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The Guardian's Chakrabortty Is Outraged At Where The Twitter IPO Money Went

Burgess COMMENTARY

Peter Burgess

The Guardian's Chakrabortty Is Outraged At Where The Twitter IPO Money Went

As regular readers will know I enjoy pointing out that the Chief Economics Leader Writer for The guardian, Aditya Chakrabortty, is in fact a history graduate. This leads him occasionally to stray from the path of righteousness when discussing matters economic. So it is today when he discusses where all the money went from the Twitter IPO. Or, if you prefer, who owns all the stock that is now a great deal more liquid than it was.

Except the more you look at what has actually happened with Twitter, the more it comes to look like the opposite of the heroic earnings of a few hard-workers. Many of the billions will go to a select group, many of whom have put hardly any work into the company or taken comparatively little risk. That is true of the stock market flotation, of Twitter itself and of its entire business model.

This is talking with the benefit of hindsight. The people who funded the company (a seriously substantial sum over the years) did not of course have the benefit of that hindsight. Twitter was as risky as any other innovative start up: and we expect some 9 out of 10 of those to go bust. We’ve even got an example of that in Kno:

Because it sold for literally pennies on a dollar. Well placed sources who were in the know told us that the company sold for $15 million with some retention bonuses for the employees. Intel bought the company mostly for its hardware-related intellectual property and the employees. Intel also was one of the largest investors in the company — having pumped in $20 million via its Intel Capital arm.

Kno started life as Kakai Inc. and was co-founded by former Chegg CEO Osman Rashid and semiconductor industry veteran Babur Habib. In its four year lifespan, raised $73.4 million from venture capital firms of Andreessen Horowitz, First Round Capital, FloodGate Capital, Advanced Publications, Ron Conway’s SV Angel, GSV Capital GSVC +0.00% and Intel Capital. It raised about $20.3 million in debt as well. Given how debt deals are structured, the venture investors lost pretty much their shirts on this deal.

That’s just how this particular game plays out. The VC investors are indeed taking huge risks every time they put money into play. And almost all of their risks come back to bite them, Twitter being an example of one of the very few that do not and thus pay for all of the rest.

But my real ire isn’t that Chakrabortty seems not to understand this. It’s that he entirely fails to understand the very concept of value here.

Finally, look at Twitter’s business. Or rather, look at its own assessment of its business, as stated in its S-1 stockmarket filing. Early on comes the delicious admission: “Our success depends on our ability to provide users of our products and services with valuable content, which in turn depends on the content contributed by our users.” Read that again: Twitter is in the business of selling us to us – our news and views and idle banter. Without those, without us, it is nothing. As with Facebook FB +0.00% and Tumblr and all the other social media, we’re also part of Twitter’s workforce. But I bet you haven’t seen any stock options, either.

This brings me to one of my favourite economics papers, Schumpeterian Profits in the American Economy.

The present study examines the importance of Schumpeterian profits in the United States economy. Schumpeterian profits are defined as those profits that arise when firms are able to appropriate the returns from innovative activity. We first show the underlying equations for Schumpeterian profits. We then estimate the value of these profits for the non-farm business economy. We conclude that only a minuscule fraction of the social returns from technological advances over the 1948-2001 period was captured by producers, indicating that most of the benefits of technological change are passed on to consumers rather than captured by producers.

The value that entrepreneurs create through the technological change they promote goes almost entirely to us, the consumers, and not to those entrepreneurs. In fact, in the paper, they calculate that under 3% of the value created does go to those innovators, the rest going to a combination of finance capital (ie, those VCs) and us the consumers. With the vast majority going to us the consumers. For example, from Felix Salmon:

I have personally already extracted many thousands of dollars in value out of Twitter, over the past five years, and it hasn’t cost me a penny.

That’s where all the value goes. To us as the consumers. So it really would be pretty odd for us to be demanding stock options as well. But there’s a larger point here as well. This basic point, about who gets the value from the creative destruction of capitalism, it’s the entire reason that the system actually works. And if you’re going to be writing about economics it’s a point that you need to grok. Yes, people do indeed get fabulously rich dreaming up things they can sell to us. But they can only do so by providing us with something that we think worth it: that is, that whatever we have to pay is less than the value we place on that thing. Thus, by definition, a successful entrepreneur must have created more value than whatever pile of money he gets to keep at the end. And on average 97% of that value goes to the consumers.

So to complain about the consumers not getting any value from Twitter’s IPO is ludicrous. We get the possibility of sending a tweet which is something that roughly 300 million people feel to be of more value than the precisely $0.00 it costs them to do.