Facebook’s Secret War on Switching Costs

When the FTC filed its amended antitrust complaint against Facebook in mid-August, we read it with interest. FTC Chair Lina Khan rose to fame with a seminal analysis of the monopolistic tactics of Amazon, another Big Tech giant, when she was just a law student, and we anticipated that the amended complaint would make a compelling case that Facebook had violated antitrust law.

Much of the coverage of the complaint focused on the new material defining “personal social networking” as a “relevant market” and making the case that Facebook dominated that market thanks to conduct banned under the antitrust laws. Because the court threw out the FTC’s previous complaint for failing to lay out Facebook’s monopoly status in sufficient detail, the new material is important to keep the case going. But as consequential as that market-defining work is, we want to highlight another aspect of the complaint – one that deals directly with the questions of what kinds of systems promote competition and what kinds of systems reduce it.

When antitrust enforcers and scholars theorize about Big Tech, they inevitably home in on “network effects.” A system is said to benefit from “network effects” when its value increases as more people use it – people join Facebook to hang out with the people who’ve already joined Facebook. Once new people join Facebook, they, in turn, become a reason for other people to join Facebook.

Network effects are real, and you can’t understand the history of networked computers without an appreciation for them. Famously, Bob Metcalfe, the inventor of Ethernet networking, coined “Metcalfe’s Law”: “the value of a telecommunications network is proportional to the square of the number of connected users of the system (n2).” That is, every time you add a new user to a network you double the number of ways that users can connect with one another.

But while network effects are a good predictor of whether a service will get big, they can’t explain why it stays big. 

Cheap printers might entice many people to buy a printer for home, and incentivize many retailers to carry ink and paper, and encourage businesses and schools to require home printouts, but why would printer owners shell out big bucks for ink when there’s lots of companies making cheap cartridges?

Apple’s App Store might be a great way to find reliable apps (incentivizing people to buy iPhones, and incentivizing programmers to make apps for those iPhone owners), but why continue to shop there once you’ve found the apps you want, rather than dealing directly with the app’s makers, who might give you a discount because they no longer have to cut Apple in for a 30% commission?

And Facebook is full of people whose company you enjoy, but if you don’t like its ads, its surveillance, its deceptive practices, or its moderation policies, why not leave Facebook and find a better platform (or run your own), while continuing to send and receive messages from the communities, friends and customers who haven’t left Facebook (yet)? 

Short answer? Because you can’t. 

Big Printer periodically downgrades your printer with “security updates” that prevent it from using third party cartridges. Apple uses legal and technical countermeasures to stop you from running apps unless you buy them through its store. And Facebook uses all-out warfare and deceptive smear campaigns to stop anyone from connecting their tools to its platform.

Software locks, API restrictions, legal threats, forced downgrades and more – these are why Big Tech stays big. 

Collectively, these are a way to create high “switching costs” and high switching costs are the way to protect the dividends from network effects – to get big and stay big.

Switching costs are how economists refer to all the things you have to give up to switch between products or services. Leaving Facebook might cost you access to people who share your rare disease, or the final messages sent by a dying friend, or your business’s customers, or your creative audience, or your extended family. By blocking interoperability, Facebook ensures that participating in those relationships and holding onto those memories means subjecting yourself to its policies.

Back to the FTC’s amended complaint. In several places, the FTC investigators cite internal Facebook communications in which engineers and executives plotted to increase switching costs in order to make it harder for dissatisfied users to switch to a better, rival service. These examples, which we reproduce below, are significant in several ways:

1. They show that the FTC is thinking about the practice of engineering in switching costs as anticompetitive and subject to antitrust scrutiny.
2. They show that Facebook understands that it owes its success to both strong network effects and high switching costs, and that losing the latter could undo the former;
3. They suggest that interoperability, which lowers switching costs and keeps them low, should be seen as an important tool in the antitrust enforcement toolbox, whether through legislation or as part of litigation settlements.

Here’s some examples of Facebookers discussing switching costs, from the FTC’s amended complaint.

Paragraph 87: Facebook Mergers and Acquisitions department emails Mark Zuckerberg to make the case for buying a company with a successful mobile social media strategy: “imo, photos (along with comprehensive/smart contacts and unified messaging) is perhaps one of the most important ways we can make switching costs very high for users – if we are where all users’ photos reside because the upoading [sic] (mobile and web), editing, organizing, and sharing features are best in class, will be very tough for a user to switch if they can’t take those photos and associated data/comments with them.” [emphasis added]

Here, Zuckerberg’s executives are proposing that if Facebook could entice people to lock up their family photos inside Facebook’s silo, Facebook could make confiscating those pictures a punishment for disloyal users who switched platforms.

Paragraphs 144/145: A Facebook engineer discusses the plan to reduce interoperability selectively, based on whether a Facebook app developer might help people use rivals to its own projects. “[S]o we are literally going to group apps into buckets based on how scared we are of them and give them different APIs? How do we ever hope to document this? Put a link at the top of the page that says ‘Going to be building a messenger app? Click here to filter out the APIs we won’t let you use!’ And what if an app adds a feature that moves them from 2 to 1? Shit just breaks? And a messaging app can’t use Facebook login? So the message is, “if you’re going to compete with us at all, make sure you don’t integrate with us at all.’? I am just dumbfounded..[T]hat feels unethical somehow, but I’m having difficulty explaining how.  It just makes me feel like a bad person.” 

Paragraph 187: A Facebook executive describes how switching costs are preventing Google’s “Google+” service from gaining users: “[P]eople who are big fans of G+ are having a hard time convincing their friends to participate because 1/there isn’t [sic] yet a meaningful differentiator from Facebook and 2/ switching costs would be high due to friend density on Facebook.” [emphasis added]

Finally, in paragraph 212, the FTC summarizes the ways that switching costs constitute an illegitimate means for Facebook to maintain its dominance: “In addition to facing these network effects, a potential entrant in personal social networking services would also have to overcome the high switching costs faced by users. Over time, users of Facebook’s and other personal social networks build more connections and develop a history of posts and shared experiences, which they cannot easily transfer to another personal social networking provider.  Further, these switching costs can increase over time—a “ratchet effect”—as each user’s collection of content and connections, and investment of effort in building each, continually builds with use of the service.” [emphasis added]

And, the FTC says, Facebook knows it:

Facebook has long recognized that users’ switching costs increase as users invest more time in, and post more content to, a personal social networking service. For example, in January 2012, a Facebook executive wrote to Mr. Zuckerberg: ‘one of the most important ways we can make switching costs very high for users – if we are where all users’ photos reside . . . will be very tough for a user to switch if they can’t take those photos and associated data/comments with them.’ Facebook’s increase in photo and video content per user thus provides another indication that the switching costs that protect Facebook’s monopoly power remain significant.” [emphasis added]

Network effects are how you get users. Switching costs are how you hold them hostage. The FTC Facebook complaint makes it clear that antitrust regulators have wised up to this phenomenon, and not a moment too soon.