Proof Facebook, Inc. Has a "Moat"

By Markets Fool.com

While Facebook is worth more than $270 billion today, its business is still a fairly new breed. Founded in 2004, the company quickly grew to become one of the world's first major online social networks. But many questioned whether the company's business was sustainable. After all, online social networks hadn't yet proved to be enduring business models. And even after the company's high-profile initial public offering in 2012, there were still a handful of critics who believed Facebook was lacking a sustainable competitive advantage. Today, however, it's clearer than ever that Facebook's competitive advantage is both powerful and sustainable.

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What is Facebook's competitive advantage?
Long-term investors are often searching for potential investments with durable competitive advantages. As famed investor Warren Buffett says, an investment should have a "moat."

"In business, I look for economic castles protected by unbreachable moats," Buffett has said.

After all, without a competitive advantage, how can investors expect their current investment to be around years into the future, let alone appreciate in value?

But what is Facebook's moat? Investors have argued that its competitive advantage is a network effect. A network effect becomes a competitive advantage when each additional member in the market makes a network stronger for all parties involved, and when, on the flipside, users are in a potentially disadvantageous situation when they aren't a part of the network.

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Consider Facebook's network effect. With about one out of seven people in the world using the service on a monthly basis, there is a high probability that users who join the service will have friends and family already actively using the service. So for every additional user, the network becomes increasingly useful, making it easier for existing members to connect. On the other hand, if someone chooses to leave Facebook's network and use a similar yet less established social network, that person will have to leave behind many friends and family who use only Facebook. A network effect, therefore, makes it very difficult for new networks to woo users away from leading networks.

Perhaps the best illustration of the strength of Facebook's social network has been Google's failed attempt to compete with Zuckerberg & Co.

Google+: far from a threat
Hoping its sheer size and reach through Google search and Google products such as Gmail and YouTube would launch Google Plus into a position to eventually compete head-to-head with Facebook, Google initially required a Google+ account to engage with others on its products.

The idea was that Google+ would be a "platform layer that unified Google's sharing models." Even more, Google+ was aimed at becoming its own "product/stream/app in its own right," said Google executive Bradley Horowitz in a Monday post on Google+ detailing Google's decision to phase out the importance of Google+ as a platform across its products. Horowitz took over Google+ earlier this year.

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This was a well-intentioned goal, but as realized it led to some product experiences that users sometimes found confusing. For instance, and perhaps most controversially, integration with YouTube implied that leaving a comment on YouTube (something users had obviously been doing successfully for years) suddenly and unexpectedly required "joining Google+."

"So in the coming months, a Google Account will be all you'll need to share content, communicate with contacts, create a YouTube channel and more, all across Google," Horowitz said Monday in a separate post on Google's official blog.

The de-emphasis of Google+ as a platform across Google's products, as well as the clear lack of traction the platform has had in the past few years, highlights just how difficult it is to compete with Facebook's network effect. And if Google can't compete effectively with Facebook, who can?

The article Proof Facebook, Inc. Has a "Moat" originally appeared on Fool.com.

Daniel Sparks has no position in any stocks mentioned. The Motley Fool recommends Facebook, Google (A shares), and Google (C shares). The Motley Fool owns shares of Facebook, Google (A shares), and Google (C shares). Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.