The Economics of Social Media

Social media is everywhere. But can anyone prove its economic power yet?

by Phil Rockrohr


Digital media may have radically changed social interaction, but has the combination of the two had as dramatic or profound of an effect on business?

Judging from the often-spirited debate among academic and business experts during the keynote panel at the 59th Annual Management Conference, the verdict—and perhaps much of the data—is still out.

Social media have revolutionized marketing by forcing the integration of analog and various digital media by “outsourcing” the process to end users, and by forcing companies to focus on customer needs, said Rishad Tobaccowala, ’82, chief strategy and innovation officer for VivaKi.

“There has been a seismic shift,” Tobaccowala said, during the luncheon panel, before 800 attendees at the Hyatt Regency Chicago on May 20. “For many, many years, you never had to understand and meet customer requirements, because customers weren’t as empowered as they are today. Like the Renaissance in painting, we need to take a completely new perspective to marketing. In the next 10 years, it will become very clear. The fact that power has shifted is pretty dramatic.”

Tobaccowala was among five panelists who included Booth faculty, a Twitter executive, and one of the cofounders of Groupon who also teaches entrepreneurship at Booth. Steven Kaplan, Neubauer Family Distinguished Service Professor of Entrepreneurship and Finance, moderated the 90-minute panel, which was followed by 13 breakout sessions hosted at Gleacher Center.

Much of the talk about seismic shifts in marketing is typically anecdotal, with relatively little quantitative analysis measuring these changes, said Matthew Gentzkow, professor of economics and Neubauer Family Faculty Fellow. “It’s really important that businesses keep a little perspective about what’s actually happening,” Gentzkow said.

The average American currently spends five and a half hours a day watching television, six minutes a day on Facebook, and four seconds a day on Twitter, he continued. “That doesn’t mean that these technologies are not important, playing an important role in various ways,” he said. “For particular businesses, whose customers, say, are really focused in demographics where they are using these tools, they are relevant. Maybe society will be changed, but the idea that society has been changed or marketing has been changed in a fundamental way already is not true. The biggest risk for business may not be moving too slowly, but rather overreacting to all of this.”

It is too early to assess which companies will matter most or where marketing is headed, but markets are efficient and will eventually settle the debate, said Eric Lefkofsky, cofounder and chairman of Groupon and adjunct professor of entrepreneurship. “The change is enormous and is just starting,” he explained. “As a company today, no matter what you’re doing, to not pay attention to and really get focused on the internet and the power of social media, mobile devices, connectivity, and harnessing these tools could be devastating.”

The grassroots marketing revolution

The increasing popularity of social media has created accountability in brands, said Jean-Pierre Dubé, Sigmund E. Edelstone Professor of Marketing and Robert King Steel Faculty Fellow. “Back in the day, brands could lie and exaggerate their benefits, but that’s not possible anymore,” Dubé said. “If you deceive customers, it just takes one person to find out and start tweeting or blogging about it. Next thing you know, millions of people are aware of the deceipt.”

This accountability creates both good and bad news for customers and brands, he said. A May morning news headline highlighted the pressure social media has put on the sale of Girl Scout cookies. Two girl scouts used social media to pressure the CEO of the Girl Scouts of the USA to stop using rainforest-destroying palm oil in Girl Scout cookies. Girl Scouts of the USA’s response was to delete all palm oil-related comments from its website and to shut off its users’ ability to post on its Facebook page. Many Girl Scout troops subsequently threatened to refuse to sell cookies—a $700 million revenue source for Girl Scouts—unless palm oil was removed from the process.

Not only can such consumer empowerment help to improve products, companies may face scrutiny over once-insignificant decisions, Dubé said. “Gap changed its logo, and normally, these sorts of things go unnoticed,” he said. “But there was enough consumer backlash about the changed logo that the company changed it back again. The good news is that firms who have brands with virtues worth peddling to the market can actually harness social media and use it to their advantage.”

Although they disagreed about the empirical impact of social media on business, panelists concurred that firms must monitor the trend. “The question would be, if you are using social media, how do you measure it?” Kaplan asked. “How do you figure out whether you are making money or not? How much money should you put in? How do you think about return on investment?”

Investment for many firms, such as Apple, is“deeply measurable,” according to Tobaccowala. “These are highly data-driven businesses,” he said. “These are also businesses that, to a certain extent, by connecting television to these other elements, you can make television more measurable, because you can follow people to sales, among other things. So you make traditional media more measurable, you eliminate costs, and you become deeply tied with customers.”

Companies like Best Buy, Dell, and Southwest Airlines use Twitter on a regular basis as a form of customer service, said Brent Hill, ’97, director for the central region at Twitter. “On day one, they set up their Twitter handle,” Hill said. “On day two, people started to try to communicate with them, asking questions, mostly challenges to the business. People at the company tweet back to them and try to solve problems.”

Thanks to Twitter and Facebook, firms get direct connections with consumers at no cost, versus paid advertising, he said. “No brand can connect with everybody on Facebook or Twitter, and they have to work at it,” Hill said. “As part of their business models, both of those companies have created solutions to help marketers connect with a broader audience. When the numbers get as large as they have on Facebook and Twitter, that becomes very lucrative to a marketer.”

The next tech bubble?

Despite the growth of social media, accurately valuing such companies has proved difficult. In an IPO the day before Management Conference, LinkedIn was valued at 33 times its sales and 200 times its cash flow, Kaplan said. In contrast, in its IPO, Google was valued at 15 times sales and 60 times cash flow, he said. That turned out to be low. “Going further back, the multiples for some of the companies in the dot com boom were almost infinite, because they had little revenue and negative cash flows. In hindsight, the dot com valuations were hugely wrong,” said Kaplan. “The question is, where are valuations now? Have we returned to the excesses of the dot com boom, or are we at a more reasonable place?”

The unknown variables of IT companies and their future create confusion about investing in them, Lefkofsky said. “Google went out at a $15 billion value, but people look back at that in hindsight as an insane valuation and a terrible IPO,” he said. “The challenge for investors and the people running these businesses is that none of us have any idea where it ends. You know there has to be an end, but you don’t quite know where it is. There is a panic to get in because, at the end of the day, there will be a select number of companies, most likely, that will hold a very unique position and be big, big businesses.”

Buying stocks and overvaluing companies “because they might be Google” is a risky strategy, Gentzkow said. “I’m not an expert nor a good source on picking stocks, but the LinkedIn valuation has all the hallmarks of froth and bubble,” he said. “Nothing in these arguments is about what is happening right now. It’s all about what might happen someday. It looks a lot like a fad in high school.”

Regardless of the valuation of LinkedIn, the most innovative technology maintains profound influence over the rest of society, Tobaccowala said. “If you can see what goes on at Google and Apple, it has amazing network effects,” he said. “If you can integrate fast and continuously build on those network effects, it gets really hard for anybody to catch up. Some of that technology—the data, the speed, and the engineering—is really hard for people to later on come on with, unless there is a seismic shift. That’s what people are betting on, that there will be few winners, and that we don’t know who they will be.”

Another hallmark of past investment bubbles is the network analogy that “everything gets brought together,” Gentzkow said. “Google is an amazingly efficient and productive company, but I don’t know what the relevance of that is to LinkedIn. In 1999, everybody was saying, ‘Look at how Yahoo and AOL are taking over the world; therefore, is going to be worth a lot.’ Loose analogy is incredibly dangerous. If you want to know whether LinkedIn is worth anything, you have to focus on LinkedIn. If you want to know whether social media is going to take over the world—and you define that to mean platforms where people have friends and interact in social ways—then you need to focus on that.”

Defining social media, however, is not so simple

Borrowing from Gentzkow and Tobaccowala, Lefkofsky described social media as a combination of quickly expanding digital platforms and the creation of a “people’s network,” respectively. “You both are probably right,” he said. “These tremendous platforms were built and businesses have been able to monetize them into highly connected social contexts. Companies that take advantage of that in some way are monetizing the social graph or web, so that gets lumped into social media. There is just no great definition. Ultimately, everybody wants to be playing in that space. It has no beginning or end.”

Hill prefers to perform a litmus test to determine if a function is both “social” and “media.” “Not everything is designed to be social,” Hill said. “Easy to share, easy to connect, easy to follow has a media component to it. For media, I think about digital messages, videos, and photos that people are creating. Not every site has the media side. It’s easy for lots of different things to get lumped into the social media category, but you have to look at the social activity and whether it has a media element.”

In the late 1990s and early 2000s, a number of companies introduced platforms offering similar services or functions as social media do today, Kaplan said. “Why has this taken off in the last few years rather than 10 years ago?” he said. “Is this really different? Or is it just evolutionary?”

The recent boom is the result of two primary developments, Hill said. “The first is that devices have emerged in the last couple of years that make some of these services almost 100 percent available—that’s a big part of the phenomenon,” he said. “The second thing—the most important thing that has contributed to growth in the whole category—is that users are more expressive than they ever have been. They’ve shared photos and videos, they’ve commented on the sites, they’ve rated and reviewed. This warmed people up to platforms that make it really easy for them to share pieces of their lives, and they were receptive to them. That just wasn’t the case 10 years ago.”

Today is dramatically different, thanks to a variety of different factors converging, Tobaccowala said:

  • The changes are led by consumers, not businesses.
  • The technology is improving rapidly.
  • Wireless broadband access is worldwide.
  • Content seems more important because it is specifically relevant to users.

Despite an audience query, none of the panelists dared to predict the future for social media.

For companies operating on the levels of Groupon or Twitter, it’s hard to imagine what’s coming next, Lefkofsky said. After launching in October 2008, Groupon is now adding almost 1,000 employees a month and between 3 million and 4 million subscribers a week in 47 countries, he said.

“Where are all these people coming from, where does it end, and when does this slow down?” Lefkofsky said. “You’re on this S curve; you just have no idea where you are. For people running these companies, we just have to take this journey wherever it leads us. The companies at the top of this sort of mountain are just on a ride. We have no idea what’s next because this thing is so fast and so big.”

For complete coverage including video and an interview with Steven Kaplan, visit

Last Updated 9/19/11