Metcalfe’s law states that the value or
utility of a network is proportional to the number of users of the network. At
one time, Metcalfe indicated that utility was a square function (utility = n2).
For example, a phone network with 10 people has a utility of 100 and a network
with 100 people has a utility value of 10,000. He has since scaled that back
and the utility of a network is based on a log function (utility = n× log (n)).
Thus, for a 100-user network, this would translate to utility = 100 × 2 = 200
or 200 utility units. The equation is not the important issue. It is the idea
that if you have more people using a phone, a fax, railroad, a Web 2.0
application or whatever, your network will become more attractive and attract
even more users. Consider the choice to go with a local cable TV network or a
satellite TV network. If individuals take into account what network other
people are choosing, then there is a network externality or a network effect
that influences the decision. In the economics literature, a network effect
typically refers to a change in the positive benefit that a consumer receives
from a good, when the number of consumers of the good increases. 15 Network
effects are not limited to phone, wireless, and telecommunications networks.
They can also include the following:
• Transportation networks such as roads,
railroads, and flight paths.
• Communication systems such as the
postal service, express mail services, and pony express.
• Communication media such as books,
printed materials, schools, and universities, because they disseminate ideas
and knowledge and those ideas have greater utility.
• Social networks involving a social
structure between individuals or organizations with similar interests. They
include political, cultural, religious, sports clubs, social clubs, volunteer
groups, family, friends, industry trade groups, and market segments. Facebook,
Twitter, and Web 2.0 social-networking applications.
Economists also talk about network
failures. That is a situation where the technology or network selected is not
the best technology, thus leading consumers and business down a path that is
not optimum. In reality, consumers are often very aware of the trade-offs in
performance that exists between competing technologies. Take the case of the
success of the VHS recording format over the Beta format. The success of VHS is
often touted as an example of network failure. The picture quality of the VHS
format was, in fact, reasonably close to the quality of the Beta format. 16 In
addition, the VHS tapes had a greater capacity and cost less than the Beta
tapes. It was not a failure of the market to recognize the superiority of Beta;
it was rather that consumers revealed their preferences for certain features by
purchasing the VHS format. The best of all worlds is when the stars are aligned
properly and an organization can realize network effects and take advantage of
Moore’s law by increasing the performance of a product while reducing or
maintain costs. The net result is to spur hyper growth in the diffusion and
sales of a product or service.
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