LN8_Network_Effects - MGCR 331 Information Systems...

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MGCR 331 – Information Systems (“IT Impacts on Organizations”) Lecture Note 8 – IT Economics: Network Effects (This study note was mainly excerpted from Gallaugher’s Understanding Network Effects and Information Rules ) LEARNING OBJECTIVES 1. Define network effects. 2. Understand positive feedback and demand-side economies of scale. 3. Recognize products and services that are subject to network effects. 4. Understand the factors that add value to products and services subject to network effects. 5. Identify the three primary sources of value for network effects. 6. Distinguish between one-sided and two-sided markets. 7. Understand how competition in markets with network effects are different from competition in traditional markets. 8. Identify the strategies for competing in markets with network effects. 9. Understand the tradeoff between performance and compatibility. U 1. Introduction 1.1 Network effects Network effects are sometimes referred to as Metcalfe’s Law, or Network Externalities. But don’t let the dull names fool you—this concept is rocket fuel for technology firms. Bill Gates leveraged network effects to turn Windows and Office into virtual monopolies, and in the process, became the wealthiest man in America. Mark Zuckerberg of Facebook, Pierre Omidiyar of eBay, Caterina Fake and Stewart Butterfield of Flickr, Kevin Rose of Digg, Evan Williams and Biz Stone of Twitter, Chris DeWolfe and Tom Anderson– the MySpace guys—all of these entrepreneurs have built massive user bases by leveraging the concept. When network effects are present, the value of a product or service increases as the number of users grows. More simply, more users = more value . Of course, most products aren’t subject to network effects—you probably don’t care if someone wears the same socks, uses the same pancake syrup, or buys the same trash bags as you. But when network effects are present they’re among the most important reasons you’ll pick one product or service over another. You may care very much, for example, if others are part of your social network, if your video game console is popular, if the Wikipedia article you’re referencing has had prior readers. And all those folks who bought HD-DVD players sure were bummed when the rest of the world declared Blu-ray the winner. In each of these examples, network effects are at work. Not That Kind of Network The term ‘network’ sometimes stumps people when first learning about network effects. In this context, a network doesn’t refer to the physical wires or wireless systems that connect pieces of electronics. It just refers to a common user base that is able to communicate and share with one another. So Facebook users make up a network. So do owners of Blu-ray DVD players, traders 1
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that buy and sell stock over the NASDAQ, or the sum total of hardware and outlets that support the BS 1363 electrical standard. Network effects are responsible for the dominance of many products and services that support
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LN8_Network_Effects - MGCR 331 Information Systems...

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