An astounding number of people use social media each day, so it's a fair question to ask, "How do social media companies make money while offering so many free services?" As of Dec. 2019, Facebook (FB) reports it has over 2.5 billion monthly active users, an increase of 8% year-over-year. Twitter (TWTR) reports it has 321 million monthly active users, while LinkedIn (MSFT) has about 260 million monthly active users. Such volume is the short answer to the question of how these companies are making money. But that doesn't tell the whole story. Here we explain exactly how the top powerhouse social media companies translate all that volume into cash.

Key Takeaways

  • The primary way social media companies like Facebook and Twitter make money is through selling advertising.
  • The concept of selling advertising while offering a free service is not new; television, newspapers, and media companies have been doing this long before social media companies existed.
  • Facebook has over 2.5 billion monthly active users worldwide and estimates the average revenue per user (ARPU) in 2019 was $8.52.
  • Facebook's ARPU comes primarily through profits earned from advertisers who use the platform to reach customers.

Making Money Through Advertising

This isn’t a unique observation, but it’s a crucial one: If you’re not paying for the product, the product is you. The real transaction here isn’t you receiving enjoyment in the form of a free temporary distraction created by a media company at great expense, but rather, that media company renting your eyeballs to its advertisers.

For many people, that truth manifests itself most clearly in the television industry. CBS doesn’t come up with a new episode of NCIS every week strictly to please you, the demanding viewer with a limitless capacity for being passively entertained. It’s because you and 12 million other people will watch that episode, and thus pay at least subconscious attention to the 16 minutes of commercials that are interspersed throughout it.

For a car manufacturer or fast-food restaurant, there are few more efficient ways to grab customers’ attention, something CBS and its rival networks are well aware of. Media companies are interested in pleasing the brewer before the viewer.

Facebook Jumps on the Advertising Bandwagon

For social media, the importance of the number of viewers glued to their computer or smartphone screens is every bit as important (if not more so) as it is to commercial television. There’s a reason why Facebook’s 10-K filing with the U. S. Securities and Exchange Commission (SEC) uses the acronym ARPU, as in average revenue per user. According to Facebook's fourth-quarter 2019 results, its worldwide ARPU was $8.52, while the combined ARPU for the U.S. and Canada was $41.41. Multiply those numbers by the aforementioned estimated user base, and now you can understand why Facebook has a market capitalization of over $600 billion.

When Facebook founder Mark Zuckerberg went looking for a chief operating officer in 2007, it’s no coincidence that he selected not an engineer nor a technologist but a vice president with a background in advertising sales. Sheryl Sandberg had spent 6.5 years selling advertising as a vice president at Google (GOOG).

Since its initial public offering (IPO) in 2012, Facebook's stock price has jumped from about $38 per share to $210 per share as of Feb. 6, 2020—an increase of 453%.

How WhatsApp Helped Facebook Generate Revenue

Growing Facebook’s user base to the point where it reached critical mass was obviously important to the company’s operations, but only to the extent that it provided something to attract advertisers. To an uninterested observer, committing $19 billion to acquire the texting application WhatsApp might sound like the height of dotcom-era hubris and recklessness. But it wasn't.

WhatsApp boasts over 1.5 billion monthly active users, which to Facebook management means an even greater stock of susceptible minds to sell as a unit to companies looking to, for instance, move a few more smartphones this quarter. Every acquisition Facebook has made since, whether it was $1 billion for Instagram or $19 billion for WhatsApp, was conducted with the same goal in mind.

Social Media's Real Purpose

Advertising isn’t just a way for Facebook and its ilk to perhaps earn a little bit of revenue in between hosting family photos and personal musings. It’s the very purpose of the site’s existence, and the same goes for Twitter and LinkedIn.

Twitter’s status as a place to find instant, unfiltered, democratized updates on everything from celebrity arrests to international civil unrest might make it important to the modern exchange of ideas, but again, that’s secondary to keeping the advertisers happy. Take Twitter’s word for it, directly from one of its SEC filings. The company’s forward-looking statements concern:

"Our ability to attract advertisers to our platform and increase the amount that advertisers spend with us."

and

"Our ability to improve user monetization, including advertising revenue per timeline view."

The Bottom Line

From the consumer’s perspective, advertising was originally a way to enjoy a finished product at a notably reduced cost. Without inserts and placements, the newsstand and subscription prices of magazines and newspapers would have to be a multiple of what they are now. In fact, such publications would not be economically viable at all—the rise in price would necessarily reduce the quantity sold to practically zero.

The same applies to broadcast television and most of all to social media sites. In theory, Facebook could just charge that $8.52 average worldwide revenue per user directly to the user, on a subscription basis. The problem is that not only would users either cancel their accounts by the millions—or never agree to pay the subscription fee in the first place—setting a fee would also eliminate the possibility of further dynamism and growth.

For a social media site to go from 300 million users to 2.5 billion and beyond, access has to be easy, almost effortless, and most of all, free. Using an advertiser-supported model, rather than charging each user individually, is unquestionably the easiest way for Facebook to garner as many users as possible. The more users on the site, the greater the number of advertisers willing to engage them, and the more those advertisers are willing to spend. This makes for the most virtuous of circles for Facebook’s management and shareholders.