World Linker

Archive for August, 2009

Many web sites also feature a network effect. One example is web marketplaces and exchanges, in that the value of the marketplace to a new user is proportional to the number of other users in the market. For example, eBay would not be a particularly useful site if auctions were not competitive. However, as the number of users grows on eBay, auctions grow more competitive, pushing up the prices of bids on items. This makes it more worthwhile to sell on eBay and brings more sellers onto eBay, which drives prices down again as this increases supply, while bringing more people onto eBay because there are more things being sold that people want. Essentially, as the number of users of eBay grows, prices fall and supply increases, and more and more people find the site to be useful.

The collaborative encyclopedia Wikipedia also benefits from a network effect. The theory goes that as the number of editors grows, the quality of information on the website improves, encouraging more users to turn to it as a source of information; some of the new users in turn become editors, continuing the process.

A key business concern must then be how to attract users prior to reaching critical mass. One way is to rely on extrinsic motivation, such as a payment, a fee waiver, or a request for friends to sign up. A more natural strategy is to build a system that has enough value without network effects, at least to early adopters. Then, as the number of users increases, the system becomes even more valuable and is able to attract a wider user base. Joshua Schachter has explained that he built Del.icio.us along these lines – he built an online system where he could keep bookmarks for himself, such that even if no other user joined, it would still be valuable to him. It was relatively easy to build up a user base from zero because early adopters found enough value in the system outside of the network aspects. The same could be said for many other successful websites which derive value from network effects, e.g. Flickr, MySpace.

Beyond critical mass, the increasing number of subscribers generally cannot continue indefinitely. After a certain point, most networks become either congested or saturated, stopping future uptake. Congestion occurs due to overuse. The applicable analogy is that of a telephone network. While the number of users is below the congestion point, each additional user adds additional value to every other customer. However, at some point the addition of an extra user exceeds the capacity of the existing system. After this point, each additional user decreases the value obtained by every other user. In practical terms, each additional user increases the total system load, leading to busy signals, the inability to get a dial tone, and poor customer support. The next critical point is where the value obtained again equals the price paid. The network will cease to grow at this point, and the system must be enlarged. The congestion point may be larger than the market size. New Peer-to-peer technological models may always defy congestion. Peer-to-Peer systems, or “P2P,” are networks designed to distribute load among their user pool. This theoretically allows true P2P networks to scale indefinitely. But market saturation will still occur.