Is Facebook's business model still fit for purpose?

Facebook shares fell sharply in after-hours trading. The company is still growing, but we may be seeing a change of attitude among the public that could hit Facebook, and other companies which rely on advertising, hard.

Article updated: 26 July 2018 9:00am Author: Michael Baxter

They say there is no such thing as a free lunch. Facebook is free, but are the public looking for a healthier diet?

In the latest quarter, revenue was up 42 per cent year on year, rising to $13.23 billion. Profits came in at $5.1 billion, representing a 31 per cent increase on last year. Now I don’t know about you, but that seems pretty good to me. At one point, three months or so after the company was floated, in August 2012, its market cap was at $41 billion. In short, quarterly profit is now around an eighth of the market cap six years ago.

Is that impressive or what? Yet the markets reacted yesterday by selling, shares down 20 per cent in after-hours trading.

Their disquiet is down to more than one factor. Words spoken by Mark Zuckerberg illustrate the problem. “As I've said on past calls, we're investing so much in security that it will significantly impact our profitability. We're starting to see that this quarter.”

The chief financial officer, David Wehner said: “Our total revenue growth rates will continue to decelerate in the second half of 2018, and we expect our revenue growth rates to decline by high single-digit percentages from prior quarters sequentially in both Q3 and Q4.”

Messrs. Zuckerberg and Wehner were simply confirming what analysts already suspected. According to the latest global digital snapshot, produced by ‘We are Social’ and ‘Hootsuite’, the median Facebook user now clicks on eight ads a month, compared to ten, when it last reported in April.

So, what’s going on?

The illusion of free

“If you're not paying for something, you're not the customer; you're the product being sold,” said Andrew Lewis in a comment on metafilter in August 2010. It’s one of those quotes that gained traction, and now those words are commonly repeated.

Facebook is free, that means its users are the product being sold.

That means, they are selling something, and increasingly that something is their personal data.

This is leading to a sense of unease. Data which is then analysed by AI to create new insights, is becoming an enormously powerful tool. If that data is used to fight disease, making healthcare preventive, for example, then few people would question it.

But if the data is used to snoop on us, used to then manipulate us, changing the results of elections, for example, and in the process undermining democracy, then that is a worry.

The danger is that data could take us into a kind of Orwellian state. Big Brother may not be watching us, but advertisers, security services and politicians peddling their agenda, might be. And Facebook may well be the medium they use.

It is these fears over the dangers of creating an Orwellian society that lie behind GDPR. It’s an attempt by authorities to pre-empt the threat, creating a new system of rules designed to protect our privacy.

Happiness

There is another snag with Facebook. It can make us unhappy. Even Facebook’s own research confirms this. Based on research carried out last year, it said: “In general, when people spend a lot of time passively consuming information — reading but not interacting with people — they report feeling worse afterwards.” On the other hand, it said that actively communicating with people “is linked to improvements in well-being.”

But there is more to it than that. A report by Deloitte concluded that: “The use of Facebook was negatively associated with overall well-being. These results were particularly strong for mental health; most measures of Facebook use in one year predicted a decrease in mental health in a later year. We found consistently that both liking others’ content and clicking links significantly predicted a subsequent reduction in self-reported physical health, mental health, and life satisfaction.”

If that is so, why do people do it? An article in Psychology Today puts it down to affective forecasting. People think using Facebook will make them happier, even if it doesn’t.

Or, as Shannon Vallor, a philosopher of technology at Santa Clara University, puts it: “Multitasking [associated with social media] did provide strong gratifications of a habitual sort—it ‘scratched the itch,’ if you will. And ‘like a locomotive picking up steam,’ the more subjects multitasked on a given day, the more they found themselves compelled to do it the next day.”

So, we go on Facebook, while simultaneously talking to someone, or walking the dog: is it like a habit?

Pay for it

Mark Zuckerberg has said that roughly 2.5 billion people use one of Facebook’s social media tools, be it Instagram, WhatsApp, or Facebook itself. One question a lot of people are asking is: ‘If these tools are so good, why not pay for them?’

End of free

According to Economic theory, price is a function of marginal cost. For digital products, marginal cost is zero, therefore all digital products should be free. But this is not the case: ten years or so ago, you could read articles in the FT, Times and Telegraph for free, jumping with ease from one publication to the next. As a user, I loved it, and hate the way pay walls, privacy policies, ‘sign up to read’ and apps have made this harder for me to carry out research. For a while, we were our own editors, but increasingly publications are forcing us to go to their apps and follow the guidance of their editors. I don’t like the change, but there had to be change, the publishing business was on the verge of collapse.

Let me give another example: TripAdvisor. In my view, it’s not as good as it used to be. As it tries to monetise it’s service, it has become harder to just get the objective opinions we want. Maybe the problem would be solved if it charged, say $1 a month to use it.

Can Facebook last?

A Facebook rival is currently going through the Kickstarter phase, called Openbook. The idea is for the service to be ad free, such that data is not used to manipulate us, ultimately making money by creating its own market place in which goods and services are traded via a proprietary currency.

Will Openbook ever become a viable alternative to Facebook? I have no idea.

The point is, though, things are changing, and Facebook is facing its biggest challenge. Only time will tell if it can overcome the challenge.


These views are those of the author alone and do not necessarily reflect the view of The Share Centre, its officers and employees

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Michael Baxter

Economics Commentator

Michael is an economics, investment and technology writer, known for his entertaining style. He has previously been a full-time investor, founder of a technology company which was floated on the NASDAQ, and a director of a PR company specialising in IT.