4: Network effects Flashcards
network effect:
- 2 alternative economic names
- Def
- Law
- Law name, in what context
-
network externality or
demand-side economies of scale - def: effect that 1 user of a good/service has on other users
- Value(network) ~= #edges ~= N^2
where N is the Nr of nodes - Metcalfe law invented it in the context of old ethernets
positive VS negative network effects: examples
- positive: each new facebook user adds a tiny bit value (=potentially interacting) for all other users
- negative: each situation of network congestion
supply side economies of scale
VS
demand side economies of scale
w volume increasing, the production costs go down due to:
- better tools
- more negotiating power w suppliers
- running process
- …
VS
(positive) network effect = each user adds value for other users
==> producers must consider this and try to profit from this, too
- resource-based economy: returns & costs
VS
- network effect: returns & costs
- conseq.
- marginal returns of resources are decreasing, while costs are increasing, therefore you can calculate the optimum production quantity
VS
- w positive network effects, returns increase w increasing Nr of users, even though costs increase, too; if returns increase faster than costs, than the optimal Nr of users is infinite!
- ==> winner-takes-it-all markets, eg 2-sided markets: it is optimal for both buyers & sellers to have just 1 market in every region
goods / service & markets:
1 consideration for both
1 differential consideration
- the type of good / service determines whether the optimal market is global or local
- services tend to have local markets
complementary goods game
- =def
- where attractive
- 3 IT examples
- availability of complementary goods makes good more attractive
- large installed base attracts producers of complementary goods
- eg.
- iTune songs & iPods,
- android phones & apps,
- Windows & compatible SW applications
interoperability & standard games:
3 types of actors
+ what economic effect is being used
should you make your standards compatible or non-compatible with competitors?
- Apple –> non-compatible strategy: use only Apple products & SW together
- MS –> compatible with all else
- regulators also play!
+ these are games with network effects!
customer facing analytics based on customer data:
example
goal
how is it made
e.g. recommender systems
–> create network effects for users
–> simple algos, but new data that adds value
bandwagon effect:
def
usage
def: the more ppl do something, the more want to… trend/hype!
usage: marketing
2 particular features of network economics
w examples
- push towards mono- or oligopoly
- path dependence ==> early choices limit your future options due to building up switching costs, e.g. in setting standards: many small decisions add up over time to a standard,
- driving on left or right, or
- VHS winning thanks to allowing porn
why are standards sometimes suboptimal?
–> 2 conseqs., 1 example
If tech A has lower initial value than tech B, even though its value increases much faster w Nr of users; but the lockin happens at a Nr of users lower than the crossover value, then tech B becomes the standard
–> big barrier for new entrants
–> Cos must build up their user base & complementary goods very fast
eg Google launched Android by pre-sending out phones to developers and also w million$ prizes for best apps
Network economics: 2 managerial conseqs.
(1 branching into 7 = 2-3 + 2 + 2)
- engineer network effects in your products
- 2-3 social:*
- connect w your customers via user forums –> powerful organization form
- recommender systems –> user data
- (bandwagon effect <– not sustainable except in fashion)
- 2 market-based:*
- market place / platform
- complementary goods
- 2 openness-based:*
- API
- interoperability
- watch for the critical mass –> there are tipping points, very difficult to identify, where value to users becomes greater than cost
