Network Effects: So, Is It a Network Effect? (1 of 3) | Summary and Q&A

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March 29, 2019
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Network Effects: So, Is It a Network Effect? (1 of 3)

TL;DR

Network effects go beyond Metcalfe's law and are not solely dependent on the number of users, encompassing elements such as accumulating advantage and brand value.

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Key Insights

  • 👮 Metcalfe's law oversimplifies network effects, which go beyond the number of users.
  • 💁 Network effects can exist in various forms, including physical networks and data networks.
  • 🧑‍🏭 Other factors, such as accumulating advantage and brand value, contribute to network effects.
  • ❓ Brands can create a network effect through their ubiquity and consumer preferences.
  • ❓ The definition of network effects is subject to debate, as some argue for a broader or more narrow definition.
  • ⚖️ Scale effect companies, such as Amazon, benefit from economies of scale as they grow.
  • 🉐 Not all cumulative advantages are considered network effects.

Transcript

why don't we start what is a network effect and I think if most Silicon Valley people think about it they'll think about Bob Metcalfe the inventor of Ethernet who proposed that the value of communications network he was thinking about phones and fax machines and of course Ethernet is sort of the value of that network is the square of the number of ... Read More

Questions & Answers

Q: What is the classical definition of network effects?

The classical definition states that as a product or service gains more users, it becomes more valuable to existing users. This relationship is often represented by Metcalfe's law, which suggests that the value of a network is proportional to the square of the number of users.

Q: Are network effects solely dependent on the number of users?

No, network effects are more complex than just the number of users. Other factors, such as accumulating advantage and brand value, also contribute to the value and growth of a network.

Q: Can brand value be considered a network effect?

There is an ongoing debate about whether brand value qualifies as a network effect. Some argue that well-known brands can create a network effect by becoming the focal point for consumers, while others believe that brand value falls outside the traditional definition of network effects.

Q: How do accumulating advantages relate to network effects?

Accumulating advantages, such as economies of scale, can be present in network effects companies. However, while accumulating advantage is often a characteristic of network effects, not all cumulative advantages are considered network effects.

Summary

In this video, the concept of network effects is discussed, starting with the common understanding based on Metcalfe's law. However, it is argued that this definition is oversimplified and incorrect. The video then explores the subtleties and dynamics of network effects, highlighting additional factors beyond just the number of users. The conversation also touches upon different types of network effects, such as data network effects, and debates whether brand can be considered a network effect.

Questions & Answers

Q: What is the classical definition of network effect?

The classical definition of network effect is that as a product or service has more users, it becomes more valuable to all existing users. This definition is based on Metcalfe's law, which states that the value of a network is proportional to the square of the number of users.

Q: What is wrong with Metcalfe's law as a definition for network effects?

While Metcalfe's law captures the underlying idea of network effects, it is an oversimplified and incorrect definition. Many public company valuations have proven that there are additional factors to consider beyond just the number of users. The video explores these subtleties and dynamics of network effects.

Q: Can you explain the concept of a network in relation to network effects?

The concept of a network can sometimes be confusing because it is often associated with physical networks, such as the telephone network. However, as the concept of network effects has evolved, different types of network effects have emerged, and the metaphor of a network can sometimes feel strained. For example, data network effects may not visually resemble a traditional network, but they still exhibit similar effects of increasing advantage.

Q: How can accumulating advantage be another way to describe network effects?

Accumulating advantage is a way to describe the idea that a product or service needs less and less work to become more valuable as it grows. While attaching a product or service to a network with more nodes is one iteration of accumulating advantage, there are different versions of network effects that may not align with the traditional network metaphor. Therefore, accumulating advantage alone is not sufficient to explain all instances of network effects.

Q: Are brand and longevity examples of network effects?

The debate around whether brand acts as a network effect is complex. While some argue that a well-known brand like Heinz ketchup acts as a focal point that attracts more customers, creating a network effect, others contest this notion. Some believe that brands have network effects through the solidification of beliefs and developing preferences, while others argue that stretching the definition of network effects to include brands may diminish its value as a concept.

Takeaways

Network effects are powerful and important, with Metcalfe's law providing a foundational understanding. However, the traditional definition of network effects is oversimplified and incorrect. There are additional factors to consider beyond just the number of users. The concept of a network can sometimes be confusing, especially when applied to different types of network effects. While accumulating advantage aligns with network effects, it is not sufficient on its own to explain all instances. The question of whether brand can be considered a network effect remains a debated topic. Overall, a nuanced understanding of network effects is crucial to fully grasp their impact and implications in various contexts.

Summary & Key Takeaways

  • Metcalfe's law states that the value of a network is proportional to the square of the number of users, but this definition oversimplifies network effects.

  • Network effects can be seen in various forms, including physical networks like phones and fax machines and data networks where data accrues to a particular place or company.

  • Accumulating advantage, brand value, and other factors also contribute to network effects, with scale effect companies and brand longevity exemplifying accumulating advantage.

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