The Economics of Facebook

When you walk into the Facebook HQ in Menlo Park CA you are greeted with a giant dashboard indicating the number of active users, their demographics and a host of other descriptive indicators put up on large screens. The visualizations do a really good job of inspiring awe, especially to an outsider. Facebook loves (big) user data. They were successful in creating structured big data out of what we would have typically considered to be unstructured data. Every design element on their site, every product they come up with is aimed at capturing more data from it’s users so that targeted advertisements could be pushed back. Notwithstanding the long term value of data, their performance engine is driven by targeted advertisements. Now, everybody knows this story and as Investopedia points out,

Facebook Inc. (FB) reported third quarter 2014 financial results on October 28, 2014. The company reported total revenues of $3.20 billion, which was an increase of 59% over revenue of $2.02 billion in the third quarter of 2013.
Revenue from advertising was $2.96 billion, representing an increase of 64% over third quarter 2013 advertising revenues. Revenue from mobile advertising was 66% of overall revenue and was up 49% from third quarter 2012 mobile advertising revenues. Revenue from payments and other fees were $256 million, representing an increase of 13% from the same quarter in 2013.

These numbers are not that big, especially when compared to Google which made about eight times more ad revenue during the same period. But analysts note that Facebook ad revenue is growing at a higher rate than that of Google’s. The numbers are interesting all around.

Facebook has the reach and conversion rates to justify selling ad space to some of the largest corporations in the world as well as many small businesses. How does Facebook obtain these reach and conversion numbers? in short, us, the users spend time on their platform, curate their pages and upload vital demographic data into the system. Again,as Investopedia points out, nothing new,

Daily active users for September 2014 were 864 million on average, representing a 19% year-over-year increase. Mobile daily active users for September 2014 were 703 million on average, representing an 39% increase year-over-year. As of November 18, 2014, the company had a market capitalization of $207.25 billion and a massive 1.2 billion total users worldwide.

The equation works out to be pretty straightforward, the more time and effort you put into curating your Facebook page (personal or otherwise) the more reach and conversion Facebook can claim (among other things), and the more excited businesses get in paying Facebook by the click or by the share to reach Facebook users. Again, nothing new. The user, us, we get the benefit of staying in touch with our “friends” and of course social karma. We can debate the benefits of social karma and reputation but there exists no clear cut way to quantify it (Klout tried it, The Whuffie Bank was another dismal example) and thus no process to extract monetary value to the user.

Now let’s frame this a little differently. Let’s look at opportunity cost,

DEFINITION of ‘Opportunity Cost’
1. The cost of an alternative that must be forgone in order to pursue a certain action. Put another way, the benefits you could have received by taking an alternative action.
2. The difference in return between a chosen investment and one that is necessarily passed up. Say you invest in a stock and it returns a paltry 2% over the year. In placing your money in the stock, you gave up the opportunity of another investment — say, a risk-free government bond yielding 6%. In this situation, your opportunity costs are 4% (6% — 2%)

Let’s make an intuition pump. Think of you, us, spending time on Facebook. Consider the amount of time and effort we put into (say) crafting a status update. Now we could have been working on our own business (say) during that time and putting in the same effort. The benefits we could have received by working on our own business represent an opportunity cost. It is clear that spending time and effort on Facebook can represent an opportunity cost which could be specified in real monetary terms. Now this kind of of thought experiment would have been fairly straightforward if this was any other activity. However, consider this experiment in the light of the business model that Facebook follows.

Every bit of time and effort we spend on the Facebook platform allows them to make claims to advertisers regarding reach and conversion (not to mention other “basic” dimensions such as demographics etc.), thus Facebook makes revenue by way of the time and effort we put into the platform. Thus, not only are we faced with an opportunity cost, but a real cost when Facebook is able to monetize our data or a status for a fraction of a dollar. I find this a little disturbing, the fact that we don’t talk about it much, even more so. If we get down to the monetary brass tacks of this line of reasoning, we are nett losers while Facebook and the people that advertise on it are nett winners. Never has an enterprise which purports to “make the world a better place” created such asymmetry and in raw monetary terms inequality. In Mark Zuckerberg’s own words,

My goal was never to just create a company. A lot of people misinterpret that, as if I don’t care about revenue or profit or any of those things. But what not being just a company means to me is not being just that — building something that actually makes a really big change in the world.

My labour, needs to be rewarded and it becomes problematic when my labour rewards Facebook in monetary terms while I’m left with the fluffier bits like social karma, reputation and a social network. I don’t want the fluffy non monetary bits. At the very least I would like to be compensated for the data I provide to Facebook at cost to me. I’ve been toying with this idea for about four years now. I even attempted to quantify social karma so that we, the users, could make a claim that can be quantified. It’s tough going, especially since we do not have visibility to the algorithms that Facebook (and others) use. This is a particularly alarming problem for a low income country such as Sri Lanka, and as we see more and more users putting their data up on Facebook a new class of “labour” would have to be defined in order to understand the terms of this debate better. Make no mistake, we labour on social media and the technocratic elite that owns these companies are making a lot of money from our labour. It’s a subtle argument, but I think an important one when it comes to highlighting the subtle ways in which capitalism exploits and spreads inequality. We must be more critical about new business models and technologies while not being drowned in technological euphoria if we are to “make the world a better place”.

Ideally we would have a black box that takes in a status update or any other user input, and output the monetary value that Facebook, Twitter or any other “social media” platform would see in our input. Once again, this is a tough idea to execute and as I mentioned above, I’ve been stuck for four years now. Nevertheless, it was an interesting exercise and got me thinking about social media in a completely different light.

There are a a few components of this post that I hope to expand about in upcoming posts, particularly the notion about being compensated for my time and effort. There are caveats to this approach as well and I will demonstrate these in future posts. For now I leave you with some food for thought by way of Jaron Lanier. It’s a provocative quote which has some bearing to the reasoning outlined above,

“Funding a civilization through advertising is like trying to get nutrition by connecting a tube from one’s anus to one’s mouth.”
Jaron Lanier