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Snap, Crackle, Pop

Snap's initial public offering is testing the patience of investors in many ways. From an unprecedented offering without any voting rights, negative cash flows greater than revenue, restricted share units taking most of current paid in capital, slowing user growth, and a valuation that makes all other social media IPO's blush, the risks are material. Those are just the financial risks. Snap is positioning itself in the marketplace as a camera company to a dedicated and narrow base of users that are fickle to fads. In a page out of a business school textbook, it is arguing that its sustainable advantage is not based on its network of users or its technology, rather Snap is a creative platform where users express themselves through video. Time will tell whether it is the fad of the moment at the peak of the equity market or an enduring creative brand.

Source: Wix.com

Platform to success. Like other entrepreneurs, it wasn't the initial idea that would lead to their success. Snap started as Picaboo, where it was positioned as a sexting app that had little interest to anyone. As necessity is the mother of invention, and sometimes legal battles, they changed the name to Snapchat and re-positioned the app as a social platform with disappearing photos. A feature that people didn't know they needed until it was too late. Success soon arrived as usage took off with young women in high school and university. Certainly, the age group was primed for using their mobile as a multi-purpose communication tool.

In an evolution away from their roots, Snapchat offered Memories last year, a collection of pictures that reside online and permit sharing later. While a move away from their original value proposition, they need to make users sticky to their platform beyond just the social network. Of course, other platforms have the social network and the disappearing pictures and videos as well.

Snap's current incarnation views itself as a camera company, and not as a social media platform. Of course, this aligns with their push into eye-ware as cameras with Spectacles. They are certainly a more stylish product than the other mobile camera company. Combining Spectacles with their new Stories platform permit their users to retell their events with ease and takes them a step away from the ubiquitous cell phone as the hardware source.

Uniquely created. In the search for differentiation, there is nothing greater than the uniqueness of the individual. Snapchat is focusing on the ability for users to express themselves through media in their way. Initially, it was through emoticons where users expressed themselves, but this soon evolved into an augmented reality with Lenses, no matter how short-lived. The next step was to sell the sponsored Lenses as a marketing platform for advertisers. Of course, brand stickiness may be somewhat questionable when throwing up rainbows is the principal outcome.

The uniqueness of the platform created an advertising medium that marketers want to capture and has room to grow. Snap's platform delivers the coveted Millennial market. With nearly all their revenue coming from advertising in the US, but only accounting for 2% of current social media spend, they have room to grow market share nationally and internationally. Snap's focus, however, is on expanding the time of use for users (e.g. engagement) and not necessarily the number of users.

Technology Dependence. Snap has the burden of using technology from other companies to deploy their product. They need Apple and Android to distribute their product and provide the physical cameras to create their products, and Google cloud to support their storage infrastructure. In a situation where they are technology and distribution dependent, their choices are limited. So, Snap is following a focused strategy where their user's needs are paramount and unique content is created for them. Of course, arguing the company is pursuing a differentiated and targeted strategy is good; however, it is easier said than done.

Snap is trying to diminish their physical dependence on phone cameras with Spectacles. Positioning itself as a camera company may lead them down a path that GoPro knows well, but the alternative is that they are social media company like Twitter, and with slowing user growth, the comparison is not favorable. Product positioning in a competitive and fast evolving market is difficult, but not an impossible task, particularly when you have lots of money to compete.

Controlling Value. As Snap seeks an IPO that has few equals, investors are pondering what the IPO signals. The markets are highly valued relative to long-term valuations, even though time inconsistent earnings may bias the valuation. Of course, the high valuation of the equity market may be just a result of buybacks. The overall markets starting position makes a good reference point, while the low volatility environment provides more certainty of a good exit. The dearth of IPO’s has given few investors exits from their investment and left the retail investor without access for most of the last decade. Certainly, the outcome is foreseeable when demand exceeds supply.

Snap launched their initial public offering to much acclaim and soared even further on its first day of trading, as high valuations didn’t concern investors. The IPO occurred despite the protest of institutional investors who have a disdain for the non-voting share structure and a financial model that offers little current revenue with losses that exceed its revenue. Regardless of the investment merits, the steep price of shorting may deter investors who question the business model. The problem is that investors may have to buy the stock anyway.

The launch broke a decade long-trend of pricing IPO’s for the benefit of all investors, not just those making the offer. Due to the fortunate reception, other unicorns may be tempted to exit because of the high multiples attached to Snap. Whatever the incentive, it's good to be a company that is disrupting legacy business models or targeting a specific demographic, preferably Millennials.

Strategy Risk. If a picture is worth a thousand words, then maybe a video is worth a million. This outcome is the implicit bet that investors are making with Snapchat: that video will be the dominant form of communication. As the world evolves into an augmented reality world, a platform that has the user base is positioned favorably to deliver the audience to marketers. The risks for Snapchat, however, are material.

Most companies would argue for a defensible technology or distribution platform. Snap has neither of these as Instagram launched its competitor product to slow its user growth. Twitter missed the picture messaging market; however, it is well ahead of it in the video market. Not to be outdone, WhatsApp has entered the market as well, but with a more secure product. The question is whether SnapChat can retain users to its platform and that, of course, hinges on the switching costs.

The value of retention hinges whether there are unique resources on the platform and the network effect of linked users who may be hesitant to enter a new platform. User stickiness is created by storing the user created content within the platform so that switching is burdensome. Snapchat's original value proposition was that it didn't store anything. As user retention is evidently difficult when following that sole strategy, Snapchat is evolving to create more permanent content with Memories. It's not clear that there is a sustainable advantage that duplicates the service the mobile device already provides.

Positioning as a camera company also comes with risk. Lifestyle brands such as GoPro have found difficulty in fending off low-cost hardware rivals and so have focused on the software side to keep ahead of the competition. This strategy includes evolving into a platform where developers can create new tools for its camera, which themselves have evolved to focus on delivering virtual reality. These actions have done nothing to restore confidence to investors, which makes the strategy a perilous one for Snap.

There is always value in a network of users; however, Twitter knows what happens when user growth stops. Snapchat's user growth slowed in the fourth quarter of 2016, which alone is one cause for concern for investors; however, when combined with the dependence upon the iOS platform it would imply they may have reached peak saturation of their distribution channel in developed markets. With stiff competition in China from Tencent's QQ or WeChat, limited user growth is available internationally.

Everything has a price. Only time will tell whether the initial public offering price was high. Given the challenges that Snapchat faces from technological dependence, well entrenched and deeply profitable competitors, and a user base that is fickle to trends, the company faces significant hurdles to realizing its value. While its strategy seems similar to Twitter and GoPro, it has the cash and user base to stay in the game for a while. Whether Snap delivers on their promises and stays ahead of their deep-pocketed competitors, hinges on their capacity to innovate and a user base that never ages.

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