Yesterday I presented an argument that’s sometimes heard for granting companies that create technological platforms monopoly rights in those platforms. Today I’m going to start to explore what’s wrong with that argument. Today, I’ll discuss network effects, the idea that as new users are added to a network, its value grows faster than the number of users.
My claim is that the more people who use a technological platform, the more valuable that platform will be per user. One classic statement of this idea is Metcalfe’s law, which is summarized well in this article:
Metcalfe was ideally situated to watch and analyze the growth of networks and their profitability. In the 1970s, first in his Harvard Ph.D. thesis and then at the legendary Xerox Palo Alto Research Center, Metcalfe developed the Ethernet protocol, which has come to dominate telecommunications networks. In the 1980s, he went on to found the highly successful networking company 3Com Corp., in Marlborough, Mass. In 1990 he became the publisher of the trade periodical InfoWorld and an influential high-tech columnist. More recently, he has been a venture capitalist.
The foundation of his eponymous law is the observation that in a communications network with n members, each can make (n–1) connections with other participants. If all those connections are equally valuable–and this is the big “if” as far as we are concerned–the total value of the network is proportional to n(n–1), that is, roughly, n 2. So if, for example, a network has 10 members, there are 90 different possible connections that one member can make to another. If the network doubles in size, to 20, the number of connections doesn’t merely double, to 180, it grows to 380–it roughly quadruples, in other words.
The article argues that n2 is probably too high, which I think is probably true. But what nobody disputes is that network effects exist: that a network or platform with 2 million users is going to be more than twice as valuable as an Internet with a million. Or to put it another way, two networks with a million users each will be worth less than a single network with 2 million users. This has the obvious implication that, all else being equal, public policy should encourage the creation of a small number of comprehensive networks as opposed to many small, fragmented networks.
Of course, all else isn’t necessarily equal, and I’ll deal with some of the complications in future posts. But for now I want to offer an analogy that I think helps to flesh out why network effects exist and how they work. I alluded to it a couple of weeks ago: there are close parallels between the argument for interoperability between networks and the classical case for free trade between nations. Just as there are gains to trade when people from different countries can exchange goods and services, so are there gains to interoperability when the users of different networks are able to freely exchange information.
The Technology Liberation Front is the tech policy blog dedicated to keeping politicians' hands off the 'net and everything else related to technology.