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s reported by The Jakarta Post last week, tech giant Microsoft is set to acquire LinkedIn for US$196 per share in an all-cash transaction valued at $26.2 billion.

From an ICT industry perspective, it is fascinating to assess whether this acquisition is reasonable and to predict whether the decision will change the industry landscape.

Microsoft’s business model is based on a revenue stream from two types of customers: intermediate customers, called direct original equipment manufacturers (OEM), which are mostly other firms that preload Microsoft’s operating systems and software for their day-to-day businesses; and final customers, comprising individuals, small and medium enterprises (SMEs), enterprises, government, education institutions, Internet Service Providers (ISPs) and application developers.

Similarly, LinkedIn’s revenue is harvested from three sources: hiring and marketing solutions, generating about 80 percent of total revenue and premium membership fees, which contribute the remaining 20 percent. The company also offers free membership with limited features for users.

How can we justify Microsoft’s spending of approximately Rp 346 trillion to acquire LinkedIn (equal to 20 percent of the Indonesian government’s total budget in 2016) as a sensible decision? Why is this strategy perceived as a better deal than a previous case involving Nokia?

There are at least three reasons.

The first reason is that Microsoft and LinkedIn are categorized in two different layers in the ICT ecosystem. Fransman (2007) introduced a framework to analyze ICT companies by classifying them in three layers.

Layer 1: ICT equipment providers, which create the elements that make up ICT networks.

Layer 2: Network operators, which string these elements together in order to make networks (e.g. telecoms operators, cable operators, satellite operators and broadcasters).

Layer 3: Platform, content and application providers, which run over the networks provided by the network operators.

Fransman classified Microsoft under the first group with Ericsson, Huawei, Nokia, Samsung and Cisco, even though it is widely known for its Windows and Office software and apps, which are more on a platform base. LinkedIn is in the third layer with the likes of Google, Facebook, Baidu and Amazon.

Microsoft and LinkedIn face different market structures and degrees of competition, where the former generally exhibits greater entry barriers and thus operates in a more concentrated market. Consequently, acquiring LinkedIn in a different layer is supposed to strengthen vertical integration.

Nonetheless, it was not the case when Microsoft spent $9.7 billion to purchase Nokia’s phone assets in April 2015. Both Microsoft and Nokia were in the same layer of the ecosystem with quite a similar degree of competition as well as facing comparable industry, market and demand risks.

The second rationale might concern network externality — characterized by the strength of the company’s products due to the size of network creation.

LinkedIn recorded astounding progress, serving about 433 million users with an additional two users per second, spread across 200 countries by mid-2016.

As the largest social media service for professional users, LinkedIn creates arguably the greatest network externalities in the reference market and thus possesses the biggest lock-in powers and switching cost.

Conversely, Nokia was not very distinctive in its respective layer — at least when it was purchased — and had lost in the smartphone market as its main products since 2010, preventing the potential benefit of stronger horizontal integration.

The third and possibly most important rationale concerns research and development (R&D) and innovation capabilities by companies. Both factors — R&D and innovation — strongly characterize and distinguish the competitiveness of ICT industries amid the current global competition.

R&D expenditure is the vein of ICT industries. Having steady R&D expenditure is an indicator of utmost importance to show a healthy ICT company capable of maintaining its innovations.

On this, the Industrial Scoreboard (European Commission, 2015) reported that LinkedIn had shown a sound performance. Compared to other social media giants, LinkedIn (founded in 2002) is older than Facebook and Twitter (founded in 2004 and 2006, respectively). LinkedIn’s R&D expenditure in 2014 was about $400 million less than Facebook and Twitter.

However, the company achieved a 43 percent growth rate of sales during the last three years — a higher rate than Facebook and just behind Twitter.

On the other side of the scale, Nokia has sent alarming signals in relation to the aforementioned indicators since 2009. While maintaining a 2.8 percent growth rate of net profit, its R&D has dropped as much as 6.1 percent and consequently its net sales slumped by -19 percent in 2009.

During more recent times, in 2012-2014 it plummeted by -11 percent in R&D expenditure, -15 percent in sales, -11 percent in capex, -2 percent in profitability and -24 percent in employment. It looks bleak at the moment.

We might conclude that Nokia was in turmoil before being taken over by Microsoft; after its glory in mid-2000, the situation seems to have shifted from bad to worse from year to year.

LinkedIn is among the best performers in the two indicators of the top 250 ICT companies while Microsoft (despite its massive value in absolute terms) has performed moderately. Nokia is located at the very end of the scatter graph in both indicators.

The acquisition of LinkedIn will also potentially drive a greater degree of internationalization. Most of Microsoft’s R&D activities are centered in its home base in Redmont, Washington State. Its global networks include laboratories in Cambridge, the UK (located with Cambridge University’s computer science department) and Beijing, China.

LinkedIn, while headquartered in Mountain View, California, has built several offices around the globe — Omaha, Chicago, Los Angeles, New York, San Francisco and Washington in the US, London, Dublin, Amsterdam, Milan, Munich, Madrid and Stockholm in Europe and Singapore, Hong Kong, China, Japan, Australia, Canada and India in Asia-Pacific, along with Dubai.

Thus, in a nutshell, its R&D activities are likely to be more globalized and spread out but at the same time more localized — a key factor in the social media business model.

For these three reasons we might expect a strong bond between the two companies in the future. Moreover, judging from R&D and innovative capabilities, LinkedIn will lead the market at least in the next few years, something that Nokia failed to maintain.

Taking into account, meanwhile, that the acquisition means a change of ownership, LinkedIn will work as usual with Jeff Weiner as CEO, thus keeping its brand, culture and independence — another good move from both parties.
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The writer, who obtained his PhD in technology management and economics at Chalmers University of Technology in Gothenburg, Sweden, is an ICT industry analyst who lives in Seville, Spain.