Facebook: The Sick Man of Silicon Valley

The Cambridge Analytica scandal caps a bad period for the social network. Bouncing back will not be straightforward.

Iain Morris, International Editor

March 27, 2018

6 Min Read
Facebook: The Sick Man of Silicon Valley

Mark Zuckerberg's nerdy awkwardness is both a blessing and a curse. On the plus side, the stereotype identifies the boyish-looking Facebook founder as a bona fide member of an increasingly influential software club. In the bad times, it can make him seem oblivious and even unsympathetic to others, qualities that were cruelly exaggerated in David Fincher's 2010 movie The Social Network. In the last few weeks, Zuckerberg has appeared more like his depiction in the Fincher movie than ever before.

Revelations that data on millions of Facebook customers may have been unethically captured by a UK-based partner called Cambridge Analytica, and then used to influence the outcome of the 2016 US presidential election, have plunged Zuckerberg into a media storm. Facebook stands accused by some of being insufficiently rigorous in its dealings with partners. Zuckerberg has shown little remorse, say opponents. His initial response was a Facebook post outlining the steps he would take to prevent similar abuses again. When this failed to silence the critics, Facebook began publishing more apologetic statements in newspapers.

Figure 1: Facing Up Facebook founder and CEO Mark Zuckerberg is feeling the regulatory heat following the Cambridge Analytica scandal. Facebook founder and CEO Mark Zuckerberg is feeling the regulatory heat following the Cambridge Analytica scandal.

The whole affair taps into anxiety that a handful of Silicon Valley companies know more than democratically elected governments about today's citizens. Customers have reportedly been shocked this week on discovering just how much of their personal information Facebook has been able to obtain (and store on file). But alongside its wider implications for the technology sector, the fracas also caps a bad period for Facebook. Even before the Cambridge Analytica scandal, it had been under pressure from regulatory authorities worried about its content and advertising practices. And despite its vast base of subscribers, there is concern that customer attention is being diverted elsewhere.

Indeed, in the fourth quarter of 2017, users worldwide spent around 50 million hours less per day on Facebook than a year earlier. Zuckerberg claims this is part of a grand plan to stop users idling away hours on "passive" video content and drive them toward "meaningful social interactions." But in its US and Canadian markets, the company also lost 1 million daily active users in the fourth quarter of 2017, the first time this figure has declined in at least three years (and possibly ever).

Figure 2: Daily Active Users in US and Canada (Millions) Source: Facebook. Source: Facebook.

The difficulty of engaging with a younger audience is one of the biggest worries for investors. In its last filing with the US Securities and Exchange Commission, Facebook acknowledged that younger users drawn to rival products were spending less time on Facebook. Snapchat, a social network built by former students of Stanford University, has proven especially popular among millennials, although it remains a long way behind Facebook on overall user numbers -- with about 187 million daily customers next to the 1.4 billion at Facebook -- and has also suffered a backlash after some in-app advertising offended and was criticized by Rihanna, a pop star.

The collapse or decline of once-popular social networks like Friends Reunited and Myspace shows how precarious the business can be. While it never approached Facebook's current scale, Myspace was the world's leading social network just over a decade ago. Today, it is virtually obsolete. No serious commentator thinks Facebook is in similar danger, but it certainly appears to be on more slippery ground than Google (Nasdaq: GOOG), another Internet giant that is often regarded as Facebook's largest technology rival. (See Robot Wars: Telecom's Looming AI Tussle.)

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That is not because Facebook's service is easier to replicate than Google's. Rather, it is that a social network seems more vulnerable to whim and changing tastes than a successful search engine, especially among fashion-conscious youngsters. Facebook is best viewed as the virtual equivalent of an evening out on the town. Google is an afternoon spent tinkering in the workshop. No self-respecting college student would be seen dead in the same late-night venue as his parents. He seems unlikely to have similar qualms about using dad's toolbox.

Facebook's response to this threat has been to copy the services offered by trendier rivals, or to buy them outright and maintain them separately. It did this in in 2012 when it spent less than $1 billion on Instagram, a photo-sharing site that many teenagers prefer to Facebook, and again in 2014 when it splurged the much bigger sum of $19 billion on WhatsApp, a popular Internet messaging app (which has subsequently added a calling feature to its service). More recently it has been trying to neuter Snapchat by adding Snapchat-like features to its own services. The risk is that an entire generation is eventually drawn to a social network Facebook fails to acquire and cannot easily copy.

Despite the slight downturn in usage metrics, and its struggle to attract a younger audience, Facebook is thriving financially. In 2017, its revenues soared 47%, to $40.6 billion, while net income rocketed 56%, to about $15.9 billion. At $160.06 on the Nasdaq at the time of publication, its share price is still about 14% higher than at this time last year. If Facebook is ailing, its condition is one that most telecom operators must still envy, particularly when it comes to profitability. With just 25,000 employees, Facebook made about $1.6 million in sales per employee last year. Verizon Communications Inc. (NYSE: VZ) , one of the world's most efficient telcos on this measure, managed about half that amount. (See Efficiency Drive by Major Telcos Has Claimed 74K Jobs Since 2015.)

Figure 3: Still Thriving Financially Source: Facebook. Source: Facebook.

The great unknown is whether the Cambridge Analytica scandal exacerbates the problems Facebook already had. Above all, it has focused regulatory attention on the company like never before. After UK authorities demanded explanations from Zuckerberg last week, the US Federal Trade Commission yesterday confirmed it was carrying out a "non-public investigation" into Facebook's privacy practices. While the affair has heightened suspicion that other Silicon Valley beasts are just as guilty of data-related abuses, Facebook could become the dog the world's regulators like to kick. (See FTC Confirms Probe Into Facebook Privacy Practices.)

Investors are rattled, too. Although Facebook's share price remains higher than it was this time last year, it has fallen 12% since the beginning of 2018. Amid reports of customers downloading their Facebook data in horror, the share price could fall a lot further if the recent scandal triggers the loss of customers, and especially the oldsters that have continued using Facebook while their children have gone elsewhere. Until now, most consumers have had a carefree attitude to their personal data, happily sharing information with Facebook and other Internet companies without a moment's hesitation. The fallout from Cambridge Analytica could prompt many to think twice.

— Iain Morris, News Editor, Light Reading

About the Author(s)

Iain Morris

International Editor, Light Reading

Iain Morris joined Light Reading as News Editor at the start of 2015 -- and we mean, right at the start. His friends and family were still singing Auld Lang Syne as Iain started sourcing New Year's Eve UK mobile network congestion statistics. Prior to boosting Light Reading's UK-based editorial team numbers (he is based in London, south of the river), Iain was a successful freelance writer and editor who had been covering the telecoms sector for the past 15 years. His work has appeared in publications including The Economist (classy!) and The Observer, besides a variety of trade and business journals. He was previously the lead telecoms analyst for the Economist Intelligence Unit, and before that worked as a features editor at Telecommunications magazine. Iain started out in telecoms as an editor at consulting and market-research company Analysys (now Analysys Mason).

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