Facebook’s Faustian bargain

By Felix Salmon
August 6, 2012
Henry Blodget explained just what it was that made Mark Zuckerberg a great CEO: his ultra-long-term time horizon.

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In the run-up to Facebook’s IPO in May, Henry Blodget explained just what it was that made Mark Zuckerberg a great CEO: his ultra-long-term time horizon. “It often takes decades to build the sort of companies that the best executives and entrepreneurs hope to create,” wrote Blodget, explaining that Facebook’s dual-class share structure, and Zuckerberg’s control of the company, would allow the young CEO to build a company for the ages, rather than one which hurt itself by chasing short-term profits.

When talking about Zuckerberg’s most valuable personality trait, a colleague jokingly invokes the famous Stanford marshmallow tests, in which researchers found a correlation between a young child’s ability to delay gratification—devour one treat right away, or wait and be rewarded with two—with high achievement later in life. If Zuckerberg had been one of the Stanford scientists’ subjects, the colleague jokes, Facebook would never have been created: He’d still be sitting in a room somewhere, not eating marshmallows…

Companies are a lot more than ticker symbols. They create jobs that employ people. They create products that help people. They devote resources to ensure that they’ll keep creating this value for decades, despite the fact that these investments reduce their near-term profits. In other words, these companies create societal value. As Warren Buffett and a handful of other investors have often observed, this balanced approach allows such companies to create huge value for some shareholders: the ones who stay put for the long term.

But where are we now, just three months after Facebook went public? Dalton Caldwell’s blog post about Facebook has gone viral this week because it seems to depict a company which, having gone public, is doing the exact opposite of the kind of things that Blodget so admires. Caldwell built a Facebook app, but was then told by Facebook that because it had embarked upon a similar project internally, he basically had two choices: be taken over and shut down by Facebook, or just be shut down by Facebook. Dalton wrote, in an open letter to Zuckerberg:

Mark, I don’t believe that the humans working at Facebook or Twitter want to do the wrong thing. The problem is, employees at Facebook and Twitter are watching your stock price fall, and that is causing them to freak out. Your company, and Twitter, have demonstrably proven that they are willing to screw with users and 3rd-party developer ecosystems, all in the name of ad-revenue. Once you start down the slippery-slope of messing with developers and users, I don’t have any confidence you will stop.

The point here is that although Facebook might be controlled by Zuckerberg individually, it’s still nothing without its thousands of employees. And those thousands of employees have entered into a bargain with Zuckerberg: they’ll accept relatively modest salaries, and work hard, because Zuckerberg is giving them substantial amounts of equity in the company. Once Facebook went public, every single Facebook employee became acutely aware of the company’s share price, what direction it was going in, what that move was doing to their net worth, and what public investors wanted to see from the company (revenues, and profits, rising sharply).

As such, despite his voting control at board level, it’s actually really hard for Zuckerberg to keep his employees focused on long-term platform-building, rather than short-term obsession over the share price. For one thing, they don’t own the company; many of them are going to leave, at some point, and so their time horizon is necessarily going to be shorter than Zuckerberg’s. And at any company with broad share ownership and a public share price, employees are always going to pay a huge amount of attention to whether it’s going up or going down.

On top of that is the classic Silicon Valley problem — which is that employees are always searching for the new new thing, the company where they can get early-stage equity and make themselves a fortune. Or, at the very least, join a mature company like Apple where the stock can still rise enormously. If Facebook’s stock is going down rather than up, its employees will start looking for other opportunities, and the company will find it much harder to attract talent.

Facebook has a lot of money and a lot of great employees, and so should by rights have the luxury of spending both money and its employees’ time in the service of building a platform for the ages. In practice, however, now that Facebook has gone public, it doesn’t work like that. The markets want to see quarterly results — and the employees’ incentives are aligned more with the markets than they are with Zuckerberg. He might have been a very good CEO of a private company. But trying to run a public company, as he’s discovering, is very different.


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What? Facebook has oceans of money. It can pay its people in money, not in equity. If it gives them enough money they don’t need to worry about their stock price. I have trouble believing that public market equity volatility is what’s causing a change in Facebook culture.

But you’re right that people want to work at a company that will make them rich, whether pre or post-IPO. A company that is on its way to taking over the world feels like that even if it’s not making any money. Once it’s taken over the world, though, it doesn’t feel like that if there’s no revenue growth.. And revenue, to Facebook, means ads, and meant ads long before the IPO.

The problem Caldwell identifies is real enough, but it’s inherent in Facebook’s business model, not in the public markets. The original sin in Facebook is Zuckerberg’s choice to monetize his users by selling them to advertisers, not his (forced) choice to go public.

Posted by MattL | Report as abusive

If Blodget said that Zuckerberg is a great CEO, then it should settle that question – he most certainly is not. I hear this comment a lot, but never hear about the great or genius decisions that he made, other than starting the company in the first place, which makes it just a great idea (which he didn’t even realize for a while).

I don’t think Facebook engineers are getting paid relatively modest salaries; especially not the ones who get hired by acquisition. Facebook lured away a lot of talent by offering the chance to be part of a fast growing company, and by offering good salaries.

It will be hard for Zuckerberg to keep his employees focused on long term platform building, because there is no long term for that platform. They have yet to demonstrate how to generate google-like revenue from their desktop page views, let alone how to monetize their mobile apps (psst: it’s not going to be easy).

The problems you mention have nothing to do with going public; they can only play the “we’ll go public soon and you’ll get rich from your options” card so long. Being a public company is not going to stop them from building a platform for the ages, what will stop them from doing that is that it’s extremely difficult, if not impossible, especially when the main refreshment served at the company is kool-aid.

To his credit, I don’t think Zuckerberg will focus on quarterly results at the expense of the “platform’s” success, but that doesn’t mean he will know what to do next. He thought of a cool way for students to interact over the web, and it proved attractive to people who had already left or never attended college, but it’s no evidence of knowing what the next big thing is.

The problem with going public is that at some point, mercenaries will run the company, and they don’t care about the product the company will sell. Zuckerberg is still in charge and doesn’t have that problem.

Posted by KenG_CA | Report as abusive

Isn’t the value of FB still higher than what it was 365d ago? Or is that not how the human psyche works?

Posted by thispaceforsale | Report as abusive

The Class A problem, when you are a platform that has dependencies on developers is how to not piss them off and encourage tight integration with you. Microsoft is the classic example of this. Their developer tools are the best on the planet. Period. They nurture the relationship and reward people for developing for their OS and products. That’s long term success. Anyone who thinks their suite of products are going anywhere, or even into the cloud, are wrong. Especially at the enterprise level.

The issue with FB is that if they screw their ecosystem in any way, people will RUN to “the next thing”. This is the issue Twitter faces (other than 99% of what passes through Twitter being garbage) and ads will not save either of them. Google is also not going anywhere. In my opinion, the best FB can hope for is more games, interactivity for regular users to keep them engaged so that they *might* click on an ad here and there, and some play to turn their business listings into something better and more integrated with people’s lives. That’s monetizable. But it isn’t a robust ad platform in the manner of Google. I can tell you from experience. If they’d figure out some way for my business page to be more important to people, I’d gladly pay. But nothing they’ve come up with so far works well. And to me that’s where Zuck’s leadership is lacking.

Posted by skyman123 | Report as abusive

Facebook, as a “company for the ages” is a pretty comical thought.

It had the first mover advantage on the idea of a well done modular customizable homepage. That is about it. Better and more importantly free/advertisement-less options will arise, and that market will fragment a bit. Facebook is AIM in 1999, something everyone is using because it is currently the best tool for the job, but not long for this world.

The main thing I think Zuckerberg has shown is a shrewd business sense. Selling much of his company at more or less its all time high.

Posted by QCIC | Report as abusive

If I were a big time investor in FB (e.g. a Peter Thiel) I’d “kidnap” Zuck for a weekend retreat, of sorts. We’d fly (private of course) to some ultra exclusive mountaintop or seaside or island getaway. Maybe Sir Richard’s Necker Island (if the construction is complete).

Joining us on this retreat would be some former head honcho of 3M circa 1990. I’d have the 3M dude (or dudette) explain to Zuck the famous bogey/mantra of “X% of our revenue today comes from products that didn’t exist N years ago.”

Play with the x and N, exchange “products” for revenue streams and … “Now, tell me, Mr. Public Founder/CEO beholden to some of the most powerful people on Wallstreet… how are you going to do that at FB? How do you keep FB from being a 1 trick pony no one with money is surprised by or particularly impressed with or crawling over top of each other to buy anymore? Sleep on that. See you at breakfast.”

When Zuck woke up the next morning under his door would be 2 blank sheets of paper and a Post It that says, “Show me your answer on these 2 sheets only. Room service for breakfast. See you at noon for lunch.”

At lunch, when his answer sucked (and it would), I’d say, “You’ve had about 15 hours to answer this question and this is the best you can do? After eating, sleeping, breathing this company for all these years? This is it? I have to be honest with you, Z. I’ve know every tech legend you admire. There was never a time they couldn’t answer that question for their company. That’s why so many admire them.”

“What if I told you I gave that exact challenge to 5 other people last week? I gave them 24 hours. Two of them didn’t make the cut. The other 3 are here. Want to see what they came up with?”

Which of course is code for, “READY TO PICK YOUR NEW CEO?”

It would be quite a weekend. :-)

Posted by DanFarfan | Report as abusive

@Dan – Yes, it would be quite the weekend. It would then be quite the shareholder meeting when Zuckerberg, who has voting control of Facebook, elects a new board who, in turn, hire him back as CEO.

That is the frightening thing to me about both Google and Facebook – you have CEO’s who essentially cannot be removed due to their voting power and who show little if any inclination to return cash to shareholders. Google has $33.6 billion of cash (net of debt) and is generating $10 billion plus of net income per year, almost all of which is converting into cash that adds to that pile. A business with that cash flow and untapped borrowing ability has no need for that much cash. They ought to do a massive special dividend before dividend rates increase on 1/1/13 and institute at least a small quarterly dividend. As for those who say a dividend signals that Google has no good use for the cash, I say that’s irrelevant BS. Google has already signaled it has no use for the cash by letting it accumulate on its balance sheet. I realize the post is about Facebook, but my connection is that Facebook/Zuckerberg will do exactly the same thing if/when Facebook generates large profits.

Posted by realist50 | Report as abusive

@realist, how much of that cash hoard at Google is held by off-shore shell companies? If they were to return it to shareholders as a dividend, they would need to pay corporate tax on it first. The tax would destroy their net income for a year!

Not sure how much of Google’s actual income is overseas, but I imagine they can use the same patent-renting tricks that Microsoft recently adopted.

Posted by TFF | Report as abusive

@TFF – fair point that some of their cash is offshore. According to Google’s 10-K, as of 12/31/11 just under half (48%) of its cash is held by foreign subsidiaries. That actually makes sense, as in recent years Google says that it’s revenue is split roughly 50/50 between the U.S. and the rest of the world. There would be additional tax to bring this money back to the U.S. I can see that the tax impact of bringing cash back to the U.S. impacts how much money Google returns to shareholders, but it doesn’t set the answer as zero.

Plenty of multinational U.S. corporations with large foreign operations face similar tax issues regarding repatriating foreign profits to the U.S. – e.g., GE, Honeywell, IBM, ExxonMobil, etc. All of these, however, find ways to work through the issue, through some combination of tax strategies (loopholes, if one prefers that term) and paying the difference between U.S. and foreign tax rates, without building up a Google-like net cash position. If Google management is using that as a rationale, it is really just an excuse for them doing what they want to do.

In searching Google’s 10K for this number, I ran across the following quote in reference to Google’s foreign cash – “our intent is to permanently reinvest these funds outside of the U.S.” – which is quite a whopper unless they are using “invest” so broadly as to include parking funds in short-term cash equivalents such as commercial paper. I cannot believe that Google has plans to reinvest anything like $15 billion in its foreign operations – remember that these foreign operations are generating lots of additional cash each year.

Posted by realist50 | Report as abusive

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