Burning Down Twitter

Elon Musk may have been kicking employees out of Twitter to reduce operating costs, but it’s possible he couldn’t have destroyed more of Twitter’s value if he’d burned down headquarters.

Let me explain…

It’s common to use the word “capital” to mean money, as in capitalizing a corporation, but to an economist, capital refers basically to tools. That is, capital goods are the things we make in order to improve our ability to make the final goods and services that we actually consume — or that we sell to other people to consume.

To a baker, capital is the kitchen and cooking utensils. To an airline, capital is the airplanes and all the associated airport facilities and service equipment. To a web business like Twitter, capital is the website hardware and software and the buildings used to hold it all and the people who run it.^[1]In the real world, some of that stuff may be rented, but that’s not important to where I’m going with this argument.

Because capital goods have to be produced — or purchased from a producer of capital goods — they take away from the production of final goods and services that the company sells to earn revenue. So every business tries to optimize the amount of capital it needs to achieve the desired level of production, and it has to expend effort to first produce (or spend money to buy) capital goods before it can produce the final goods and services it will sell. You have to have a kitchen before you can bake some bread, you have to buy airplanes before you can sell travel tickets, and you have to build a social media website before you can monetize traffic.

Not all capital is physical goods like factories and airplanes and server farms. Economists recognize that some capital is intangible.

Consider why a surgeon earns far more money than most other laborers: Because he knows how to perform surgery. That’s a skill he acquired by paying for an expensive education and spending years in training. He could have spent that time working at a paying job, so developing the ability to perform surgery required a sacrifice, an investment of money, time, and energy that could have been spent on other things. But having made that investment, he now profits from being able to produce an incredibly valuable service. In other words, a surgeon’s training and skill is a form of capital. It’s an example of what economists call human capital.

Because it’s intangible, human capital is a difficult concept to work with. You can see physical capital like airplanes and factories and tools, and you can trace the transactions involved in its purchase or construction, but human capital is created and forever invisibly encoded in the mysterious convolutions of the human brain. This makes it less obvious than it probably should be. But just because it’s difficult to see doesn’t mean it’s any less real.

Like many high-tech companies, Twitter has a lot of human capital. Much of it was brought into the company by its employees when they were hired, but some of it was task-specific human capital that is specifically of value only to Twitter. The Java programming skills of a Twitter software engineer may be general-purpose, useful on any software product built in Java, but a software engineer working at Twitter will also develop Twitter-specific human capital: They will learn the architecture of the Twitter application suite, the structure of the code base, the operating procedures of the server farms, the capabilities of the build tools, the methodology for managing the software process, and much more. It typically takes 3 to 12 months for a new software engineer to learn the ropes and reach full productivity.

In addition, Twitter employees will build shared Twitter-specific capital in the form of teamwork. Just as armies become battle-hardened, teams become work-hardened: They learn to communicate better, they learn to reach consensus faster when planning, and they learn each other’s strengths and how to allocate tasks efficiently among the team members.

This knowledge makes the engineers more productive, so it is definitely human capital, but most of it will only increase their productivity at Twitter. Many parts of the job will be very different at other companies, so the Twitter-specific knowledge will provide little benefit at a different job. The thing about task-specific human capital is that you can’t take it with you.

The two types of human capital play different roles in the salary bargaining process. Incoming engineers can successfully demand higher salaries for their general-purpose human capital. And because they can credibly threaten to take that capital to another job where it will also earn them higher salaries, Twitter has an incentive to keep paying the cost for using the engineers’ human capital.

As for task-specific human capital, by definition engineers can’t bring task-specific human capital into Twitter — it has to be developed on the job — so it has no effect on their starting salary. However, as they work at the Twitter, the build-up of Twitter-specific human capital makes salary negotiations more interesting: On the one hand, since engineers can’t take Twitter-specific human capital with them to their next employer, it won’t help them earn a higher salary at a new job, which makes it harder to demand a higher salary at Twitter. On the other hand, if they do leave, Twitter will lose access to their Twitter-specific human capital, so Twitter has an incentive to pay them at least a little bit extra to stick around.

When Elon Musk lays off one of these software engineers, Twitter loses access to their human capital, both general and specific. What Twitter gains in return, however, is the reduction in expenses that comes from no longer having to pay that engineer’s salary. Since the engineer’s salary included the full carrying cost of the engineer’s general human capital, Twitter is more-or-less compensated for its loss. But Twitter wasn’t paying nearly as much for use of the Twitter-specific human capital, so Twitter saves far less when it goes away.

I’ve been talking about software engineers because I am one, but clearly many other well-paid jobs at Twitter must involve the sort of Twitter-specific learning curve that results in Twitter-specific human capital. And in simple terms, when Elon Musk lays off an employee, they take their general human capital with them to their new job, and Twitter is compensated for that loss by not having to pay them. But their Twitter-specific human capital is simply demolished on the spot. It’s a deadweight loss that benefits nobody.

In some ways, laying off skilled employees is a form of capital liquidation that reduces Twitter’s capability of producing final goods and services in return for a cost savings. It’s not much different from Twitter shutting down one of its server farms — Twitter loses some capabilities, but it saves the cost of operating the server farm, including the carrying cost of owning the servers.

In one important way, however, laying off employees is very different from shutting down a server farm, and it leads to a pernicious temptation for the people running the company: The value of the server farm is tracked by the company’s accounting system, but the value of the human capital is not. Thus the loss of value from laying off skilled employees doesn’t have an immediate effect on the balance sheet. This makes the savings from layoffs look like free money when in reality it has a high cost.

Since taking over Twitter, Elon Musk has terminated thousands of employees, and I think it’s fair to say that in doing so, he has destroyed hundreds of millions of dollars — if not billions of dollars — worth of Twitter assets in the form of human capital.

That’s not necessarily a bad thing, if the human capital assets would serve no purpose. If Elon Musk’s grand plan for Twitter doesn’t require the capabilities provided by all that human capital, then it’s not really capital at all because it wouldn’t help produce anything Twitter can sell. It’s no great loss. Or rather, it’s a loss of capital value that has already occurred, and Elon Musk is just trying to capture the savings.

But…does it really seem like Elon Musk is doing anything from a plan?