Facebook's troubles in India keep snowballing

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For more than a month, Facebook has been trying to convince Indian regulators to lift a ban on its Free Basics program but recent developments indicate the social media giant isn't having much success.

Launched alongside telecom operator Reliance Communications, Free Basics was designed to bring more Indians online by offering Reliance customers complimentary access to a range of Internet sites. It was first unveiled last year under the name Internet.org as part of CEO Mark Zuckerberg's goal of universal digital access, especially for the 30 percent of Indians living below the poverty line.

But it's come under fire from net neutrality advocates and cast doubt on the social media giant's strategy in emerging markets (EMs). The program is currently pending approval from regulators who are concerned about carriers charging different prices for digital content.

The crux of the problem lies in the fact that Free Basics content won't incur data costs but other sites will, angering activists who argue that all Internet content should be treated equally. With explosive mobile penetration, India is Facebook's biggest market after the U.S., making such a ban especially significant.

A stinging letter from the Telecom Regulatory Authority of India (TRAI) last week has fanned the flames further. Earlier this month, officials consulted Facebook on the topic of data pricing for different websites but the firm's response was apparently less than satisfactory.

Addressed to Facebook India's public policy director Ankhi Das, TRAI accused the company of using the consultation as a chance to shamelessly promote Free Basics, saying its replies had "the flavor of reducing this meaningful consultative exercise into a crudely majoritarian and orchestrated opinion poll."

In response, Das said Facebook did its best to cooperate with TRAI's request.

"While we did not include all of the specific language drafted by TRAI, we did deliver a request for additional information and included in the draft email the exact language from the four specific questions posed in the consultation paper. More than 1.4 million Indians responded by submitting revised comments that addressed these questions."

TRAI's letter is just one of many criticisms being hurled at the 12-year old company.

The content available on Free Basics is in itself questionable, according to Mahesh Murthy, co-founder of Mumbai-based venture capital firm Seedfund. The list includes Bing, Wikipedia, ESPN, Accuweather, BBC News, and dictionary.com, but noticeably excludes pages frequented by Indians, such as YouTube, Google , Amazon , Flipkart, LinkedIn , Twitter , or Rediff, Murthy points out.

"From friends in the publisher community, I understand that Facebook has approached virtually every single site of significance in India and asked them to join the program. Most of them declined for two reasons: no site wants to hand over user data to Facebook and they believe in net neutrality," he told CNBC.

Twitter and Google, which owns YouTube, are known rivals of Facebook while Amazon is fast becoming one as Facebook launches an e-commerce marketplace.

Chris Daniels, vice president of Facebook's internet.org campaign, told CNBC that the service is open to any developer that complies with technical guidelines.

"Free Basics is not intended to be the whole internet, but it is open to any developer that wants to bring their internet service onto the platform....We are happy to have anyone on the platform."

Instead of offering access to a limited number of sites, Murthy recommends Facebook offer the full internet by subsidizing carrier costs. By using the same amount of capital spent on Free Basics advertising [up to $100 million], Facebook could have connected 5 million people, a number 50 times larger than what it achieved with Free Basics, he said.

For its part, the social network said it has explored several other connectivity models but none work as well as Free Basics.

Murthy likens Free Basics to digital apartheid, saying it primarily serves Facebook's interests rather than upholding the idea of connectivity as a basic human right.

Facebook needs a story to support its inflated valuation since compared to other tech names such as Google, he said.

Facebook's 12-month forward price-to-earnings (P/E) stands at 34.03, according to Reuters, with third-quarter revenues of $4.5 billion. For the corresponding periods, Google parent Alphabet's P/E was 21.84 with revenues of $18.68 billion. Both tech firms are due to report fourth-quarter earnings within the next week.

Acquiring a large number of users is the best way to justify Facebook's valuation, said Murthy.

"This large number can only come from China and India. China doesn't let Facebook in, which leaves India. That's what Free Basics India is all about: finding a story to make sure Facebook stock doesn't fall to the same P/E as Google's."

To its defense, Facebook says it launched Free Basics to make the world more open and connected.

"We're not making money on this, but if our efforts contribute to getting everyone online, we will fulfill our mission as a company...In the very long term, it's true that more people online is better for Facebook, but it will be good for the whole internet ecosystem and for society too," said Daniels.

After 30 days of using Free Basics, there are 8 times more Indians who have paid for and are using the full Internet than those who have chosen to continue only using Free Basics, he continued, adding that this clearly demonstrates that Free Basics is an effective strategy for bringing people online.

Regardless of Zuckerberg's intentions, tech analysts agree that gaining new users is vital to Facebook's business plan in EMs.

Typically, there are two key ways social media companies can grow: acquiring more users and more revenues per user, explained Bob O'Donnell, president and chief analyst at market research and consulting firm TECHnalysis Research. But in EMs, revenues per person tend to be lower so the former option is Facebook's best bet, he said.

"Given the relatively low Internet connectivity rates in India [and other EMs], that's probably why Facebook is placing so much effort on associating themselves with connectivity. In theory, that means new Internet users will almost immediately become new Facebook users as well."

The company has adamantly denied that, saying Free Basics users don't require Facebook accounts.

Facebook has used the Free Basics model to penetrate prominent EMs, including Colombia, the Philippines, Thailand, and Mexico, but India isn't the first case of trouble. Earlier this month, Egypt suspended the program after its initial two-month permit wasn't renewed, Reuters reported.

While the model isn't sustainable, it could still be effective for the next few years, O'Donnell added.

Ultimately, the controversy in India isn't expected to hurt Facebook's profits in EMs but it certainly threatens the firm's reputation and serves as an important cultural lesson.

"The worst thing Mark and Facebook can do is come across as disingenuous in their mission here. That would be something that would be far more difficult to overcome down the road...Mark must find a delicate balance in fulfilling his desire to make the world more connected without coming across as greedy and serving an ulterior motive," said Jason Moser, senior analyst at The Motley Fool.

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