But Meta wouldn’t end there. It would run the digital worlds with yet unknown revenue potential. Perhaps it could act as a metaverse landlord, earn from sales of virtual land, sell advertisements on in-game billboard or directly projected in the glasses. In theory, the opportunities are limitless.

Was the investment too high?

So if the reasoning behind the metaverse strategy was right, how about the sheer size of the investment? Investors such as Altimeter Capital don’t doubt the giant should pump some money into the metaverse. Rather they worry about the amounts of cash flowing into an area without immediate payback. Regardless of the exact figures, CEOs and boards will always be criticized. After all, usually the criticism goes the other way, namely that they only make half-hearted commitments into future tech. And usually, incumbents doing too little on disruptive technology end up beaten by inertia. They get steamrolled by later joiners who pursue the new technology with more zeal.

The real question, I would argue, is not about the amount invested but at which point in time it is invested. Getting the timing of a technology right is extremely difficult, but critical. Spend too early and you won’t live to reap the rewards. Spend too late and you will be an adopter at best.

Unfortunately for Meta, the margin for error to get the timing right has shrunk significantly. Due to the war in Ukraine and the global inflation chaos, the cost of capital has shot through the roof. Burning through $15bn at a time of 0% interest rates is one thing, but doing so at a time when the Fed and the ECB are continuously hiking up the interest rates without an end in sight is another. This endeavor could starve Meta’s core business of vital liquidity and impart massive opportunity costs, especially considering it will take the tech at least another decade to become mainstream.

Did Zuckerberg misjudge user appetite?

There is another, even more crucial question to ask: What about the user uptake? While many experts shook their heads at Mark Zuckerberg’s announcement last year and others saw in it a ploy to divert from the bad press, it seemed after a couple of months that Facebook’s founder was onto something. Eventually Meta grew on a hype it had fanned itself.  Citibank estimated the metaverse could address 5 billion people and generate between $8 trillion and $13 trillion by 2030. Others had put the estimate even higher, while one top-tier brand after the other announced its presence in one of the new digital worlds.

Now the hype is yielding to reality. It was recently revealed how the two largest metaverses Decentraland and The Sandbox have 38 and 522 daily actively users respectively. Though only users that make a purchase with the native currencies are counted as active users, this is a massive mismatch to metaverses’ prices. The big worlds fetch valuations above $1bn each.

The technological potential of building the metaverse on a Web3 infrastructure is fascinating. Thanks to blockchain technology money and other unique assets such as digital land or clothing can be recorded and managed without a central authority (hence Web3). But this will all be in vain if people see no benefit in logging into it regularly. What has driven the hype so far was speculation that the initial digital assets will multiply in value, just like some of the early cryptocurrencies. People prefer spending money on the metaverse to spending their time there.

The incentive to spend time in the metaverse is hardly discernable. Whether that is because of the sub-standard, pixelated graphics, heavy and pricey VR glasses, unappealing content or because of a deeper problem is yet to be seen. Diving into the metaverse takes an investment into smart glasses, as well as actively dedicating time to it every time when entering. Social media, on the other hand, is often a filler while sitting on a bus or waiting for an appointment. It is the ease of use and the omnipresence that make social media so attractive.

What does the foray mean for Meta’s ambitions into banking?

If the metaverse ever materializes, a decisive question will be who will run the monetary system. It is no secret that Big Tech is fighting for every inch of the finance value chain, and the metaverse is a whole new frontier. It would represent a parallel system of material value. Money changes hands, unique assets in the form of NFTs are sold, digital land is mortgaged – all those scenarios are important profit pools.

Running the financial flows of the metaverse is at least as important as running its infrastructure and the interfaces to it. And it is even more than that, because capabilities built for finance in the metaverse will also come in handy in the ‘real’ world. Enter Meta Pay.

Meta filed five trademark applications that lay bare the strategy on how the social media giant wants to run money in the metaverse. It envisions Meta Pay as a wallet for crypto and fiat assets of all kinds, regardless of whether it is NFTs, cryptocurrencies, or dollars. If you are interested to learn more about money in the metaverse and why this aggregation of multiple assets and functionalities will be so crucial, read my article on MetaFi, ie metaverse finance here.

Meta Pay is not nearly as ambitious as the initial Libra project Facebook had kicked-off in 2019 and which had imploded by 2022, but if realized it could be a powerful money machine that can be extended step by step. Even if the metaverse idea falls apart, this multi-asset machine will be an advantage in the finance arena. Other innovation will also flow from Meta’s metaverse efforts that will yield a benefit outside of this new envisioned world.  

Has Meta invested too much too early?

Many argued that Facebook had charged forward last year because it faced insurmountable problems. In many ways it was easier to announce a bold new ambition than to tackle problems at the heart of its operating model, things such as the core dilemma between data security vs. targeted advertising, the algorithm’s proneness to exacerbate extremism, or the ease by which it could be abused for propaganda by absolutist regimes. But jumping to the next generation of social media without solving these issues will just exasperate them. If you can’t prevent propaganda in written posts, then how could you manage to do so in a complex 3D-world with multiple formats?

Whether Meta will make it to the stage where it needs to sort out these problems depends on whether users will populate the metaverse sooner than the company runs out of money. Very soon after Apple had introduced the first smartphone competitors like Blackberry and Nokia faltered. This will not happen with the metaverse, as it is a much more complex arena depending on a number of technologies. Moreover, the added value for the user is not yet clear. Meta is facing an uphill battle and it will take years until we finally know how successful its strategy will be. Innovation that Meta comes up with along the way such as Meta Pay might, however, prove to be highly valuable even before the metaverse-era takes hold.