Facebook makes money on selling connections
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How Facebook REALLY Makes Billions From Your Data
Network effect disrupting business models across industries, explains UC Davis professor

During his recent Congressional testimony, Facebook CEO Mark Zuckerberg fielded more than 600 questions about the company’s data sharing scandal. His answer to one of those questions lit up social media with memes, parody videos and commentary: 

“How do you sustain a business model in which users don’t pay for your service?” Senator Orin Hatch asked.

Zuckerberg: “Senator, we run ads.”

True, however the underlying business model has fueled Facebook’s ability to build a global audience that allows ad revenue to grow exponentially. Neither Facebook nor it’s brethren of the five most popular and best-performing tech firms—Apple, Amazon, Netflix and Google, coined the FAANGs—were platform company when they launched.

Today the platform model drives these firms and unlocks trillions of dollars in sales.

PLATFORM ECONOMICS

Platforms like Facebook connect users through value-added features and connected network. Over time that network grows organically. The firms then leverage that network by delivering scores of potential customers, explains Professor Hemant Bhargava of the UC Davis Graduate School of Management. The process involves massive speed, scale and simplicity, and technologies that are typically free to consumers.

For decades, Bhargava has tracked this trend and shared what he’s learned in his courses at the UC Davis Graduate School of Management. Platform economics is “one of the most exciting things happening in the world of business and more broadly in the world, and in society and our economy,” he said in his recent “Conversation on Platforms” at the UC Davis Institute for Transportation Studies.

“It’s one of the most exciting things happening in the world of biz and more broadly in the world and in society and our economy.”

THE NETWORK EFFECT OF PLATFORMS

Before the current era of platform economics, customers interested in a mortgage would go to a bank. For auto coverage, they connected with an insurance company. For a credit score, it was one of three reporting agencies. Then Credit Karma came in.

When it launched in 2007, Credit Karma had a singular goal: free credit reports for all. It collected a few details about its customers, purchased their information from credit agencies and delivered that to inboxes. In his talk, Bhargava pointed to Credit Karma as an example because after about five years the company had millions of customers and decided to make a strategic pivot. It adopted a platform business model.

“With the web coming in in the ‘90s it was massive but still dwarfed by what’s happened in the last 10 years.”

Credit Karma is now in the business of suggesting financial products to consumers. It acts as an intermediary, brokering deals with outside merchants for a fee—often without delivering a single credit report.  

This is called a network effect, which Bhargava began teaching his MBA course about 14 years ago, well before it became a buzz word in tech.

The network effect is enriching the products customers care most about. Like Google Search, PayPal or eBay, it is often free to use, explained Bhargava. Behind the curtain, however, the platform architecture is building businesses. Execution is easier said than done. It has played out in many of Silicon Valley’s successes and failures.

“For every one of these,” said Bhargava, “there are 15 or 20 that have tried and failed.”

The dot-com boom and bust two decades ago was small potatoes compared to today’s growth. The FAANG quintet has become the epitome of growth stocks, with steadily expanding revenue and earnings.

“With the web coming in the 1990s it was massive,” Bhargava said, “but still dwarfed by what’s happened in the last 10 years.”

TECH CONNECTS SUPPLY AND DEMAND

When a large event releases crowds looking for a ride, traditional taxi companies—bounded by decades-old rules and strategies and a long process to get a new license—struggle with ramping up their fleets to match the sudden demand. But a company like Uber, through its technology, a network effect and a certain management structure, can respond with a swift bump in the supply of drivers incentivized by higher rates, Bhargava said in his talk.

“Imagine if you could rapidly take pieces in and out and rapidly build your world in a way that you can really quickly and costlessly move things in and out,” he said. “That’s an Uber or a Lyft.”

Such companies are built on the strength of their network and their back-end velocity.

“The idea is to create an equal system of players with whom together you can create mutually beneficial relationships.”

POWER OF SYMBIOTIC COMMUNITIES

The software company Atlassian began with $10,000 on a credit card in 2002 and in 2017 was valued at $11.5 billion, with millions of users. Its network effect: open source code.

By lifting the curtain to reveal all its machinery, Atlassian soon had thousands of external developers improving its product for their own businesses, says Bhargava. The company saved on hiring costs and could offer a continually refined product to its software users at the other end of its model.

“Now businesses using their software are looking not just at the product they put out, but the army of developers they have engaged outside the firm,” said Bhargava. “The idea is to create an equal system of players with whom together you can create mutually beneficial relationships.”

Bhargava pointed out that Apple in the 1990s deployed strategies that damaged their ecosystem of developers, plunging its personal computer market share to just three percent. Since then, it has grown into the second most popular smartphone vendor in the world for more than five years, largely because outside parties have developed three million apps for its iOS operating system.

Companies with traditional business models are following suit, rethinking how they engage with their customers through their platform and rediscovering the communities they have built.

Bhargava has studied its growth from the earliest days: “This is the platform business revolution.”