By Economists at Large director and ACF Economic Advisor, Simon O’Connor, crossposted from The Drum
The Facebook initial public offering (IPO) was all over the news last week, and there has been furious debate about what it means for both investors as well as the site’s users.
Investors are yet to find out that they’ll never be able to extract the earning levels a $100 billion company should produce. And if investors get what they want, chances are the users will run a mile.
It all comes down to the definition of value, which is where investors can learn a thing or two from environmental economics.
Environmental economists have been grappling with this idea of value for decades. Is natural environment priceless? Well, yes. But tell a Treasury official that a tropical reef, forest or river is priceless and they’ll quickly enter a ‘zero’ in the balance sheet and before you know it, they’re damming, digging, cutting or otherwise extracting ‘value’ in a way that rapidly makes ‘priceless’ become ‘worthless’. You’re left with a once-wonderful natural asset that’s value has been dramatically undermined.
So environmental economists talk about market values versus non-market values.
The former are those values that involve dollar and cent transactions – such as the ticket price to enter a national park.
Non-market values relate to those myriad roles the natural environment plays that are not bought or sold with cash – and they are many. Providing habitat for animals, cleaning the air we breathe, filtering our water, storing greenhouse gases, the spiritual and cultural values associated with a place, even the value humans gain simply by knowing it exists (imagine the sadness you would feel if you heard the Great Barrier Reef was wiped out overnight) are all benefits we get from the environment without paying a cent.
To ensure we don’t just chop up and sell the whole country, then, it’s critical to consider how much we value nature, beyond simply ‘priceless’.
Think about a beautiful region like WA’s Pilbara. It’s an amazing ecosystem, but the ‘value’ that we attach dollars to has been all about iron ore. The result? We disregard the environmental benefits, dig the lot up and ship it to China.
Likewise, Facebook’s investors don’t seem to get this distinction between market and non-market value.
Right now, Facebook doesn’t make a great deal of money. It has a price-earnings ratio (a handy guide for investors looking to see if their potential investment actually, you know, makes money) of 100:1, instead of the average company’s 15:1. It had revenue last year of only $3.7 billion (by contrast, PepsiCo, with identical market value, had revenue of $66.5 billion, and more than six times more profit).
So that’s not where the value is. Instead, the ‘value’ is in the big numbers that dazzled the investors – 845 million active users, 100 billion individual connections, 2.7 billion ‘likes’ and comments daily.
And they certainly are impressive statistics, making Facebook sound awfully valuable.
Unfortunately, these numbers are the iron ore of Facebook. Investors want to dig it up for profit, not thinking that by doing so, they will rob Facebook of the very things its users love.
Facebook is a social ecosystem, one that is important to many of its users, one that allows them to connect with their friends. These users don’t value Facebook because it has one in seven humans using it. They value it for its intangibles; the connections it allows.
The investors who pumped billions into the Facebook float last week have been dreaming of capitalising on that ability to reach into one-in-seven people’s lives. They assume all this value can be monetised through the frequently suggested business model of online advertising – slapping billboards all over Facebook, or through the more surreptitious method of capitalising on users’ data.
Which means they’ve all missed the point. A social ecosystem, like a natural ecosystem, is priceless. Like our friends in real life, the value is intangible.
So what happens when we try to extract market values out of an ecosystem? Well, the very value of the asset in question is undermined. There’s a decent chance that in order to ‘extract value’, Facebook is about to get strip-mined.
Take the Murray-Darling Basin. We’ve tried for decades to bleed it dry while largely ignoring those services it provides for nothing (like washing away salt build-up). But we’ve run down the very asset that the river’s industries rely upon, to the point where the whole system crashed in 2007 during the drought and will likely do so again during the next one.
Take MySpace as a case in point. Rupert Murdoch purchased MySpace for $580 million in 2005 and sold it six years later for $35 million – a catastrophic loss. The model News Corp was aiming to apply to extract market value? Advertising! Murdoch learnt the hard way that ecosystems, whether social or environmental, change and morph and defy monetisation, and when you try to bleed one of them for value, it will crash, and new ecosystems will rapidly grow to fill the space left.
Unless Facebook’s investors, particularly its controlling shareholder, can figure out a way to mine Facebook of its ‘value’ without robbing it of the intangible value its users take from it every day, it’s hard to see how anyone is going to be happy with this deal.