Facebook and the economics of a public good

In the 18th century, when the South Sea bubble was inflating, one company raised money through a prospectus that said “the purpose of which investment, me hearties, will be reveal'd in the fullness of time”. But such was the mania that people went ahead and invested anyway.

I am reminded of that company after reading the sort of things that have been written about Facebook's IPO of $5 billion. No one, after all, seems to agree on what Facebook actually is, or is offering. Yet the money is pouring in.

Facebook, I hasten to say, is not part of a bubble. It is a very real and solid company. It will do its investors proud.

Even so, when someone asked me if economics offered any explanations to the Facebook phenomenon, I had a long and hard think. Eventually, I think, I found an answer.

Meum and teum

As an object for economic analysis, Facebook comes as close as possible to a public good. In economics a public good has the three characteristics shown in the accompanying diagram.

The marginal cost of producing it is zero. This means an additional unit of it costs nothing to produce.

Second, there is enough for everyone. Thus, when the army fights off an enemy, the defence it provides me does not reduce the defence it provides you. Same-same for justice, etc.

Third, there is what is called ‘non-excludability' which means you can't prevent anyone from consuming it. It is not a right or an entitlement both of which are typically granted by the State. It is simply there.

One may ask: If the marginal cost is zero, why does Facebook need the IPO? The answer lies in improvement.

If you want a better justice system, or a better army, you need to spend some money. The point is not an increase in output but enhancing the efficiency of existing output.

One may also ask: Is there enough of Facebook for everyone? And I may answer: Isn't there? If someone else uses Facebook, does he or she reduce my consumption of it?

Finally, the ill-informed will ask, in barely concealed triumph, what about non-excludability? After all, people can, and are, indeed barred from it.

Actually, no. What is barred is an electronic identity. If I create a new one, I can come right back on it. So there, dummy.

A unique public good

But you can justly ask: what has all this got to do with brands? Simply this: all this would be of no use if Facebook was a monopoly, which it is not. Facebook does have substitutes. So as products go, it must be treated as a brand.

This follows from my formulation on (see Brandonomics column Are Authors Basically Brands? in BrandLine edition dated January 26, 2012) where I had said that in order for something to become a brand, substitutes must exist. The real question, therefore, is this: Why does it have such a disproportionate share of the market?

Usually when there are three or four competitors, the market leader has a maximum of about 45 per cent share. But Facebook probably has 95 per cent, which is unprecedented in any market. Indeed, it is almost a monopoly.

This is what makes it so absolutely unique. It has become a public good in all but name. It is unique because it is provided neither by nature (air) or the State (defence or justice).

Its strengths is minimising not just intermediation but also its costs. That, precisely, is what advertisers are seeking to do.

That is what the State should also do, instead of gagging it.

(T. C. A. Srinivasa-Raghavan is Senior Associate Editor, Business Line).

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