Posts Tagged: economics

Thoughts — 16 Comments
13
Feb 07

Facebook Gifts: Pushing the limits of rationality

A few days ago, Facebook introduced gifts, a cute little feature that enables you to sends “gifts” to a fellow Facebook friend. The gifts are little icons, and the sending of a gift is broadcast to the friend’s network via feed (there is explicit publicness in this gifting). The gifts are cute, the gift-giving process is simple, and generally I like this feature – well, except for one thing.

First, a little background on Facebook’s strategy. Micropaying for virtual items is precedented in a number of online services. In the Korean social network Cyworld, individuals can (and do) purchase various accoutrements for their minihomes. In Second Life, an entire virtual economy of goods producers and buyers exists, as SL netizens purchase things like clothes, accessories or land. Facebook is obviously following these trends with the addition of gifts, though they differ in a key area.

In Cyworld and SL, virtual commodities are persistent and explicitly tied to identity. In SL, if you buy a cool shirt, you get to wear it. In Cyworld, if you buy neat wallpaper for your minihome, it stays there and makes your house look better. In Facebook, the value tied to the transaction is less identity-centric. First, you are explicitly buying the gift for another person, and this gift simply shows up in their profile as a received gift. In the other services, you were investing money in yourself, your appearance, your persona. In Facebook, the value you get from gift-giving is that one-time feeling (hey, we all love giving gifts, so I can’t fault Facebook) that doesn’t exactly last (i.e. you still love that awesome shirt you bought two years ago, but do you really feel good about the gift you gave your mom 9 months ago?).

Simply, motivation for micropayments are different between services. In the SL and Cyworld model, the motivations are built on very sound logic. People like to buy stuff for themselves that makes them look cool. Since online identity is primarily about the representation of self, people will pay to differentiate themselves. In Facebook, you’re buying a gift for someone else, so you’re getting that one-time rush. This rush is great, but it doesn’t last. It is actually a completely different value proposition. And sure, if you give out a lot of gifts, you get to make an identity statement about how generous you are – but I worry that it will be interpreted as “I’m someone with lots of dollars to waste.”

And that gets us to the crux of the problem – the price of Facebook gifts. The price of Facebook gifts are one dollar, an arbitrary amount set by FB. What else on the internet costs a dollar? For one, an iTunes song costs a dollar. A Flickr membership costs two of these dollars a month. A ringtone costs two of these dollars. The comparison? All of these goods hold actual value. Facebook gifts do not hold the same value as these goods.

And this is what gets us to rationality. Yes, we tried to throw away the rational-consumer model of economics a long time ago, especially in the luxury and incidental goods category. However, people are used to getting value for their dollars. Facebook, by setting the price of these gifts at the ridiculously high price of a dollar, is stetting itself up to severely limit the growth of this product. And why? People rationally want value for their money. They want things. They want more than a one-time rush. And to that extent, I would expect to see interest in a system like gifts peak early, and then tail off rapidly. People will get tired of giving gifts, especially when the price is one dollar. College students are smarter than Facebook is giving them credit.

Of course, this doesn’t have to be how the story ends. Facebook can arbitrarily shift the price of their gifts, they can diversify pricing, they can make some gifts free and some gifts pay. Since gifts are nothing but profit, Facebook can slide the price and see exactly how much that one-time gift is worth to a consumer. Of course, this will look like a reversal on behalf of Facebook, a company who prides itself on never being wrong.

It doesn’t have to be so drastic, however. Rather than Facebook devaluing their gifts by setting the price at 10 or 15 cents, they should sell packs of gifts. I think a good price would be 25 gifts for 5 dollars. Facebook should use the text message model – not the iTunes model. And to that extent, gifts are much more like text messages than they are iTunes songs. With a text message, we know we’re only getting something temporal – much like a gift. And we’ll pay 10 or 15 cents accordingly. If Facebook gifts had any of the value of a song, we’d be willing to pay more. But they don’t, and we aren’t.

Thoughts — 13 Comments
12
Jul 06

The Network Effect Multiplier, or, Metcalfe’s Flaw

In valuing a social technology, it is impossible to avoid the enhancement in value the network provides. Stated quite simply, social technologies benefit from an economy that awards value to the service as more people join the service. This, of course, is the network effect; a network gains value as more people join the network.

The classic example of network effect is illustrated in Metcalfe’s law. In valuing a telecommunications network, Metcalfe speculated that the value of the network increased proportionally to the number of participants in the network. As a simple illustration, consider a telephone network with three participants. When the fourth participant joins that network, the value of the network increases for all participants in the networks. Odlyzoko and Tilly, in 2005, further refined Metcalfe when they illustrated that the value of a network doesn’t actually increase proportionally, but logarithmically. To illustrate this refinement, each addition to the network adds value, but in reality, more value is added when my relative joins than someone in Dubai. My patterns of connectivity cluster around my relatives, hence Odlyzoko’s and Tilly’s refinement.

Metcalfe’s law provides the groundwork for a substantial amount of applied network effect theory. One of the foremost applications of Metcalfe is to internet technology, particularly social network technologies. One can easily see the lineage that validates the application of Metcalfe – the internet is indeed a telecommunications network, and the value we perceive from additional entrants is visceral.

Getting to the point, Metcalfe’s law holds fundamentally, but the application of Metcalfe to a wide range of social internet technologies proves remarkably flawed. To illustrate: Metcalfe’s law is built on a core assumption that entrants to the network have a limited set of options. In the 1980’s, when someone joined a telephony network, they had but two options – use the phone or not use the phone. This binary calculation assured that whenever the phone was taken advantage of, the user was getting full value. Ethernet is another telling example; when you plug your computer into an ethernet network, the only options you’ve got are to accept packets or not accept packets. Either way, when you use the network, you’re getting full value.

This notion of “full value” makes the mathematics of network value calculation quite appealing. If everyone on the network gets the same value from using the technology (everyone has the same options – i.e. call or not call on the phone), then valuing the network is absolutely possible. When using Metcalfe (or Reed, or Odlyzoko and Tilly’s refinement) to value a network, the core assumption is that the value we derive from the network is binary – this works for things like ethernet and telephony, but the mathematics prove to be overly crude when applied to social network technologies.

I’ll try to illustrate a comparison. Indeed, Myspace’s network provides two options to you – you can either join or not join the network. If we wanted to apply Metcalfe to Myspace, this is where we’d stop. However, the value in Myspace is much more nuanced than simply being on the network; you can take value from the many things you can do on the network. The network offers a myriad of associations, including friending, grouping, messaging, browsing, stalking – actions that create a compound value that is unique for each network entrant. Indeed, each new entrant to Myspace offers others in the network the chance to create these relationships, but these many types of relationship create a value continuum – which is different than a value binary.

Therefore, the fundamental flaw in applying Metcalfe to social technology is its inherent lack of nuance and granularity. When people join the network, they are given more options than simply connecting; the network is worth the sum of associations and actions that are allowed in the network. We must instead think of network value in terms of a network effect multiplier, as the actual value a network adds to an application is under the direct control of the application designers.

Consider flickr. Flickr is a socially-enabled application built around photographs. Stripped of flickr’s social tools, the service would provide a core value to its users – it would be a very high quality image host and archive. This core value is the “real” economic value of the product; this theory is consistent because flickr users have proven willing to pay for their services. Indeed, the core value provided by flickr is important, but the core value alone is not flickr’s total value. Enter the network, and network effects. Flickr is a socially-enabled tool, allowing users to connect around photographs. The social actions that can be taken in flickr are fairly limited; comments, page views, connections, groups and pools – these are fairly “commodity” social tools (in a sense, all of the social actions are native to the users as they have been previously pioneered). This is lightweight social networking, with very low barriers of entry; the network effect is light as well. To understand the final value of flickr, we multiply the core value by the network effect value (the network effect multiplier).

As a contrast, consider Myspace. Myspace’s core value is quite low. When you log onto Myspace you get a profile, a message box that doesn’t interoperate with the rest of the world, some limited image hosting, etc. However, the network effects of Myspace are tremendous. The size of the network and myriad uses of the network create a network effect multiplier that is much greater than flickr’s. However, since the final value of the network is a function of the core value and the network effect, we see a balancing function.

This balancing function is the key to valuing social technologies. The core value is the raw economic value the service provides to the user. The telephone was useless without the network; however, a service like flickr, or even Myspace would provide value stand-alone. With the telephone, you only had two options when using the network – call or not-call. In flickr and Myspace, you literally have millions of ways to use the network, each with a different value outcome. The network adds value to flickr and Myspace, but the value it adds is distinctly more nuanced than what Metcalfe proposed – and the value the network adds is in the hands of the designers.

As social networking becomes commoditized, as more and more sites make social a part of their experience, the value-add of embracing social will need to be quantified. Metcalfe’s theory is absolutely valid in context, but the applications to social technology lack the nuance that will be required to quantify cash outlays. The good news is that quantifying the value of the network isn’t overly complex. We start with the core value of the service (the non-social value proposition), and the network effect multiplier. As the network effect multiplier is contingent on the site’s design, this can certainly be quantified. Network-enabling a product does not produce a binary value-add; some sites will add lightweight social networking to enhance a core value tool (flickr), whereas others will derive almost all of their value from the network (Myspace). The key to understanding this is knowing that the value provided by the network is variable, and the outcome value of the service is contingent on the core value and the network effect multiplier.

In thinking this through, I’ve tried to focus on the value of the network. However, divorcing the actions you can take in the network from the network’s value kept leading me back to my initial train of thought. The value of a social technology’s network simply can’t be divorced from what you do in the network – the actions you can take are deeply nuanced. We’ve matured from the binary assumption of communicate/not-communicate that network effect theory is built upon. Of course, Metcalfe’s core theory still holds for things like telephony and ethernet networks. However, humans are not computers; our actions, and the derived actions of network participation have variable values. The compound effect of our actions is the network effect multiplier. As we develop socially-enabled applications, consideration of this network effect multiplier will prove useful in determining the value of our labor.

I’m going to officially call this an idea in progress. I’m really struck by the potential value of articulating this properly. At this stage, I’m just at the beginning of doing so. Thoughts, comments and feedback are certainly welcome.

Thoughts — 4 Comments
17
May 06

Facebook’s Critical Success Factors

In the May 15 issue of the New Yorker, Facebook is profiled in a ten page article that features some insightful commentary by founder Mark Zuckerberg. Unfortunately, the article is not online – for those of us who spend too much time thinking about this stuff, it’s a good read and worth tracking down. A bit of the article deals with how Facebook got off the ground – how the site was developed and rolled out, eventually becoming one of the most visited sites on the internet. A big part of Facebook’s success was being in the right place at the right time, though as the article points out, Facebook had a number of competitors – they weren’t simply handed the keys to the castle. In preparation for a talk I’m giving this Friday, I figured it would be interesting to sit down and think about Facebook’s critical success factors. Zuckerberg rightly acknowledges that “gating” the networks was a huge factor in long-term success – but what were the things that brought in that initial audience and kept them coming back? Here’s my take on Facebook’s critical success factors, in a convenient list form.

  1. There was a huge market. Until that time, Social Networking Services (SNS) had largely been targeted and adopted by an older demographic. Friendster was largely popular with twentysomethings, not high school students. Whatsmore, in 2004, Friendster was on its downturn from the market, and Myspace was not the phenomenon it was today (in Summer 2005, a study I piloted found ~5% penetration from Myspace on campus). In 2004, a lot of us felt burned and a little jaded by SNS due to our Friendster experiences, but there was a whole enormous youth market segment that hadn’t had that experience, and Facebook captured it.
  2. The Experience was designed for college students, by college students. I’ll talk a little more about key features later on – but the fact this site was designed by members of the demographic it served is huge. The youth perspective informs every facet of the site; Zuckerberg’s decisions weren’t screened by a 27 year old product manager. In my last job, I managed extremely bright, extremely technical students for five years. These students taught me many things – including the need to keep my hands off of projects that motivated the students. Had Zuckerberg been answering to a 30 year old manager, or a 45 year old CEO, the site would have been different.
  3. Privacy. Beyond the market segment and the experiential aspects of the site, the fact Facebook walled networks was its most critical component. That the students could create their profiles for their audience (other students on their campus), and for their audience only created trust in the site. It also created behavior that made the site viral – students were incentivized to create profiles for each other, rather than for the world at large. As Zuckerberg notes in the New Yorker article, the privacy is largely false – but for most students, the privacy is good enough.
  4. Socioeconomic motives. People commonly cite the fact that Facebook was started at Harvard as a factor in its success – that these ivy league students proved tastemakers for the rest of the country. Sure, this may have been a slight motive very early in the rollout process, but I do not believe it is a critical factor. However, there are critical socioeconomic factors tied in to the Facebook. First, the class of student who uses the Facebook is a unique subset of the youth market. That is to say, they are the privileged class of youths who can attend a four-year college. The Facebook represented a place where they and their like friends could be found; I’m sure I can dig a study up where it shows that high school students of like socioeconomic and educational status cluster together. The Facebook allowed these like clusters to be transplanted virtually, into a members-only place. Compared to a Myspace or Friendster, where you’re forced into the pile with everyone else, this made the initial adoption of a SNS much easier for members of this socioeconomic class. As Facebook radiated outward, taking on colleges further down in US News rankings, it was a class effect that elevated the perceived status of membership, one that continues today.
  5. Features, and the Experience. That the Facebook was designed for students by students merited its own bullet on this list. However, there are a number of features Facebook incorporated that made the service sticky. Here are the most important
    • Feature – Organization by Classes. The Facebook allowed people to list their class schedules online, making them browsable. That is, if you’re in English 101, Section 9, you can browse all the other profiles of students in English 101, Section 9, as you sit in English 101, Section 9. Think about how powerful this is. The kid sitting next to you who you never talk to? You know his favorite bands, his interests, you’ve browsed his friends and realized you actually have friends in common. This was an incredibly important part of Facebook’s early success.
    • Feature – The Poke, or low-involvement communication. In Facebook, you can poke people. It means nothing and everything. There’s no documentation for the feature, but the students got it. The poke is a way to simply place yourself on someone else radar, and it quickly became culturally appropriate to poke. The poke is the precursor to full-duplex communication; for students trying to figure out who its OK to talk to and not, the poke is a low-involvement way to test these waters. Low-involvement communication is a key factor of Facebook, and it really makes sense in a situation where communication barriers are still being figured out.
    • Feature – Groups. Groups are a way to say everything or nothing about yourself. They’re a fun way to come together to represent part of your identity. Mostly, though, they just gave students another fun thing to browse endlessly – and you were rewarded for your wit (most group names are in-jokes).
    • Experience – Directory Services. The Facebook is a directory. As it turns out, students need that directory to figure out how to contact each other. The directory provided by their school? Not so good. A directory like Facebook? Invaluable.
    • Experience – Simplicity. The Facebook is a simple website. It uses common design features, uses text links for feature navigation, and the site is largely unobtrusive. This means that students could learn it fast. The site isn’t full of Ajax, there aren’t overly complicated functions, and the Facebook doesn’t try to design above anyone’s head.
    • Experience – Speed. Those of us who suffered through Friendster, and loathe browsing MySpace on Firefox know how important speed is. The Facebook has always been lightning fast – and that has helped their brand immensely. Lets face it, when we browse a social network we want to move around frequently and rapidly. We’re stumbling, not following an explicit path. Fast response enables this fun stumbling process, and the fact that Facebook has stayed consistently fast has left a very positive impression in users minds. Anyone working in the SNS space should keenly try to replicate Facebook’s successes in this area.

A couple of things to keep in mind. In making this list, I approached the question from a past perspective. I wanted to explore what worked for Facebook in 2004/2005 – factors that contribute to their success today. There’s no doubt that I’ve missed things, or that people have different opinions. Please leave a comment if you do. Readers should also note that Facebook hasn’t done everything perfectly – they’ve made mistakes like any other business. I’m just concentrating on their success factors, because I think it might be useful for those of us in the SNS space to think about. Again, feedback is welcome.

Thoughts — 14 Comments
25
Apr 06

Transience in Social Networks, or How to Beat MySpace and Facebook

Palopia, if nothing else, has done promotion right, earning a mention by Steve Rubel. Of the 100 or so Social Networking sites in existence, and the 1000 or so currently being incubated, the market is about to explode with a number of sites attempting to duplicate the success of MySpace and Facebook. To that extent, its a sexy proposition – the notion of being the next MySpace or Facebook – and the good news is, its certainly possible. Looking at Palopia, the strategy seems to be throwing features at the user; in my opinion, that’s not the winning strategy (primarily because its the strategy shared by 90% of the emerging social networks competition). So you wanna beat MySpace or Facebook? Here’s how you do it.

  1. Give up on the idea that you’re going to steal the eyeballs of MySpace’s audience with flash, professionalism, or better social networking. 98 percent of the people who use MySpace don’t realize they are using a social networking community. They are simply using a website that their friends are on – they are using it for the same reasons they use email or IM. The social networking aspects are practically moot – they are interested in the content (friends profiles) and goofing off. The SNC parts are completely secondary.
  2. A top-down play will only wash you out in the competition space. If you want to develop a social network, find a niche and exploit it. They key is you’ve got to find a niche that is situationally relevant. There are lots of people who want to explore social networks – people who have moved to new towns or neighborhoods, parents at schools, church patrons – they just don’t know it yet. And the key is to keep thinking about point 1 – people don’t really care about the SNC aspects, they just want a fun site where they can find their peer group.
  3. Be geolocal. Did you know there are a bunch of other Facebooks out there? And that in certain parts of the country, they are more popular than Facebook? Xuqa.com and Sconex each found relevant geolocals and created value (Sconex was purchased at the incredibly undervalued price of 6M). Sure, its not as sexy a proposition as being a national social network, but social networks aren’t national. They are local.
  4. Investing in better technology, sexier UI’s, more professional templates, etc. is not enough. Look at MySpace, which is one of the clunkiest experiences on the net. People will tolerate clunky user interfaces because they are used to them. Those 68 million people don’t care about Web 2.0, AJAX and XHTML. They are used to clunky webforms, slow connections and poorly designed HTML. MySpace wins by not shooting over their heads. Facebook, on the other hand, is simple, clean and understated. And the best part is it’s fast, and people love Facebook for that. Your sysadmin should be the highest paid person on your technical staff.
  5. Exploit a content area. Basically, find some content that people love and wrap a social network around it. This is a little tricky because it flips the notion of social networking on its head, however, this might be one of the easiest successes to pull off. There are lots of content areas on the net that are served poorly by old websites. Think about any community of practice, the endless forums and listservs on the net. A lot of these people could be better served by websites designed with their interest in mind. You build a website they like, wrap a lightweight social network around it, and you might have a winning proposition.

The emerging social networking sites will not succeed by chance; the notion of build it and they’ll come will fail miserably. The new social network winners will win because they have done their research, completely understand the market, and they’ve made a relevant play. MySpace and Facebook are closely researching the failings of past social networks, and investing heavily in the gut instincts that made their products winners. Waiting on them to stumble is not a business proposition.

It is key to remember that a horde of young people now understand the social network model of websites. This is why I scoff when people say that social network websites are a fad. Sure, people might become uncomfortable with information disclosure, but the young audience is now native with the underlying model. It isn’t going to go away. However, social networking will be commoditized as more and more sites integrate aspects. There may be a few more big social networks waiting to emerge, but I think these will be few and far between. Facebook started out with a niche, and they grew nationally.

Beating MySpace or Facebook is a tough proposition. They’ve got a head start, they have great employees, and they’ve managed growth successfully so far (three absolutely key business facets). What’s more, they have extremely passionate userbases, and they seem to understand their users. Beating them is not like beating Google, but as each day passes that gets a little bit closer to a reality. Will there be a bubble in social networks? Of course – because hundreds of extremely similar ideas will be funded, and the market can’t support this. Without question, though, social networks are here to stay; it will just take some genuinely creative thought to create value in the space.