Strategic analysis for implementing a corporate social networking website

Social Networking

A vertical integration strategy is when "a firm owns its upstream suppliers and downstream buyers" (QuickMBA, 2010). There are a number of different ways that this could manifest for a firm in the social networking business. The first is that one needs to consider who the upstream suppliers are, and who the downstream buyers are. The inputs in a social networking business are everything from servers and web development staff to the advertising company that helps to sell the content to advertisers. Many major tech companies will own and manage their own server farms, while smaller ones will rent space. A social networking site by definition needs to achieve a certain critical mass in order to be relevant to either consumers or advertisers. Thus, there is a case to be made for integration of servers and other back-end equipment. Owning these will allow the company to have a more scalable operation, and will allow for cost control.

The same can be said of the development team. While the design and construction of a basic website can be outsourced, a social networking site needs a lot of work just for maintenance, let alone the new features that it will need to be relevant. That is more difficult to outsource -- maintaining an in-house development team makes sense here. Most large social networking sites will keep key technology and functions in -- house for these reasons.

Additionally, the only way a social networking site can make money is to sell advertising, or perhaps services to its members, though the latter has not proven remotely profitable for anybody yet. Facebook and Google have two of the more prominent social networking sites, and both of those companies keep their marketing functions in-house. This allows them to have significant control over the cost of their advertising programs. This is important, because online advertising pricing is competitive and largely set by the market. For smaller sites, it is more likely that they would contract out the advertising function to Google, Yahoo or another major online advertising company. While the scale required to build a serious online advertising business makes this option appealing for smaller websites, the reality is that if our site did that, we would be giving a significant cut of the revenue to our competitors. Ideally, we would control our own advertising function and keep costs lower than what we would pay Google to do the same thing.

Cost control is one of the most important competitive advantages that can be gained from vertical integration (Kokemuller, 2012). If these functions are contracted out, the company will have less bargaining power over the price paid for these services. Major web design firms, server farms and especially online ad companies are much larger than we are, and will therefore have the ability to dictate prices to us. By keeping these functions in-house, we will hopefully be able to keep costs lower than our competitors, which in turn will give us greater control over the prices we can offer in the marketplace. This, however, might not be much of a course of competitive advantage. The key competitors in social networking tend also to be vertically integrated -- we can only have competitive advantage when we are doing something differently from our competitors, or doing it better. We would be in tough to outperform Google in online advertising.

Stuckey and White (1993) note that a company should only vertically integrate when it will "create or protect value." In our case as a startup, the costs of running our own advertising program are going to be very high, and there will be a steep learning curve. When the site is in development and the user base small, we may have trouble finding advertisers will to work with us. Under those circumstances, vertical integration may not create much value. The exception is the programming function. From a strategic standpoint, our success will depend on our having the ability to build a great social networking site. Initially, this should be our sole focus. Vertical integration is a strategy that can be employed at a later point, when there is genuine value to be gained from having our own in-house ad team, servers, and other ancillary functions.

The other major drawback is that we will not be able to vertically integrate with either our customers or our core product. The customers are the people who will buy our advertising, and by definition they will need to be external. The external money is who we will finance our ongoing operations. The product will be the users of the social network. In this case, they will also need to be external. We will be the ones who attract them, with the website we will build in-house, but ultimately they must come from somewhere else because a social network consisting of just our employees will not be particularly attractive, as Google + demonstrated.