Eli Dourado

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.