Meta’s metaverse wager is also a bet on founder control

Meta’s other bet is making Alphabet’s long-running Other Bets segment appear cheap, both in cash and market cap terms.

Shares of Facebook’s parent company plummeted after the company reported huge costs and losses associated with its future-facing metaverse project, accompanied by a revenue decline that, while forex-impacted, was still far from the heady days when Meta only seemed to grow no matter the business climate. And the company is signaling that more spending is coming.

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Meta’s trailing results and future operational guidance pushed its shares down just under 23% in pre-market trading. That the company is not changing course even after shedding more than half of its value, measured from 2021 highs, amid public calls from investors for a course-correction is notable.

Today, I want to go over the company’s results as they relate to Reality Labs, or what is colloquially known as the Meta metaverse project, and what the company said in its earnings report. Meta, I believe, is behaving like a startup — wagering a large portion of its wealth on building what’s next. If you don’t agree with CEO Mark Zuckerberg’s vision for the future, I feel you.

But the company has a notable — and risky! — control structure that is designed to give a single person outsized sway over the direction of the business. If you are in favor of founder-led companies, Meta is showing what happens when that model is applied to not just upstart tech companies, but to firms that once broached the $1 trillion market cap threshold.

Let’s talk spend, losses and the future.

The Metaverse

It’s Big Tech earnings season. With the public investor mood seemingly tilted away from expensive efforts to scale revenue at any cost and toward cash generation via operational efficiency, we’re examining some of the wealthiest companies ever with a similar lens as we currently view startups.

During the zenith of the 2021 startup boom, money was cheap, allowing startups to raise more capital, more quickly, than perhaps ever in the history of venture capital. The result of the rush of funding was, at times, inefficient startups with far higher cost structures than their revenue could support. The result? Layoffs and other spending cuts.

Big Tech is in similar straits today. We’ve seen cost-cutting at companies of all sizes, including Microsoft and Alphabet. No tech shop is immune from the market perspective that they could do more with less and that an era of cheap money caused tech concerns to become overfed and slothful.

Meta, however, is taking a different tack. The company’s Q3 results included the following:

• Reality Labs revenues of $285 million (down from $558 million in the year-ago period).
• Reality Labs operating loss of $3.672 billion (up from $2.631 billion in the year-ago period).

Lower revenues and greater losses? This should remind you of the Alphabet skunkworks project set that it calls Other Bets, which somewhat infamously loses more money than it brings in, in revenue terms. But while Other Bets losses were worth around 2% of total Alphabet Q3 2022 revenue, Reality Labs represented 13.2% of Meta’s revenue in operating loss terms.

The two efforts are related but not really of the same scale. Reality Labs is Other Bets cubed, making it a far larger wager. Other Bets, really, feels like a modest drag on the great Google profit machine. Reality Labs is more material.

And becoming more so. Meta is not done spending on the effort. Here’s Zuckerberg during yesterday’s Meta earnings call (emphasis: TechCrunch):

As I’ve shared before, our goal is to grow Family of Apps operating income, such that even with our AI infrastructure and Reality Labs investments, we can still meaningfully grow our overall company operating income in the long run. Our current surge in capex is largely due to building out our AI infrastructure and we would expect capex to come down as a percent of revenue over the long term. We expect Reality Labs expenses will increase meaningfully again in 2023, with the biggest drivers of that being the launch of the next generation of our consumer Quest headset and hiring that’s been done in 2022 but for which we’ll be paying the first full year of salaries next year. More broadly, beyond 2023, we expect to pace Reality Labs investments to ensure that we can achieve our goal of growing overall company operating income. Our capital allocation philosophy over the long term is to allocate a portion of the profits generated from the Family of Apps toward these future focused areas while enabling greater return of capital to shareholders.

Investors, as we’ve mentioned, were not enthused. (It’s worth noting here that Meta CFO David Wehner added later in the same call that the company does not “anticipate that Reality Labs operating losses in 2023 will grow significantly year over year,” implying that some spend increases will be offset by revenue gains. Small mercies, etc.)

Why is Meta not changing course? It has certainly heard investor and market commentary regarding its plans. And yet. So, what’s driving the company forward? There’s a hint in the above, namely that Meta views itself as reinvesting some of its present-day profits to secure longer-term incomes. Fair enough, but how does the company get there?

Per Zuckerberg on the same call, there are really four efforts inside the Reality Labs bucket. The first, per the CEO, is a “social metaverse platform where you see an early version of that with Horizon with the avatar system.” The second? “VR is the second major platform,” Zuckerberg said, adding that he expects “that there’s going to be a consumer-focused product that probably will reach very large scale” along with a “work-focused product.”

Third and fourth? Augmented reality and what the executive calls “neural interfaces.” It’s a broad portfolio of efforts, which explains, to some degree, the spending involved. Reality Labs is not consumer VR headsets alone.

But what could the four endeavors be good for? Thankfully, Meta’s chief was willing to riff during his company’s earnings calls. The following quote captures his core argument, I think (emphasis: TechCrunch):

I know that sometimes when we ship a product, there’s a meme where people say, “Hey, you’re spending all this money, and you’ve produced this thing,” and it’s — I think that that’s not really the right way to think about it. I think there’s a number of different products and platforms that we’re building where we think we’re doing leading work that will become — launching consumer products and then eventually mature products at different cadences in different periods of time over the next five to 10 years. And in all of these areas, I think the teams are making very good progress.

And I think that this will be fundamentally important for the future. Nothing that we’re seeing suggests that that’s not going to be the case. We are pacing a bunch of the investments given the kind of macroeconomic environment and the rest of the business performance. But ultimately, I mean, look, I get that a lot of people might disagree with this investment. But from what I can tell, I think that this is going to be a very important thing, and I think it would be a mistake for us to not focus on any of these areas, which I think are going to be fundamentally important to the future. So we’re going to try to do this in a way that is responsible and matches the way that the rest of the business is growing over time.

And I think we’ve built up the team to a point now where I think we’ll be able to kind of match that growth with the rest of the business more going forward. But over time, I think that these are going to end up being very important investments for the future of our business. And I think it’s some of the most historic work that we’re doing that I think people are going to look back on decades from now and talk about the importance of the work that was done here.

To summarize, Zuckerberg is not changing course because he sees a particular technological future and is spending a sizable portion of his company’s profits to build that tomorrow.

Isn’t this what founder-controlled companies are supposed to be able to do? Take short-term, unpopular steps that go contrary to leading market sentiment and spending more than would make more technocratic leaders uncomfortable. To aim more at a nebulous future over focusing on incremental boosts to shareholder return mechanisms, perhaps.

You can disagree with where and how much capital Zuckerberg is putting to work. But this is the model. This is the thing that founder-controlled companies are supposed to be able to do. Reality Labs’ experiment is an immaculate test case. Fans of the most recent startup corporate governance models can hate the content here, but not the form.

It is fine to argue that founders should have absolute control of startups but cede that power post-IPO. But that perspective doesn’t answer the complaint that founder control is supposed to combat, namely short-term-focused investors forcing management teams to work myopically instead of with their eyes on the horizon. The issue, however, with corporate monarchy, is that a king is a king. And you can’t argue with an absolute.

Meta has long been a chief supporting data point of the supposed intelligence of allowing founders to run their companies in perpetuity, public or private. Perhaps the Reality Labs effort will topple the example. Unless, of course, Zuckerberg’s bets come up good.