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Why Lack of Social Consent Could Kill Facebook or Google

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FACEBOOK ACCUSATIONS
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I am willing to bet that when the chaps at Goldman Sachs sat down to value Facebook, they didn't spend too much time worrying about social consent (in fact, the chaps at Goldman Sachs have proven themselves rather adept at flying in the face of social consent). However, they should have done, and here is why.

Traditional media had social consent. There was a basic social contract between the providers of information and the consumers of that information which went something like this: "We know that running newspapers, publishing books or operating TV stations is expensive and so, if we want to have these things, we know we need to pay for them -- either directly or by allowing the content to be interrupted by advertising." The economics of this contract were not driven by the cost of producing the content (as we often think) but by the costs of distributing it. It was only because distribution was expensive that it was necessary to fill its' precious channels with equally precious content (i.e. content of mass appeal).

But the world of social media is different. Distribution now costs virtually nothing and, in the case of Google and Facebook, the content is produced by other people. What kind of social deal should govern this situation? Google and Facebook would say that the deal here is zero price -- it doesn't cost you to use our services, and the advertising is both much less intrusive and also much more relevant. That seems like a pretty fair deal, but is it really?

For this to be a fair deal, what we give has to be balanced by what we receive. Looking at what we give, the assumption, as per the Google and Facebook response, is that we give very little. However, this is not true. Through our usage of tools like Facebook and Google, we give away huge amounts of information about ourselves and we are only just starting to work out the value and implications of this gift. If you want the details on this, read The Filter Bubble by Eli Pariser. This presents a fantastic and slightly frightening look at this hugely important subject. Did you know, for example, that your Facebook friends could affect your ability to get a loan? I didn't, until I read Eli's book. But the key point here is that what we give Facebook and Google is very valuable, far more valuable that we (possibly even they) realize.

This could be fine, provided that this is balanced by what Facebook and Google give us in return. Putting a value on this is a more tricky question, but the answer is to be found in the work of the 19th century economist David Ricardo. He proved that in a functioning market environment, organizations cannot make super-profits and the reason for this is linked to the relationship between marginal costs and marginal revenue (basically, they both have to be in the same ball-park). Well, neither Facebook or Google are making super-profits, so why is this relevant to determining the value of what they deliver to their users?

Possibly one of the most profound remarks ever said about social media and money was by Craig Newmark, founder of Craigslist. When asked why he wasn't making billions, he simply replied "I don't need that much money." He may have said this because he, personally, didn't need that much money, but his words cover a more fundamental business truth. He literally didn't need that much money. He had replaced a machine costing and generating billions of dollars (regional advertising in the U.S.) with something than required only a few geeks and some server space. And here is the thing: what is Facebook if not some geeks and server space?

Going back to Ricardo, what is the true marginal cost of adding an additional Facebook user, and thus what are the boundaries of its' permitted marginal revenue, assuming that it operates in a functioning market? The numbers on Facebook are moving so rapidly, but let's assume that Facebook has estimated revenues in 2011 of $4.2 billion and this corresponded to something in the order of 800 million users. This gives us an estimate of marginal revenue of around $5.25 per user. Are we seriously being asked to believe that it therefore costs Facebook something of this order to add and service each additional user? Or to put it another way, are Facebook's costs rising by this amount as it grows? No, would be the answer.

Facebook is possibly growing at around 300,000 users per day, but its costs cannot also be increasing by $1.5 million per day. Of course, Facebook has many costs beyond that of simply providing the geeks and server space, but these are costs it has chosen to add in order to support the business model it has decided to pursue (and the valuation the chaps at Goldman have put on it), they are not related to the costs of actually providing the service the users want. Also bear in mind that most of the geeks are not busy improving the service to users, they are developing services that make it more attractive to brands. To return to Craig - "being Facebook" does not actually need that much money.

As David Ricardo would have put it, Facebook is already making unsustainable levels of profit, albeit its' books and business operations don't allow us to see this at present (hence why Goldman Sachs places a value on the business that assumes its ability to generate profits is going to increase dramatically). This will only become apparent when Facebook users wake up to the inequality in their relationship with it, probably as part of a much broader re-negotiation of the social contract with social media. And this won't result in them demanding that Facebook give them more, but that it takes less. The catalyst for this will probably be the emergence of a competitor in the space that says "Hey guys, we can give you everything (x social network or tool) does without having to sell information about you (because we don't need that much money)."

Facebook's only defense against this is to try to colonize so much territory that it can hinder the emergence of any such competition -- probably by buying them in the first instance. Google is basically doing the same, although its position is a little different. Google is already in the business of giving us more -- it gives us all the tools of Google World, which are subsidized by the super-profits it generates from search (and thus disguises the extent of this super-profitability) -- albeit these tools are increasingly designed and promoted according to their ability to extract data from us.

Social media is a bit like the Wild West. Everyone is trying to seize the territory before the wagon trains of civilized society and attendant rules of behavior roll into town. But those wagon trains will arrive, and when they do, Facebook, Google et al. will have to establish a social license to operate, and this is likely to involve creating a very different business model based on a world where people attach much greater value to the data they decide to share. And that is why the clever chaps at Goldman Sachs need to understand the concept of social consent (or, alternatively study the work of David Ricardo).

P.S. If you want a more extensive take on this same theme, you can get this here.

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