Network Effects and N Sided Markets
Three major factors: The Long Tail, Network Effects and Attention scarcity underpin the Network Economy. These factors combine to fundamentally alter the theories of economy that have generally been accepted since the industrial revolution.
Network Effects in mathematical terms is the expontential explosion of transmitted data, information and knowledge that is created by human interaction with the internet. There are various types of networks present on the net. There are physical networks and various offline networks that link online to become the virtual networks that create the Network Economy.
Image of network economy (network economy, n.d.)
Physical networks of a multitude of computers networked together via the telephone network, cables, radio signals or even power lines. Each computer has a unique IP (Internet Protocol) address that identifies it to all other computers on the network and ensures that data sent from one computer to another makes it to the right address each time. Information is sent as packets that are routed via the fastest route then re-assembled by the receiving computer. TCP (Transmission Control Protocol)/IP protocols are the technology that enables data to be moved around the network in the most effective manner.
However, whilst these dumb machines facilitate network effects they are not by themselves responsible for role networks play in the Network Economy. Inevitably it is networks of people who create the "effect". There are vast networks of Suppliers, Producers, Customers, standard coalitions and techonolgy cooperation networks, (Rifkin, 2001) and perhaps many more. All of these types of networks existed - albeit to a lesser degree - prior to the interent, so what is new about them now that has fundamentally altered the way commerce is conducted?
The combination of the SPEED in which INFORMATION can be sent, the REACH of the internet and the interconnectedness of virtual and "real" human networks is the key to understanding the effect networks have on the economy. Information may be termed "useful" data and might consist of a price list of goods, a notification of delivery, a review of a service provided, in short any data that is deemed useful by both sender and receipient. Groups of geographically and culturally people transmit this information - or knowledge - to other members of their network who may send it to members of their networks etc creating an exponential explosion of information around the globe. Businesses who are able to harness network effects harness the exponential power of them that will elevate their potential revenues beyond the traditional linear effect of economies of scale.
The Long Tail Effect [need to write} about how the hits are just as important as the misses and how the network economy has effectively overturned Pareto's 80/20 rule. It is now as profitable to sell the bottom of 80% of desired products as it is to sell the top 20% because network effects create enough of a market (it only takes a few consumers each from the thousands of linked networks that exist).
Network Effects compound the Long Tail Effect in a networked economy to overturn general rules about scarcity and value. Traditionally the more units of a good or service produced, less desirable and therefore less valuable it will be to consumers. In a networked economy the reverse is true. The more people who access the good or service the more valuable it becomes (Kelly, 1997).
The secret is to capture and retain the scarcist good of all - attention. The proliferation and availability of information on the internet means a business who cannot draw eyeballs to their "shop" cannot hope to sell their wares.
Network Effects
Direct
Simples, increased use of a system increases its value e.g. Skype, the more people who have Skype, the more valuable it became to the Mango group.
Indirect
The more a product is used the more attractive it becomes for suppliers to produce complementary goods (value adding).
Cross-network (two sided effects)
Increased use by one group of users can increase the value of the complementary products/services to another group. E.g. Hardware/software relationships.
Social network effects (local networks)
A user is directly influenced by other users within his/her social network. IM is an example.
Demand-side
Users bring other users to the market, social networking flow on. Means the entire network becomes more valuable as usage rises which is the opposite of physical networks that rely on economies of scale to decreasing prices of goods as usage rises.
Characteristics of digital economies:
- High up front costs but negligible incremental costs
- Potential for exponential growth by harnessing positive network effects
- Online networks are created more quickly than offline, more frequently and are more interactive than offline (the many-to-many) web 2.0 business model innovation.
- Online networks can spread more rapidly and are less hindered by geography than offline
- Barriers to entry are lower than ever and barriers to success are low compared to offline economies.
N-Sided Markets
A traditional market consists of two groups; buyers and sellers. Markets that connect two or more groups have been dubbed “N-sided” markets by economists with n referring to the number of different groups.
