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Lecture - Network Effects & Strategy

Lecture - Network Effects & Strategy - BMGT 301...

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Prof. Don Riley Farris & Pfeifer. “ Almost everything I need to know about .. ..” Brian Arthur. “ Increasing Returns and the New World of Business ”. BMGT 301 INTRODUCTION TO INFORMATION SYSTEMS • “Traditional Economy” • Leverages physical assets • Supply-side economies of scale • Characteristics of physical assets? • Diminishing returns to scale • e.g., land, labor. • Industries in the traditional economy • Competitive (Oligopoly or Perfect competition). •“New Economy” • Knowledge/Information & Technology Intensive • Network Effects (Demand-Side Economies of Scale) • Increasing returns to scale. ! More units produced -> lower cost per unit ! manufacturing efficiencies from scale ! learning by doing ! Examples ! Automobiles, Coke, plastic, paper,… ! PC’s, consumer electronics ! Diminishing effect after a certain level ! GM has a market cap of 11 bn. Today? ! Microsoft has a market cap of 280 bn. ! Where factors drive Microsoft’s dominance/size?
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! More units consumed –> higher value per unit ! Network effects, network externalities ,... ! Network product: product that displays significant network externalities number of users value to each user Linkages can be physical or virtual Direct Network Effects Product is for person-to-person communication telephone, fax machine, email, Instant Messenger Output/information needs to be shared across users • Excel, Word, PowerPoint Value relies on the volume of user-generated content WWW, online communities Value depends on number of sellers/buyers Trading Exchanges Indirect Network Effects •Value depends on the quality and variety of complementary assets • Ferrari (Service) • Windows (Applications); PS3/XBox (Games Devp.) • Blue-Ray/HD-DVD (Movies Formatted) ! Metcalfe’s Law: The value of the network goes up as the square of the users! ! If the number of users (nodes) in a network is ‘n’, ! The value of the network to each user is proportional to the number of other users. ! The total value of the network (to all users) is proportional to n x (n-1). If each user gets a value of $1 from every other user in the network: ! A network of size 10 has a total value of ~ $100 ! A network of size 100 has a total value of ~ $10,000 A 10-fold increase in size leads to a 100-fold increase in value!
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