Broken Symmetry

Externalities and Semi-closed Platforms

Jason Calacanis warns companies away from the Facebook platform because of the uncertainties associated with how Facebook will share revenue with third-party application developers.

I don't disagree with many of the points he makes.  There is considerable uncertainty at this point as to how exactly revenue will be shared, what metrics will be used, and so on.  And there is no doubt that the companies that can successfully generate their own user base will monetize those users at higher margins than the companies that must rely on Facebook for customer acquisition and distribution.  That's the deal.

Rather I want to point out that Jason seems to ignore an important class of potential economic benefits for users that can be achieved by a semi-closed platform.  These benefts may enlarge the economic pie enough so that the deal is still better than what companies could achieve by monetizing at higher margins (with a smaller user base).

As I have eluded to in an earlier post, Facebook as a semi-closed platform promises to solve some of the collective action problems associated with user-generated content on the Internet.  Facebook is mostly spam free because it is a semi-closed platform.  An analogy is that Facebook:books what the open Internet:magazines.  We can expect to see a better valuable content/page ratio (and hence more users and more time-spent) on Facebook because it is a semi-closed platform.

What does the Facebook News Feed have to do with the Price System?

In The Road to Serfdom, F.A. Hayek observes that the price system:

enables entrepreneurs, by watching the movement of comparatively few prices, as an engineer watches the hands of a few dials, to adjust their activities to those of their fellows

Hayek probably has the train engineer in mind, trains seeming a favorite source of examples for mid-20th century economists.  The point is that divisions of labor, which permit more fine-grained and complicated activities within an institution (or the economy at large), require quicker feedback, which the price system permits.  This key strength of the price system is achieved through its compact representation of aggregated information about value.

But the compactness of price information also creates a key weakeness:  price collapses the measurement of value, which in general might have as many independent dimensions as the number of market participants, into a single dimension.  The price system thus tends to work best in markets where the measurements of value have lower dimensionality -- i.e., where different market participants are more likely to measure value using similar input data, with similar means for processing that input.

The price system and its single dimension is at one end of a spectrum with the bartering system at the other.  In the bartering system, there is no aggregation of information about value, and hence no information is lost in the collapse of the real multi-dimensional phenomenon of value into the artificial, single dimension of price.  The bartering system works poorly, however, when the goods are "lower-dimensional" in how their value is measured by market participants.  The extra transactions costs (of time) associated with the bartering system are hardly worth the information preserved.  For example, every holder of wheat does not have a unique perspective on how much wheat (much less that particular grain of wheat) is worth.  Yet something like the opposite is true of transactions involving human capital, such as the market for a potential spouse.

What if there were a more multi-dimensional means for aggregating information about value?  What would that look like?  My suggestion is that it would look something like the Facebook News Feed.

For non-Facebook users, the Facebook News Feed provides status updates and links to multimedia that provide new information about your friends on Facebook.  New information about myself that I add to my profile is automatically pushed out to all my friends, usually showing up as a single line on their News Feed.  Now the value of a friendship with me must be among the most difficult things to measure in a single-dimension.  Yet the value of my friendship, like the value of wheat, is going to depend in part on how many others are offering you the chance to know someone like me.  If all of your friends love to go kite surfing, you may be indifferent to whether I too enjoy kite surfing.  On the other hand, if it turns out that I'm your only friend who shares your taste in medieval English legal history, we may be spending more time together soon.

Notice how the Facebook News Feed falls somewhere in between a pure barter system and a pure price system.  Unlike a pure barter system, I don't have to transact bilaterally with everyone who might be interested in what I have to offer.  Unlike a pure price system, I don't have to submit to my value being collapsed into an almost inarticulate number.

Notice also how the News Feed system requires market participants to internalize the positive and negative effects of their status updates.  For example, by posting photos of yourself at a party, you may get more party invitations, but fewer job offers.  This is how the News Feed is distinct in an important from other social networks, such as Wikipedia.  Professor Sunstein had an insightful post related to this about six months ago.

Now what if instead of collecting information about the relative value of various friends, the news feed collected information about the relative value of various projects within a large organization, or the relative value of different programs within government?