In the space of barely a week, News Corp has sold its great white hope for internet profits (MySpace, for $US35 million), bought a niche advertising site directed at young parents (KidSpot for $A45 million). Meanwhile Google has announced a challenge to Facebook with Google+. What will this mean to Facebook? Probably not very much.

While MySpace was embarrassing the business was almost certainly doomed before News actually bought it, just nobody realised it. Way back in 2007, not long after Facebook had started its international expansion, this column noted, “while the mainstream media has well and truly caught onto to the success of the MySpace website, the leading social networking site is in danger of losing its crown, with Facebook, its prettier, more functional competitor rapidly gaining market share”.

The problem MySpace always had was that it wasn’t a well-designed product. Even back in 2007, when MySpace had triple the number of visitors as Facebook, its dominance appeared tenuous. Facebook’s other advantage was its early exclusivity, giving membership an immediate value. Initially, Facebook was used only by Ivy League college students, before being opened to more students and eventually, in 2006, to everyone.

So the logical question arises, as posed by Stilgherrian in Crikey last Friday, if Facebook was able comprehensively destroy MySpace, will the same happen to Facebook? Especially against the might of Google.

The answer? Probably not.

Facebook, more than almost any other company, is a beneficiary of a global “network effect”. A network effect will occur when the effect on a user of a product or service is improved as more people use it. The telephone is a perfect example — the more people who have phones, the more benefit everyone gets (if only one person has a phone, it’s completely useless). As a social network, Facebook derives almost all its value from the fact that it is the social network.

In fact, most of the leading internet companies have cemented their positions due to network effects. Many of the best internet businesses are in effect, lists that have become dominant because people use them. Companies such as Seek, Realestate.com, Craig’s List or eBay are merely lists of products or services being offered for sale. (KidSpot, which NewsCorp bought last week for $45 million, is another example.)  The companies are extraordinarily valuable because users trust that these lists are comprehensive. That encourages more people to advertise on the list, and the virtuous cycle continues. (Not all internet businesses survive on the network effect, with Google and Groupon being two fairly significant exceptions).

So why didn’t the network effect help MySpace? Largely because it never reached a satisfactory level of ubiquity. As noted in 2007, while Facebook was used by college kids, MySpace was “home for Latino and Hispanic teens, immigrant teens” as well as “other kids who didn’t play into the dominant high school popularity paradigm”. (Those users have less value to advertisers than say, someone looking for a mortgage on Google.) Plus, MySpace was clunky, poorly designed and provided minimal utility to users, especially when compared with Facebook. Many users of Facebook would never use MySpace, so it is arguable the two weren’t even direct competitors.

Because Facebook has achieved such a strong network effect, it will be exceptionally difficult for business, even a far more profitable company such as Google, to muscle in on Facebook’s market dominance. Most people, especially those under the age of 30, are already using Facebook. They would need a very significant incentive to stop using Facebook and start using Google+. Further, a new social network needs a large number of users initially, otherwise, it’s a bit like trying to hold a party in an empty room. Why would anyone stop using a social network that all their friends use, to start using a social network that none of their friends use?

But for all Facebook’s dominance, that is yet to transfer into significant profitability. Facebook’s key area for potential profit is Google’s own turf, targeted search. Currently, most of Facebook’s profits come from relatively untargeted banner/text advertisements. Unlike Google, which earns revenue from Adwords, that is, advertisements that are tailored to what users are actually searching for.

Figures released in January suggested that Facebook could earn about $US1 billion this year, compared with Google, which made $US8.5 billion last year and is the eighth most valuable company in America.

Of course, if Facebook are able to muscle into search, then Google has a real competitor on its hands. Which explains the attempt at Google+.

Peter Fray

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Peter Fray
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