What Edge Does Facebook Still Have?

While The Social Network was a fictional take on the rise of Mark Zuckerberg and the development of Facebook (Nasdaq: FB  ) , it did encapsulate some of the defining reasons that Facebook beat other primitive social networks. Take this dialogue between founder Eduardo Saverin, and Mark:

EDUARDO: It would be exclusive.
MARK: You’d have to know the people on the site to get past your own page.

Back when Facebook started, you had to be invited in. You had to have an email address from a college. It not only helped guarantee real users, which Facebook recently has had problems with, but also cultivated a desire to be on Facebook.

In addition, Facebook lacked ads at that point. Here’s another exchange from the movie between Eduardo, Mark, and Napster founder Sean Parker:

EDUARDO: Mark…
MARK: Are you going to talk about ads again?
EDUARDO: Unless you’re the Ballet Theatre of Hartford, the purpose of a business is to make a profit.
later in the scene…
EDUARDO: Settle an argument for us, would you? I say it’s time to start making money from theFacebook, but Mark doesn’t want any advertising. Who’s right?
SEAN: Neither of you yet. TheFacebook is cool, that’s what it’s got going for it.
MARK: Yeah.
SEAN: You don’t want to ruin it with ads because ads aren’t cool.
MARK: Exactly.

Obviously, Facebook dropped its exclusivity in favor of a larger user base, and had to start selling ads to make money, but has this move opened up Facebook to new competition? And, now that Facebook has lost its cool, what edge does Facebook keep over potential competitors?

Its network?
Usually, Facebook’s competitive advantage is said to be its network effect. That is, the more people who use the service, the more valuable that service to its users. This is the same advantage that eBay (Nasdaq: EBAY  ) , Microsoft (Nasdaq: MSFT  ) , and Apple (NYSE: AAPL  ) have. For eBay, which added over 2 million users in the recent quarter for a total of 104 million, more users means more potential buyers, and more potential sellers for each user. Additionally, in its PayPal business, the more companies that accept PayPal, the more convenient for those looking to pay with it.

Microsoft, with its stranglehold on the PC market, became the standard in business. The more people who used Microsoft programs, like Office, the easier it was to collaborate with the same file types. The more that people used Windows, the more other programmers wanted to build for it. This is also the same thing that's happened for Apple with its App Store. The more iPhones and iPads sold, the more developers want to build for the iOS platform to access those users. It also helps Apple that for every $1 an iOS developer earns, a Google Play developer receives $0.23, according to mobile analytics firm Flurry.

But network effects can also work in reverse. That is, the addition of more users for an exclusive network takes away the exclusivity. For Facebook, did the addition of the original users’ parents and grandparents and, eventually, children, kill its network effect? Probably not immediately but, for the newest generation, will they continue to join the same social network that their parents are on? Do your children listen to Frank Sinatra, the Beatles, or Pink Floyd?

The illusory competitive advantage
On the other hand, is it that hard to amass hundreds of millions of users for a free web-based service? Take a look at Pinterest, a photo-sharing site, which, after two years, has 10.4 million users. Facebook only had 6 million users two years after it began. Or, take a look at Instagram, a mobile photo-sharing app, that not even two years after launching, now claims over 80 million users. And, Instagram added roughly 10 million users per month over the last three months.

It seems that Facebook knows of its vulnerability, as it is in the process of acquiring Instagram. But what if the founders of the next explosive startup refuse an offer from Facebook? It’s as if Facebook has now become the Microsoft of social networking, and hopes to use its massive size to acquire smaller competitors and sit on the fact that they’re the largest player. One major difference, however, is that Microsoft makes about $123 in revenue per PC sold according to analysis by Asymco, and Facebook doesn’t charge anything for its service. And, there is a large switching cost for Microsoft users, whereas Facebook users just have to sign up with another service.

Sorry Eduardo
While it’ll be a tough slog for any Facebook competitor, the younger generation is going to need a more exclusive network, and there will be plenty of entrepreneurs looking to provide one. For a deeper look at Facebook’s opportunities and key areas that you must watch, check out our brand-new premium research report. Find out more here.

Fool contributor Dan Newman owns shares of eBay. He holds no position in any of the other above companies. Follow him @TMFHelloNewman.

The Motley Fool owns shares of Microsoft, Facebook, and Apple.
Motley Fool newsletter services have recommended buying shares of eBay, Facebook, Apple, and Microsoft. Motley Fool newsletter services have recommended creating a bull call spread position in Microsoft. Motley Fool newsletter services have recommended creating a bull call spread position in Apple. The Motley Fool has a disclosure policy. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. Try any of our Foolish newsletter services free for 30 days. 


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