Why Lock-In and Switching Costs are More Substantial at LinkedIn than Facebook

Network effects exist when the value per user rises as the number of users increases.   In a situation where strong network effects exist, we often see high switching costs and a lock-in effect.  Take eBay, for example.  Why has eBay remained so dominant for so long in the online auction market?   Well, compare the value per user at eBay to the potential value per user at a startup that might challenge them.   Users place a high value on eBay because the existence of many fellow buyers and sellers makes it likely that they can find someone with whom they can engage in a mutually beneficial transaction.   They would have a much harder time making that match on a new auction site with  a limited number of users.  For that reason, the network effects create switching costs for users, and a lock-in effect emerges.   That's all good news for an incumbent player with high market share, such as eBay.

Ok, so clearly LinkedIn and Facebook benefit from strong network effects.  Does that mean that they will remain as dominant for as long as eBay has in the auction market?  I would argue that Facebook and LinkedIn face quite different levels of switching costs and lock-in effects.   Consider the cost of switching from Facebook to Instagram or Twitter.  What's keeping you on Facebook?  Well, it's probably that circle of fairly close friends and relatives with whom you keep up to date and exchange photos and messages via the social network.  Suppose that a critical mass of that small circle of friends defects from Facebook to another social network such as Snapchat or Twitter.  Would it be costly for you to switch as well?   Well, as long as a critical mass of friends has left, then your switching costs are rather low.  Yes, you have other acquaintances who might still be on Facebook, but are they really going to keep you there?  Perhaps not. 

Now compare Facebook to LinkedIn.  What's keeping you from potentially switching from LinkedIn to another prospective professional social network?   You should recognize rather quickly that your small circle of close friends is not what is keeping you on LinkedIn.  Instead, you derive value from a much wider range of users on LinkedIn.  Many of those folks are not people with whom you communicate often.  They might be former classmates, co-workers, and the like.  They are people with whom you share weaker ties, but maintaining a connection to them has potential value to you professionally.  Now suppose that a few close friends defect from LinkedIn. Would you consider defecting?  Well, the problem, of course, is that all those acquaintances and former associates remain on LinkedIn.    In short, the switching costs are higher on LinkedIn.  The lock-in effect is stronger.   You would be much more reluctant to abandon that expansive "rolodex" that LinkedIn has become for you professionally.  

Why the discussion today about LinkedIn vs. Facebook?   Consider the latest news from an iStrategyLabs report.  It found that the number of Facebook users ages 13-17 have declined by 25% in the past three years.  The number of users ages 18-24 has declined by 7.5%.   These young user defections show that Facebook's lock-in effect may not be as strong as people once thought.  We've seen the story before of a social network losing traction; remember MySpace?  I'm not saying that Facebook will face that fate, but it's worth noting that network effects don't guarantee that an incumbent will remain on top forever. 

Are Network Effects Over-rated?

Nir Eyal and Sangeet Paul Choudary have written an absolutely terrific column for TechCrunch about network effects.  The essay is titled, "The Network Effect Isn't Good Enough."  Network effects, of course, exist when the value per user rises as the number of users of a particular good or service rises.  When network effects are strong, one firm can become the standard in a market - think eBay in auctions, for instance.  In these situations, firms tend to try to "get big fast" so as to move up the curve and achieve a high value per user.  Then they hope that switching costs will lock users into their good or service.    Eyal and Choudary point out that many startups in Silicon Valley bank heavily on the notion of network effects.  They willingly run up huge losses in the early years, hoping to cover those losses with venture money.  Then they hope to reap the rewards when they have become the dominant player in their particular market. 

The authors point out, however, that network effects may not be the elixir that many startups believe they will be.  Why?  The authors make several key points.  Here is an excerpt from their argument:

For one, in the old days, consumers paid to access the network through their upfront investment in hardware. These upfront costs locked users into the network and once they were in, they were in for good, thus erecting barriers to entry for would-be competitors. However, the cost of providing access to the network has fallen precipitously. The days of customers buying expensive hardware to use a network are gone as is the correlating lock-in effect. In addition to access costs falling to zero, another key component of what once kept users locked into a network has vanished. Once, porting contacts onto a new network, like switching instant messaging services from Yahoo! to AIM, was a non-trivial task. Today however, customers use their Facebook, Twitter or Google profiles to join a new service in seconds. A burgeoning network, take Instagram or Pinterest, can leverage the single sign-on enabled by the social graph to reach critical mass faster than ever before.

In other words, switching costs may not be nearly as high as many startups believe them to be.  Thus, the lock-in effect doesn't materialize as hoped.  Consumers flock to a platform, but then they may just as quickly move on to a different product or service.   Think MySpace relative to Facebook.   This limitation on switching costs may explain why many startups have a hard time "monetizing" their eyeballs.  If they try to extract more value from their consumer, they face the startling possibility that people will simply switch to another product or service.