Facebook is really pushing the limits to explore the boundaries of the privacy versus targeted advertising efficiency tradeoff. As I talked about before (see here and here), Facebook has a lot of data about its users that in theory allows them to target more appropriate ads to people, which makes Facebook’s platform valuable to advertisers. However, more aggressive use of the data probably requires a reduction in privacy, which people might care about. So Facebook’s tradeoff is to increase its efficiency to advertisers, versus making its users upset. This is a very interesting non-price aspect of its business and obviously no one really knows where the optimal solution lies, so Facebook’s been experimenting a bit lately.

At the bleeding edge of the privacy/matching efficiency frontier right now is Facebook’s ‘Beacon’ service, which links Facebook to online retailing partners. It seems to work like this: When you go to a partner retail site, the site checks for a Facebook cookie on your computer to see if you’ve got a Facebook profile. If so, data about what you purchase gets sent to Facebook and referenced to your Facebook profile. Thus Facebook gets more interesting data about the preferences of its members, which allows them to target ads ever more efficiently in future. In addition to this, things that you purchase may be displayed on your Facebook profile for your friends to see, unless you tell Facebook not to do that. This gives extra publicity to products and might generate extra sales if people tend to buy what their friends also buy.

As documented in this post on the NY Times Bits blog, the Beacon service has been evolving quite a lot lately. It seems that people aren’t too keen about having their purchases displayed on their profile (a number of potentially embarrassing products come to mind …). It’ll be interesting to see how this evolves in terms of how much revenue it generates for Facebook from advertisers or retailers versus how much it annoys their users. To my mind, it’s one thing for Facebook to know what I’m buying and use that data to show certain ads to me, but it’s quite another thing for Facebook to tell my friends about what I’ve been buying. I’m sure that people who are more paranoid about privacy than me can think of many more bad scenarios about what could happen to this data.

Relatedly, Tim Harford wonders if Facebook is doomed because it’s becoming too annoying. These latest developments have me wondering the same thing. It’s really not that hard for people to switch to an alternative social networking site. Sure it’s a pain to set up your profile again and add your friends, but if Facebook tramples its users’ privacy too much, I expect to see a competitor with a higher default level of privacy emerge and take users away from Facebook. Exponential growth doesn’t last forever. Let me finish with a graph: