Why Zynga Should Worry About the Laffer Curve

It used to be trendy to compare the size of Facebook to the size of countries. That’s gotten boring lately—at 400 million users, Facebook is ahead of the US, and only behind India and China. But population size is not the only thing Facebook has in common with governments—they also have the same business model. Both Facebook and governments can profit from letting people do business with their constituents, and taxing away some fraction of their profits.

In the case of the US, India, or China, that tax rate is determined by all sorts of lobbying, voting, personalities, and compromises. In Facebook’s case, they can collect taxes by forcing companies to use Facebook Credits. It’s just a question of maximizing profits. And that means taxing companies that profit from Facebook at the peak of a slightly modified Laffer Curve.

The Laffer Curve normally describes government revenues compared to marginal tax rates. It’s a curve because, given a sufficiently high tax rate, the incentive to work, report income, or live in a particular country declines. This leads to the argument that lower taxes are net beneficial: if we’re past the peak, they’ll raise government revenue, but even if we’re not, they can produce economic growth.

Facebook doesn’t have to care about “economic growth.” Their goal is not to grow the companies that exist on their platform, just to profit as much as possible from them. It might seem that this implies taxing at the Laffer maximum, but that’s not quite true: Facebook can afford to maximize the net present value of their future income, and to set their tax rate accordingly.

In practice, that will mean low (or zero) taxes as long as a company using Facebook’s platform is still growing. But once their growth slows, it shifts the Laffer curve to the point that taxing them more produces extra income even if it slows down their growth (and discourages other companies from using Facebook’s platform).

Since Facebook can easily prevent tax evasion, and since corporations have a fiduciary duty not to be lazy, the only mechanism by which the Laffer Curve can operate is emigration: at some point, Zynga could theoretically decide that Facebook isn’t worth it; they’ll take their bigger slice of a smaller pie elsewhere. I’m not sure what it costs Zynga to move one person from Facebook to a non-Facebook platform for the same game, but it’s probably a painfully high number when you multiply it by, say, the 82 million active users of Farmville. This might also explain why Facebook is okay with stickiness—it’s bad for business, but good for keeping existing business from going elsewhere.

Taxation or Nationalization?

Fred Wilson argues that Twitter can be free to ‘fill in the holes’ in their experience, but not to go after new verticals. In the Laffer context, the question is not which features a platform will duplicate and which it won’t, but which features it will tax and which it will expropriate instead.

Facebook, and more recently Twitter, have also done a form of “nationalization”: they turn someone else’s product into a feature of their own product. This seems to work best when the product works as a feature, and doesn’t have a clear monetary value: the classic example being Internet Explorer and Netscape Navigator; soon after IE came out, selling a computer and charging for the browser would have made as much sense as selling a car and charging for the steering wheel.

The “features they should have had” versus “value-added extras” dichotomy is false. The real question is which is worth more: taxing a platform user at the Laffer maximum, or subsuming them in order to shift the Laffer curve in a more profitable direction. At first, this sounds like an academic distinction—but it implies that the more people make money with Facebook apps, the more desirable it is to nationalize rather than tax other apps: Zynga’s $300 million in revenue is worth taxing; but if Zynga produced $1 billion in revenue, it could easily be worth giving up the chance to tax other companies, in order to make it easier to tax that billion dollars at a higher rate.

Twitter isn’t monetizing in the same way, but they do face the same equation. In their case, they’ve nationalized more, but it’s easy to see where they could start taxing instead. If you’ve looked at many financial sites that monetize through ad networks, you’ve seen who can bid the most for finance-related ad space: penny-stock promoters. That’s why Stocktwits has been so successful: it culls the spam. If Twitter sells ad space to the highest bidder, Stocktwits will get spam, and it’ll be official spam, too. A nasty outcome, but possible (though Stocktwits has mitigated this risk by building their own non-Twitter income sources, and their own independent platform; more than anyone else, they’ve figured out how to launch from someone’s platform, without being anchored to it.)

Why To Stay Bullish

Thanks to the power of Metcalfe’s law, squared, platforms have an incentive to encourage new applications, and to make them rewarding. Like a country that encourages people to start small businesses, these platforms will get more activity without having to try very hard.

So for small startups, this is irrelevant: they don’t have enough of an income for it to be worth Facebook’s time to determine the optimal tax rate, and they’ll produce more taxable income if they grow fast. Once a company hits the saturation point, though, there’s little reason for Facebook to let them earn excess profits. Sure, it will discourage VCs from funding some companies on Facebook’s platform, since they won’t be able to participate in quite so giant an IPO. On the other hand, the independent programmers who put together a simple app over a couple weekends won’t be too discouraged; Facebook is likely to tax only when it’s already fantastically profitable.

And even companies like Zynga won’t be left behind. There’s still no cheaper source for new users. Converting a small fraction of them from one platform to another is still easier than trying to get them to start out on the Zynga platform itself. Meanwhile, it makes a $25 billion market cap sound a bit more believable.


Steganographic Typo-Based URL Shorteners: Add a Link With Zero New Characters

Watch out, j.mp! Back off, tinyarro.ws. You can shorten a URL down to zero characters by steganographically embedding it into the text. Think of it this way: how many potential typos could be autocorrected for a given sentence? You’ve got the off-by-one errors, like “typ[“, the random capitalization errors (“tYpo”), transpositions (“tyop”), and full-word off-by-ones (“yu[p”). The word “typo” alone has:

  • 24 off-by-one-character potential typos.
  • 9 random capitalization errors (discard all-caps and capitalize first letters).
  • 3 transpositions.
  • 6 full-word off-by-one errors.

This gives you 42 unique ways to misspell typo, and in all cases it’s fairly easy to determine that the original word was “typo.”

What I’d like to propose is a service that uses typos to encode URLs. You visit a site, input your tweet and URL, and get, as an output, a tweet with a strategically insert typo (or typos). Someone who sees this tweet can input the text into the site, and get the URL that’s mapped to that particular set of typos.

Imagine! Instead of reading something lame and garbled like:

@ev this is a neat microblogging service: http://bit.ly/xE2sK

You could say something clean and space-saving, like:

@ev yjod iS a neta micRolbohhing sevriCe:

Don’t think of it as transmitting 140 characters at a time—think of it as transmitting 1140 bits—meaning there are far, far more potential unique tweets than there are atoms in the universe.

(Note: I have no interest in implementing a steganographic URL shortener, but it might be an interesting exercise. It’s probably possible to have an effectively infinite number of embedable URLs without making things unreadable. Maybe adding some backend analytics could tell you which typos result in a click-through and which don’t. If anyone does anything like this, please let me know.)


Twitter is Overhyped—Which is Why It Will Succeed

In April, I decided Yelp would Make It. They’re growing fast (like lots of companies that tank), they’re offering a fun product (like about half a dozen competitors in their own industry), and their users love them (like, oh, everybody). But what Yelp did in April was simpler: they hired Cuil’s former PR guy. Cuil pulled off the PR coup of the decade when they managed to get portrayed as the Next Big Thing for about a week.

That’s the kind of advertising you can’t buy. Which is why it’s too bad they didn’t get their money’s worth. Google deflated the announcement by beating Cuil’s numbers, and talking numbers down. But what really killed Cuil is that you can’t build anything on it. When you’re looking at platforms to build something on, the most overhyped is likely to win. Read the rest of this entry »


Metcalfe Was a Pessimist

The value of a network grows at roughly the square of the growth rate of the users. That makes sense for telephone networks—add one more user to a network, and the number of new connections available goes up by the number of existing users.

Classically, this breaks down because the first people to add it get the most out of it. Maybe a phone was crucial for the first few people to use it—but the next phone sold today is probably going to replace an old phone, replace borrowing somebody else’s phone, or complement an existing Skype connection.

But Metcalfe’s law can break in the opposite direction, and I think we’re seing that in social media. In fact, I think we’ll see a lot more of it. Read the rest of this entry »