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CHAPTER 6: Understanding Network Effects

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Brian Zohn

on 11 December 2012

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Transcript of CHAPTER 6: Understanding Network Effects

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Images from Shutterstock.com Network Effects Perfected Facebook allows for social interaction of people through visual images, videos, and self-depicting blog entries and shares. Each time one user joins Facebook, all 1 billion pre-existing Facebook users have the new opportunity to connect with that user allowing for the possibility of another 1 billion connections. Types of Markets Network Effects
Explained and Beyond Crash Course on Critical Mass!
by Brian Zohn, bbzohn@gmail.com One-sided Market: a system that derives its value from a single class of users
Two- sided Market: network with two distinct groups that both need to add value tot he network
Same-side exchange benefits: benefits that arrive from the interaction/exchange of a single-class of users
Cross-side exchange benefits- when an increase in one side of users facilitates for the increase in the other side of users.
Total Cost of Ownership (TCO)-economic measure of total cost of owning a product
Complementary benefits- products or services that add value additional value to the primary product or service that makes up the network
Platforms- products and services that allow for the development and integration of softwatre and other complementary products. Metcalfe's Law When the value of a product becomes more valuable, the more number of users you have interacting with the system, also known as "Metcalfe's Law" or "Network Externalities". One of the first recognized working network effects came from the creation of the telephone pole network by Theodore Vail. The diagram illustrates that with an increase of just one more user you can have an additional 100, 1000, 10,000, or 100,000 more connection depending on the size of your existing network. While Facebook may coddle your darkest social stalking needs, there is another site that has leveraged the idea of a network to an unprecedented level. Craigslist.com has become one of the few buy/sell/trade site moguls. At 60 million page views each month in the USA, 50 billion each month in the world, supported by 13 different languages, and only 30 some odd staff workers handling 200 million user postings in 100 topical forms. Craigslist has exploited the benefits of their network effect far beyond many other trade sites. What makes them so successful? Two sided market: markets comprised of distinct categories of users, both of which are needed to deliver value for the network to work Industry Example In the video game industry Xbox and Playstation design their consoles understanding what great games can be made for their system. Conversely, video game designers design such great games because they know the system they are writing code for is going to sell in the market. If neither of these two agents believe in the system, or themselves, than the effect cannot work. Staying Power Network Effects innately produce what is considered staying power; a product with a high staying power has a long term viability. Switching Costs These costs are incurred when a consumer decides to change from one firm's product to a competitors *High switching costs allow for companies to have strong staying power as well.

Companies looking to facilitate a network effect will be able to leverage it's power much easier with high switching costs. Video Game Markets The earliest Network Effects... Complementary Benefits
Industry Example Due to the high volume amount of videos being uploaded to YouTube, camera companies are now including in their manuals "YouTube Upload" sections. Platform Industry Example Technology industry leader, Apple, has designed it's iPhone software to allow developers build applications on their platform. This is a mutually beneficial in many software situations Monopoly- a market where there are many buyers but only one supplier Examples of Monopolies One company, Monsanto, has been sued hundreds of time for acting as a monopoly. At any given moment they handle 70-100% of American seed. Others sued for monopolistic activitie.... -National Football League
-Microsoft
-De Beers
-U.S. Steel
-Standard Oil Oligopoly- a market occupied by a small number of a few buyers Oligopolies usually hold a majority of one industry. For example, music record giants Sony, Warner, Universal, and EMI provide over 85% of music sold in the US. Examples... Technological Leapfrogging When technological innovaters design something so profound they leapfrog past industry leaders. Their new technology becomes the new paradigm for tech in that industry. Photovaltic solar power has completely replaced 99% of energy uses in Rizhao, China. Competition with Network Effects Established network effects are difficult to compete with some strategies are... Move early Subsidize product adoption Leverage viral promotion Expand by redefining the market place and the categories of users Form alliances and partnerships Establish distribution channels Seed the market with complements Encourage the development of complementary goods Maintain backward compatibility Blue Ocean Strategy Firms will attempt to compete under a blue ocean strategy, or a space or environment has largely been uncontested....
vs
...what is called "blood-red water" where sharks of highly competitive firm vie for every available market space. Vocabulary: Convergence: when two or more markets begin to offer features and capabilities; the markets for phones and media players are converging Envelopment: when one market attempts to conquer another market by making it a subset, feature, or add-on of it's primary offering Backward Compatibility: the ability to take advantage of complementary products developed for a prior generation of technology Adapter: a product that allows a firm to tap into the complementary products, data, or user base of another service or product Congestion effects: when a product or services experiences failure due to increasing number of users lowering the value of the product "The Osborne Effect" Caution: Software, and other companies, must make careful decisions about how and when they want to release their new products.
Example: Computer company Osborne Computers prematurely announced the release of their new product.
Results: began witnessing sinking sales Reasons: Customers opted out of purchasing the current model with their sights on waiting for the new model to arrive or v perceiving better quality competitor products and prices.
Solution: Align business marketing and sales goals with R & D/tech development. YouTube Wikipedia Which product/service has the better network effect and why? 4 billion videos viewed a day
800 million unique views a month
a trillion page views every month
39 countries, 54 languages
500 tweets per minute w/ a youtube link 23 million articles on Wikipedia
100,000 active contributors with in 285 languages
365 million readers worldwide
2.7 billion pages view from America Is the amount of users and number of visits on a websitde the most important thing about having a powerful network effect?
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