August 28, 2012

The title of this fillip will win no medal for originality. Google returned about 2,000 pages with this exact sentence. Even more striking, the positive answer, "Facebook is a Ponzi scheme", came back with more than 14,000 citations, or more than 5 millions when the quotes were dropped.

These fillips attempt to fish long term findings from the fast flowing stream of daily news. How well I succeed in entertaining my readers week after week is for them to appreciate, the real judgment will have to wait a generation or two. Meanwhile my method has its limit, I admit. In the past few days, Facebook shares briefly traded as low as half their opening price. Do I dare to ignore such a rapid fall of grace? But what is there to fetch?

Perhaps we need to forget about the long term, go with the flow and simply tip our hat to Mark Zuckerberg's genius. A couple of months before his untimely death, I had saluted Steve Jobs's magical powers. Making us believe we move the world with our fingers and forget the magnifying glass we wield, the latter merely manipulated our senses. Mark Zuckerberg totally trumped our common sense, an illusion harder to pull out.

Ponzi himself and his imitators, Bernard Madoff among them, were not so ambitious. They too promised the public a sure way to reap a fortune but backed their words with legal covenants and hard cash. They would have fooled nobody without it. With it, they also incriminated themselves for, as soon as an illusion returns real money to investors, it rests on finding funds from a source of unlimited growth, a material impossibility.

A Ponzi scheme then behaves like a bubble, it robs the future to feed the present. If its rate of return is small enough, its future victims might not been born yet, a very pleasant prospect for politicians everywhere. Nevertheless no scheme can be maintained without a minimum of growth. It is precisely because Western economies currently fail to grow that their present social solidarity system is now exposed as nothing more than a Ponzi scheme. Between jettisoning solidarity altogether and hoping to run the scheme a while longer, aren't there better and more sustainable solutions?

Naturally the smaller the rate of return, the more difficult it is for a private citizen to launch a scheme. To run major risks for little rewards goes against common sense. Admire then Mark Zuckerberg's achievement. No Ponzi, he boldly and safely guaranteed nothing more than a zero return.

Legal or not, any successful scheme demands a credible story. Listen to Professor Tamar Frankel of Boston University, interviewed by Diana B. Henriques (*). "[Madoff] said, "I have a secret way of doing something," and it may have seemed plausible that he did". Indeed his investors thought he had access to privileged market information and did not want to be told anything more factual lest they be made accomplices to a crime.

Observe how Madoff is bettered by Mark Zuckerberg. The latter's investors did believe he too had a secret way, despite it being morally repulsive, to exploit his access to the private data of Facebook's growing flock, now close to a billion people. But this time isn't the story true? He has created the most successful social network so far, a feat few can deny. Facebook has cleverly lobbied US law makers with in kind services, so much more invisible than cash contributions. And who doubted its influential initial investors could insure no real attempt would be made to protect eprivacy?

Yet whenever Facebook users rebelled against too naked an attempt to cash on their personal profiles, the company has been prompt to retreat. The power of Facebook is impressive but brittle because it is so public. Contrast this with Acxiom. Who knows it derives all its revenue from privacy violation? Mark Zuckerberg is careful not to believe his own story too much and most Facebook revenues come from regular banner ads.

Genius is seldom recognized at its true value. An anonymous informer told Somini Sengupta that "[Mark Zuckerberg is] doing a very bad job of managing Wall Street" (**). Not at all. He has used Wall Street brilliantly to fulfill Professor Frankel's advice. "Many con artists make it seem that they are limiting access to their investments, making them available only to a select few". How can one speak of "gullibility" when Mark Zuckerberg could tell his victims the law itself limited the number of his investors to 499 as long he felt Facebook was not yet ready for its initial public offering?

Mark Zuckerberg understood that the IPO mechanism neatly divides the early investors from the public. To the latter he made no binding promises. To the former he only made the implied promise that they would be handsomely and quite legally rewarded on the day of the IPO if they helped to blow the bubble to reach maximum size by then. And indeed Somini Sengupta reports "many of Facebook's early big backers - including Accel Partners, one of its first venture capital investors - sold a hefty portion of their shares at the peak price in May", pocketing $9 billion (***).

Not all insiders could sell on the day of the IPO because of the so called lockup period. "The largest tranche of shares are eligible to come on the market in November". But if, once worth more than $100 billions, Facebook is now down to 50 or so, this is still 50% above what it was two years ago. Who will complain? True, the company may not be able to raise more capital from Wall Street, but it just got $6 billions. Can it complain?

I add a special reason to be grateful for Mark Zuckerberg's business acumen. Remember Facebook sold shares without any voting rights. This may have incurred the wrath of many. Yet were its CEO answerable to investors whose shares had dropped by 50% in three months, could he resist the pressure to exploit his trove of personal data to maximum, if deleterious, effect? Mark Zuckerberg's independence is eprivacy's best protector.

Free from any short term worry, Facebook faces three issues. "[It] has not mastered how to convert customer use into mobile ad revenue", James B. Stewart explains (****). Adds Brian X. Chen, "advertisers like that their ads are difficult to ignore on smaller screens - but at the same time, that's what annoys users" (*****). That and the fundamental fact it is still valued on the potential offered by the data created by the users for free.

"The company's strategy [will] mostly focused on so-called sponsored stories, which treat posts from users as ads, amplifying word of mouth". Targets today, tools tomorrow. For "Gokul Rajaram, product director of ads at Facebook", the story remains to hold users in bondage. Scary.

The problem is, Mark Zuckerberg has so far failed to recognize users are people. This very blindness in his genius magnifies the issue created by the transition to mobile. For, smart telephones being even closer to users than computers, all three issues mentioned above compound one another.

Short term brilliancy notwithstanding, long term sustainable business models must take users as partners. This is the lasting lesson.

Philippe Coueignoux

• (*) ......... Examining the Ponzi Scheme Through the Mind of the Con Artist, by Diana B. Henriques (New York Times) - August 21, 2012
• (**) ....... The Facebook Frown, by Somini Sengupta (New York Times) - August 21, 2012
• (***) ..... Facebook Shares Hit New Low Amid Fear, by Somini Sengupta (New York Times) - August 17, 2012
• (****) ... Social Media, Once Soaring, Are Coming Down to Earth, by James B. Stewart (New York Times) - August 18, 2012
• (*****) . Facebook Reorients Itself for a Small-Screen World, by Brian X. Chen (New York Times) - August 24, 2012
• (1) for more details, see the Ponzi in the wikipedia