41126-piy-ch05-01.pdf_18891

41126-piy-ch05-01.pd - CHAPTER 5 Understanding Network Effects 1 INTRODUCTION LEARNING OBJECTIVES After studying this section you should be able to

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network effects When the value of a product or service increases as its number of users expands. Also known as network externalities or Metcalfe’s Law. CHAPTER 5 Understanding Network Effects 1. INTRODUCTION LEARNING OBJECTIVES After studying this section you should be able to: 1. Define network effects. 2. Recognize products and services that are subject to network effects. 3. Understand the factors that add value to products and services subject to 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 lever- aging 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 ex- ample, 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, net- work 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 net- work 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 that buy and sell stock over the NASDAQ, or the sum total of hardware and outlets that support the BS 1363 electrical standard. KEY TAKEAWAY < Network effects are among the most powerful strategic resources that can be created by technology- based innovation. Many category-dominating organizations owe their success to network effects, including Microsoft, Apple, NASDAQ, eBay, Facebook, and Visa. Network effects are also behind the establishment of most standards, including Blu-ray DVD, WiFi, and Bluetooth.
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This note was uploaded on 02/02/2012 for the course BMGT 301 taught by Professor Wang during the Spring '08 term at Maryland.

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41126-piy-ch05-01.pd - CHAPTER 5 Understanding Network Effects 1 INTRODUCTION LEARNING OBJECTIVES After studying this section you should be able to

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