I'm not Afraid of Facebook

A lot of pixels have been spilled in the last week about how Facebook has seized control of the Internet with their new API initiatives. This is supposedly troubling: unlike Google, Facebook might be evil, the hand-wringers say. But even if Facebook is able to monopolize a large segment of our time on the Internet, I’m not worried. I have one simple reason: social networking is a network industry (seems obvious, no?).

Let me preface my argument by reiterating that there is a lot about Facebook that I don’t like. I hate the “walled garden” approach, and would prefer that decentralized protocols like those used in Google Buzz take off. I’m not a cheerleader for Facebook or its strategy by any means. Nevertheless, I don’t think Internet users have much to fear.

The way to start thinking about network effects is to think about fax machines. A fax machine is absolutely useless if you are the only one who has one. It’s only when other people have fax machines that they become useful. A fall in the price of fax machines has two effects. First, it will induce people to buy more fax machines—this is the ordinary demand effect of moving along the demand curve. Second, because people are buying more fax machines, fax machines become more useful, which increases demand for fax machines—the demand curve shifts out, amplifying the effect of the price drop on quantity. Since the effect is amplified, the true demand curve, the one that takes this into account, is very “flat” or elastic.

Facebook accounts are like fax machines—they are only useful if other people have them. There is the same positive feedback effect of price on quantity. As a thought experiment, imagine that Facebook started charging $10/month for access. My intuition is that many people get more than $10/month of value out of Facebook, and therefore would be willing to pay the fee. However, a lot of marginal users would drop the service. The fact that a lot of users would drop the service would make Facebook less useful to those people who remained; they may no longer get $10/month worth of value out of Facebook if half their friends weren’t on it any more.

I’m not suggesting that Facebook is going to start charging a fee for access. But nevertheless, elastic demand plays a role in how it relates to its users. For instance, one way of cashing in on the service’s popularity would be to plaster it with interstitial ads. This would be kind of like charging a “price” for the service. Why doesn’t Facebook do this? Elastic demand. And elastic demand places limits on the amount of “evil” that Facebook can do, or at least the amount of wealth it can transfer from its users to itself.

Finally, think about network effects and monopoly. Goods and services that exhibit network effects are going to tend toward monopoly (at least if the network effect applies to the good or service directly, and not the protocol, as with fax machines). We should not be surprised that Facebook is becoming huge; if it wasn’t huge, something else would be huge. That’s just how these industries work. But with very elastic demand, having lots of users doesn’t translate into a large monopoly rent. And meanwhile, Google has a strong incentive to ensure that the Facebook tax is not very high.

So my advice is stop worrying and enjoy your consumer surplus. Facebook is not good or evil—it is profit-oriented and faces a serious demand constraint due to the nature of its own product.

3 replies to “I'm not Afraid of Facebook

  1. Jeffrey Horn

    A most excellent rational analysis of facebook. Indeed, network goods are far more sensitive to user base concerns. I was tempted in a conversation earlier this evening to suggest Google should attempt to satisfy the average customer instead of the marginal customer, since doing so would expand its customer base. I was discussing with a friend the constraints facing the search giant when implementing its social search tools. It’s quite alarming to learn just how much Google knows about your reading habits, and who you talk to. But I’m confident my data won’t be misused.

    I do think, however, that facebook could get away with more advertising and a higher “fee” for its service. I suspect most people are immune to ads, or at least so used to seeing them it doesn’t bother their user experience. I’m a fan of advertising within desktop programs for this reason. I don’t care whether or not I see an ad in my twitter client as long as I get something that makes shortening links and viewing pictures easier, and so long as it’s free.

    But, I doubt there are serious reasons for worrying about the abuse of your personal data. Everyone I meet gives me data about them every time they open their mouth. No one has stopped talking yet.

  2. Wei Dai

    Facebook knows a lot about its users, and presumably could do a pretty good job of inferring what each user would be willing to pay for its services. It doesn’t have to charge the same amount for everyone (and thereby drive away a lot of marginal users).

    I’m not sure whether we should be afraid of Facebook or not, but it seems like a more sophisticated analysis is needed to answer the question.

  3. Eli Post author

    The price discrimination argument is a good one. I think that any price above zero would drive away some users. So Facebook’s optimal pricing strategy is probably to charge nothing to light or low-value users and some positive fee to it’s heavy or high-value users. Again, this fee can be implicit such as privacy violations.

    However, I think that if marginal users observe the “abuse” of inframarginal users, the marginal users will be wary of becoming inframarginal ones. They might preemptively quit the service. The network *could* still unravel.

    I think that the fact that social networking has network externalities still constrains Facebook, even if the simple model in the post does not cover every possibility. You are correct that a more sophisticated analysis would give more texture to the claim, but I don’t think that means that looking at the simple case is useless.

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