Part 1: Some Interesting Facts, Laws and Observations             Part 2: Externalities and Network Effects                ...
Part 1: Some Interesting Facts, Laws and Observations   Interesting Facts             Part 2: Externalities and Network Eff...
Part 1: Some Interesting Facts, Laws and Observations   Interesting Facts              Part 2: Externalities and Network E...
Part 1: Some Interesting Facts, Laws and Observations   Interesting Facts              Part 2: Externalities and Network E...
Part 1: Some Interesting Facts, Laws and Observations   Interesting Facts              Part 2: Externalities and Network E...
Part 1: Some Interesting Facts, Laws and Observations   Interesting Facts              Part 2: Externalities and Network E...
Part 1: Some Interesting Facts, Laws and Observations   Interesting Facts              Part 2: Externalities and Network E...
Part 1: Some Interesting Facts, Laws and Observations   Interesting Facts              Part 2: Externalities and Network E...
Part 1: Some Interesting Facts, Laws and Observations   Interesting Facts              Part 2: Externalities and Network E...
Part 1: Some Interesting Facts, Laws and Observations   Interesting Facts             Part 2: Externalities and Network Eff...
Part 1: Some Interesting Facts, Laws and Observations   Interesting Facts              Part 2: Externalities and Network E...
Part 1: Some Interesting Facts, Laws and Observations   Interesting Facts              Part 2: Externalities and Network E...
Part 1: Some Interesting Facts, Laws and Observations   Interesting Facts             Part 2: Externalities and Network Eff...
Part 1: Some Interesting Facts, Laws and Observations   Interesting Facts              Part 2: Externalities and Network E...
Part 1: Some Interesting Facts, Laws and Observations   Interesting Facts              Part 2: Externalities and Network E...
Part 1: Some Interesting Facts, Laws and Observations   Interesting Facts              Part 2: Externalities and Network E...
Part 1: Some Interesting Facts, Laws and Observations   Interesting Facts              Part 2: Externalities and Network E...
Part 1: Some Interesting Facts, Laws and Observations   Interesting Facts              Part 2: Externalities and Network E...
Part 1: Some Interesting Facts, Laws and Observations   Interesting Facts              Part 2: Externalities and Network E...
Part 1: Some Interesting Facts, Laws and Observations   Interesting Facts              Part 2: Externalities and Network E...
Part 1: Some Interesting Facts, Laws and Observations   Interesting Facts              Part 2: Externalities and Network E...
Part 1: Some Interesting Facts, Laws and Observations   Interesting Facts              Part 2: Externalities and Network E...
Part 1: Some Interesting Facts, Laws and Observations   Interesting Facts              Part 2: Externalities and Network E...
Part 1: Some Interesting Facts, Laws and Observations   Interesting Facts              Part 2: Externalities and Network E...
Part 1: Some Interesting Facts, Laws and Observations   Interesting Facts              Part 2: Externalities and Network E...
Part 1: Some Interesting Facts, Laws and Observations   Interesting Facts              Part 2: Externalities and Network E...
Part 1: Some Interesting Facts, Laws and Observations   Interesting Facts              Part 2: Externalities and Network E...
Part 1: Some Interesting Facts, Laws and Observations   Interesting Facts              Part 2: Externalities and Network E...
Part 1: Some Interesting Facts, Laws and Observations   Interesting Facts              Part 2: Externalities and Network E...
Part 1: Some Interesting Facts, Laws and Observations   Interesting Facts              Part 2: Externalities and Network E...
Part 1: Some Interesting Facts, Laws and Observations   Interesting Facts              Part 2: Externalities and Network E...
ExternalityPart 1: Some Interesting Facts, Laws and Observations                                                        Ne...
Externality Part 1: Some Interesting Facts, Laws and Observations                                                         ...
Externality Part 1: Some Interesting Facts, Laws and Observations                                                         ...
Externality Part 1: Some Interesting Facts, Laws and Observations                                                         ...
Externality Part 1: Some Interesting Facts, Laws and Observations                                                         ...
Externality Part 1: Some Interesting Facts, Laws and Observations                                                         ...
Externality Part 1: Some Interesting Facts, Laws and Observations                                                         ...
Externality Part 1: Some Interesting Facts, Laws and Observations                                                         ...
Externality Part 1: Some Interesting Facts, Laws and Observations                                                         ...
Externality Part 1: Some Interesting Facts, Laws and Observations                                                         ...
Externality Part 1: Some Interesting Facts, Laws and Observations                                                         ...
Externality Part 1: Some Interesting Facts, Laws and Observations                                                         ...
Externality Part 1: Some Interesting Facts, Laws and Observations                                                         ...
Externality Part 1: Some Interesting Facts, Laws and Observations                                                         ...
Externality Part 1: Some Interesting Facts, Laws and Observations                                                         ...
Externality Part 1: Some Interesting Facts, Laws and Observations                                                         ...
Externality Part 1: Some Interesting Facts, Laws and Observations                                                         ...
Externality Part 1: Some Interesting Facts, Laws and Observations                                                         ...
Externality Part 1: Some Interesting Facts, Laws and Observations                                                         ...
Externality Part 1: Some Interesting Facts, Laws and Observations                                                         ...
ExternalityPart 1: Some Interesting Facts, Laws and Observations                                                        Ne...
Externality Part 1: Some Interesting Facts, Laws and Observations                                                         ...
Externality Part 1: Some Interesting Facts, Laws and Observations                                                         ...
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Externalities and network effects (examples, laws and interpretations)

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Externalities and network effects (examples, laws and interpretations)

  1. 1. Part 1: Some Interesting Facts, Laws and Observations Part 2: Externalities and Network Effects Externalities and Network Effects (Examples, Laws and Interpretations) Sumant Kulkarni International Institute of Information Technology, Bangalore Sumant Kulkarni Externalities and Network Effects 1/54
  2. 2. Part 1: Some Interesting Facts, Laws and Observations Interesting Facts Part 2: Externalities and Network Effects Some Interesting Laws Part 1: Some Interesting Facts, Laws and Observations Sumant Kulkarni Externalities and Network Effects 2/54
  3. 3. Part 1: Some Interesting Facts, Laws and Observations Interesting Facts Part 2: Externalities and Network Effects Some Interesting LawsAgenda: Part 1 Some Interesting Facts The Observation. Some Interesting Laws. Some Interesting Arguments. My Observations on Laws. Sumant Kulkarni Externalities and Network Effects 3/54
  4. 4. Part 1: Some Interesting Facts, Laws and Observations Interesting Facts Part 2: Externalities and Network Effects Some Interesting LawsMarket growth of Maruti Cars Started in 1981. Buying a car adds a new car to the group of Maruti cars. More service stations will be started due to more cars. Buying a new car with value X ⇒ Having a car with value X + Better and cheaper service availability Maruti is the only company in India, which has sold more than 10 million cars.1 In March 2011, Maruti had 45% Indian car market share2 !!! 1 http://en.wikipedia.org/wiki/Maruti_Suzuki 2 http://articles.economictimes.indiatimes.com/2011-04-10/news/ 29403269_1_market-share-car-segment-passenger-car Sumant Kulkarni Externalities and Network Effects 4/54
  5. 5. Part 1: Some Interesting Facts, Laws and Observations Interesting Facts Part 2: Externalities and Network Effects Some Interesting LawsMore vehicles on the Road When the first vehicle comes on the road, there will be full space for that vehicle. No need to overtake, give way etc., As the number of vehicles increases, they will also start occupying the space on the road. The problem of overtaking, giving way to others etc., starts. At some point, this starts looking like a congestion where, there is no incentive to drive a vehicle on the road!!! Adding New Vehicle worth X to the City Traffic ⇒ Having Comfort worth X + More Pain to Travel + More Expensive Travel Sumant Kulkarni Externalities and Network Effects 5/54
  6. 6. Part 1: Some Interesting Facts, Laws and Observations Interesting Facts Part 2: Externalities and Network Effects Some Interesting LawsMigration of People to USA When first group of people moved to America, there had to face lot of problems. As more people moved to USA, they also better life as well as the social life in USA improved. New Person Moving to USA ⇒ New Person Having Met His Expectations + Adding More social Life to USA + Adding More to Technology Sumant Kulkarni Externalities and Network Effects 6/54
  7. 7. Part 1: Some Interesting Facts, Laws and Observations Interesting Facts Part 2: Externalities and Network Effects Some Interesting LawsBuilding Roads Batter Roads (e.g. National Highways like NH4) More number of people travelling in a route pressurized government to make that route betters. Due to better road and more people using (safety at night) it attracted more people to use it. Using Better Roads by paying toll X⇒ Travelling in Better Road worth X + More Night-time Travel Safety + Better Restaurants Today, you can reach Hubli from Bangalore in 6 hrs in Car without crossing the speed limit!!! There are no reports of robbery in the night as well. Sumant Kulkarni Externalities and Network Effects 7/54
  8. 8. Part 1: Some Interesting Facts, Laws and Observations Interesting Facts Part 2: Externalities and Network Effects Some Interesting LawsSocial Networking Initially few people join. Every person joining the SN gets more people to interact with and hence gains in terms of contacts and knowledge. Every person joining the SN adds one more person to the SN to interact with. This intern allows already using people to get more knowledge. New Persons Spending Time Worth X to Join Social Network ⇒ More People worth X to Interact With + More Knowledge Sumant Kulkarni Externalities and Network Effects 8/54
  9. 9. Part 1: Some Interesting Facts, Laws and Observations Interesting Facts Part 2: Externalities and Network Effects Some Interesting LawsMobile Network More users prompted more number of towers in the areas. More towers increased the quality of service. Also, more users offered low tariff. Better QoS and Tariff attracted more users. Spending value worth X to buy a Mobile connection ⇒ More People to Interact With (worth value X) + Low tariff + Critical Communication Possibility Sumant Kulkarni Externalities and Network Effects 9/54
  10. 10. Part 1: Some Interesting Facts, Laws and Observations Interesting Facts Part 2: Externalities and Network Effects Some Interesting Laws356CW Initially by the end of 2011, they started around one bus/hour. People started liking it. More number of people using the bus prompted to run more buses. This might be helpful to reduce some amount of traffic. New Person using 356CW ⇒ Less Money Spent on Travel for him + Lesser Congestion Today, in prime time, there is a bus every 5 min!!! Sumant Kulkarni Externalities and Network Effects 10/54
  11. 11. Part 1: Some Interesting Facts, Laws and Observations Interesting Facts Part 2: Externalities and Network Effects Some Interesting LawsMany more ... People forming villages. People buying more Nokia phone in early 2000s. People buying Hero Honda vehicles in mid 90s. Internet. Arrival of IT Companies in Bangalore. Plantations. Electricity Consumption. Mobile Network Congestion. ........ Sumant Kulkarni Externalities and Network Effects 11/54
  12. 12. Part 1: Some Interesting Facts, Laws and Observations Interesting Facts Part 2: Externalities and Network Effects Some Interesting LawsWhat Did We Observe? Joining the group of Product/Service users ⇒ Having the the Product/Service + Change in the Welfare of the System/Third Party (and hence in own welfare). Sumant Kulkarni Externalities and Network Effects 12/54
  13. 13. Part 1: Some Interesting Facts, Laws and Observations Interesting Facts Part 2: Externalities and Network Effects Some Interesting Laws Some Laws Trying Explain the Above Observations. Sumant Kulkarni Externalities and Network Effects 13/54
  14. 14. Part 1: Some Interesting Facts, Laws and Observations Interesting Facts Part 2: Externalities and Network Effects Some Interesting LawsMetcalfe’s Law -1980 First proposed by Metcalfe in the context of Ethernet 3 devices (not in terms of users). He hypothesized that the network the cost of adding new elements increases linearly with each elements. But, the value of the network increases in proportion to the square of elements. The reason for high values is the number of connection possible in the network with n nodes is n(n-1) = O(n2 ) 3 Metcalfe’s Law, Web 2.0, and the Semantic Web Sumant Kulkarni Externalities and Network Effects 14/54
  15. 15. Part 1: Some Interesting Facts, Laws and Observations Interesting Facts Part 2: Externalities and Network Effects Some Interesting LawsMetcalfe’s Law - 1993 George Gilder, a writer and techno-utopian intellectual, formulated Metcalfe’s Law for all networks (in 1993). Highly important and accurate in small networks like LAN. There are question about its accuracy to bigger networks. The mathematical model only takes care of number of possible connections. But, it does not take care of the possibility of those many connections. As number of users increase, it becomes difficult to believe that the law holds good. It is an approximation law(like Moors Law). Hence, does not have any hard bindings! Sumant Kulkarni Externalities and Network Effects 15/54
  16. 16. Part 1: Some Interesting Facts, Laws and Observations Interesting Facts Part 2: Externalities and Network Effects Some Interesting LawsReed’s 3rd Law David P. Reed proposed 3 laws4 to comment on “how the information architecture of our world interacts with the people who inhabit (live in) it”. 3rd Law (a scaling law for network value): “As networks grow, value shifts: Content (whose value is proportional to size) yields to Transactions (whose value is proportional to the square of size), and eventually Affiliation (whose value is exponential in size)” Content ⇒ Number of participants in the network. Affiliation ⇒ a social or business relationship. 4 http://www.reed.com/dpr/locus/dprpapers.html Sumant Kulkarni Externalities and Network Effects 16/54
  17. 17. Part 1: Some Interesting Facts, Laws and Observations Interesting Facts Part 2: Externalities and Network Effects Some Interesting LawsReed’s 3rd Law The Reed’s (3rd ) law5 gives the following insight: The value of network is much higher than the one proposed by Metcalfe. If there are n user in a network, then the value of the network is 2n − n − 1 (O(2n )) 2n is due to the number of elements in the power set of the set having n elements. Power set represents the different Group-Forming-Networks (GFN). 5 http://spurspectives.com/why-reed%E2%80% 99s-law-powers-social-networks/ Sumant Kulkarni Externalities and Network Effects 17/54
  18. 18. Part 1: Some Interesting Facts, Laws and Observations Interesting Facts Part 2: Externalities and Network Effects Some Interesting LawsReed’s 3rd Law According to Reed, the value of a network is equal to the number of group-forming-networks (GFN) it can form from the available set of nodes/users. “Even Metcalfes Law understates the value created by a group-forming-network as it grows. Lets say you have a GFN with n members. If you add up all the potential two-person groups, three-person groups, and so on that those members could form, the number of possible groups equals 2n. So the value of a GFN increases exponentially, in proportion to 2n . I call that Reeds Law. And its implications are profound.”6 6 David. P. Reed,The Law of the Pack Sumant Kulkarni Externalities and Network Effects 18/54
  19. 19. Part 1: Some Interesting Facts, Laws and Observations Interesting Facts Part 2: Externalities and Network Effects Some Interesting LawsReed’s other Laws (Optional) Reed proposed 3 laws7 to comment on “how the information architecture of our world interacts with the people who inhabit it”. 1st Law (on Long-term Data Storage): “If you want to keep information for a long time, never separate the head from the recording.” With removable storage, ha a drive to read the data from it. Example: Floppy and Floppy Drive 2nd Law (on communications): “Communications media exist to confirm the prejudices of their audience.” Most of the information given out on the media is already know!!! They repeat it to satisfy the prejudices of people. 7 http://www.reed.com/dpr/locus/dprpapers.html Sumant Kulkarni Externalities and Network Effects 19/54
  20. 20. Part 1: Some Interesting Facts, Laws and Observations Interesting Facts Part 2: Externalities and Network Effects Some Interesting LawsSarnoff’s Law “The value of a broadcast network is proportional to the the number of views”. Talks only about the broadcast networks, where only one way channel exists. We see that the value attributed to the network is linearly proportional to the number of participants. Sumant Kulkarni Externalities and Network Effects 20/54
  21. 21. Part 1: Some Interesting Facts, Laws and Observations Interesting Facts Part 2: Externalities and Network Effects Some Interesting LawsBeckstrom’s Law - 2009 “The value of a network equals the net value added to each users transactions conducted through that network, summed over all users”8 . Rod Beckstrom Talks about value only in terms of transactions of the users in the network. The value of the transaction decays over time. Hence newer transactions add more value. The number of users/nodes in the network do not have any impact on the value of the network unless they participate in transaction. 8 http://en.wikipedia.org/wiki/Beckstrom%27s_law Sumant Kulkarni Externalities and Network Effects 21/54
  22. 22. Part 1: Some Interesting Facts, Laws and Observations Interesting Facts Part 2: Externalities and Network Effects Some Interesting LawsQuestioning Matcalfe’s and Reed’s Laws (Dunbar’sNumber) Both Matcalfe’s law and Reed’s Law have been criticized9 by many computer scientists for their ignorance of limitations. Dunbar’s Number is used to highlight the limitations of the laws. The research on Dunbar’s Number argues that There is a cognitive limitation to the number of stable social connection a person can have. The limit on the number of stable social connection is a direct function of relative neocortex size of the human being. 9 http://en.wikipedia.org/wiki/Reed’s_law, http://en.wikipedia.org/wiki/Dunbar%27s_Number Sumant Kulkarni Externalities and Network Effects 22/54
  23. 23. Part 1: Some Interesting Facts, Laws and Observations Interesting Facts Part 2: Externalities and Network Effects Some Interesting LawsQuestioning Matcalfe’s and Reed’s Laws (Dunbar’sNumber) Cont.. The research on Dunbar’s Number more insights like What happens if all the people in network are full in terms of Dunbar’s Number? There can be a clique of maximum size N with stable social connection as the edge between people. In such a condition, N is the smallest Dunbar’s Number in the group. Matcalfe’s law and Reed’s law overstate the network value by ignoring the cognitive inability of people to form networks of larger size than Dunbar’s Number. Hence Matcalfe’s law and Reed’s law are not scalable beyond some point. Sumant Kulkarni Externalities and Network Effects 23/54
  24. 24. Part 1: Some Interesting Facts, Laws and Observations Interesting Facts Part 2: Externalities and Network Effects Some Interesting LawsQuestioning Matcalfe’s and Reed’s Laws (Cont..) Bob Briscoe, Andrew Odlyzko, Benjamin Tilly10 argued that the quantification of value of a network by Matcalfe’s law and Reed’s law is wrong. Quadratic value growth is unrealistic. Exponential is even more unrealistic. Similar to Moore’s Law the Metcalfe’s law is also not immutable. 10 http: //spectrum.ieee.org/computing/networks/metcalfes-law-is-wrong Sumant Kulkarni Externalities and Network Effects 24/54
  25. 25. Part 1: Some Interesting Facts, Laws and Observations Interesting Facts Part 2: Externalities and Network Effects Some Interesting LawsQuestioning Matcalfe’s and Reed’s Laws (Cont..) They hypothesized that the connections distribution in a network is a Zipf’s law11 . The number of connections are inversely proportional to the rank (simplest form of Zipf’s law). 1 1 1 1 Connections distribution looks like 1 + 2 + 3 + 4 + ... + n−1 which approaches log (n). As there are n users in the network, the value of the network is n·log(n). 11 Benford’s Law and Zipf’s Law - http://www.cut-the-knot.org/do_you_know/zipfLaw.shtml, INFINITE SERIES - www.math.uconn.edu/~kconrad/blurbs/analysis/series.pdf Sumant Kulkarni Externalities and Network Effects 25/54
  26. 26. Part 1: Some Interesting Facts, Laws and Observations Interesting Facts Part 2: Externalities and Network Effects Some Interesting LawsWhat Can We Derive From This? We can not simply reject these laws as they talk about very basic nature of the networks. Metcalfe’s law - Small LAN Sarnoff’s Law - Broadcast TVs, Radios etc., These laws are very very loosely (vaguely) defined. Hence, it is very difficult to accept them as they are. Though intuitions are clear, no real proof that the laws work like they are stated. Sumant Kulkarni Externalities and Network Effects 26/54
  27. 27. Part 1: Some Interesting Facts, Laws and Observations Interesting Facts Part 2: Externalities and Network Effects Some Interesting LawsWhat Can We Derive From This? - Beckstorm’s Law Beckstrom’s Law looks to be more realistic law. It realistically assumes that value of a network is the total value of the transactions between the users. It can also give negative value as it deducts the cost of the transaction from the benefit of the transaction to give the value. The value generated rightly decays over time. But, it ignores the kind of transaction on the network. There can be value add to the system just by being a part of a network. The law ignores this factor. Sumant Kulkarni Externalities and Network Effects 27/54
  28. 28. Part 1: Some Interesting Facts, Laws and Observations Interesting Facts Part 2: Externalities and Network Effects Some Interesting LawsWhat Can We Derive From This? Each of these laws is defined based on one or few of the properties (facets) of a network. I do not see any law covering all the properties of the network. Matcalfe’s Law and Reed’s Law ignore the probability of the connection. Sarnoff’s Law ignore the kind of programs for which there are audience. There will not be uniform value addition for all kinds of programs. Sumant Kulkarni Externalities and Network Effects 28/54
  29. 29. Part 1: Some Interesting Facts, Laws and Observations Interesting Facts Part 2: Externalities and Network Effects Some Interesting LawsWhat Can We Derive From This? These laws do not look into the kind of network. Many networks might be homogeneous, but still will have properties related to their kind. Many other times, the network itself may be highly heterogeneous (like Internet), which makes the problem of identifying properties more complex. Sumant Kulkarni Externalities and Network Effects 29/54
  30. 30. Part 1: Some Interesting Facts, Laws and Observations Interesting Facts Part 2: Externalities and Network Effects Some Interesting LawsMy Observations/Hypothesis - Saturation of NetworkEffect in Finite Resource Environments Figure: In a finite resource network having network effect, initially the welfare of the users increase. But, after all the resources are efficiently used by the incoming users, more users will reduce the welfare of the users. Sumant Kulkarni Externalities and Network Effects 30/54
  31. 31. Part 1: Some Interesting Facts, Laws and Observations Interesting Facts Part 2: Externalities and Network Effects Some Interesting LawsMy Observations/Hypothesis - Saturation in the Increasein Welfare of Individual Users Figure: In a network, initially the welfare of the individual users increases. But, after the number of connection of the individual user reaches the Dunbar’s Number, it saturates. Sumant Kulkarni Externalities and Network Effects 31/54
  32. 32. ExternalityPart 1: Some Interesting Facts, Laws and Observations Network Externalities Part 2: Externalities and Network Effects Network Effects Externalities and Network Effects. Sumant Kulkarni Externalities and Network Effects 32/54
  33. 33. Externality Part 1: Some Interesting Facts, Laws and Observations Network Externalities Part 2: Externalities and Network Effects Network EffectsAgenda Externality. Network Externalities. Types of Network Externalities. Network Effects. Compensated Effect. Sumant Kulkarni Externalities and Network Effects 33/54
  34. 34. Externality Part 1: Some Interesting Facts, Laws and Observations Network Externalities Part 2: Externalities and Network Effects Network EffectsExternality Two parties do business willingly only if there is a profit for both of them12 . Business may be the exchange of financial value (like renting house) or social welfare (like marriage). Externality either puts some cost or provide some benefit to the people not involved in the business. For example: Renting out a house to a night club in the residential complex (assume that it is legal). Renting out a house to a very influential politician with mindset of helping people. 12 Kelvin Hartnall, Externalities and Network Effects Sumant Kulkarni Externalities and Network Effects 34/54
  35. 35. Externality Part 1: Some Interesting Facts, Laws and Observations Network Externalities Part 2: Externalities and Network Effects Network EffectsNetwork Externalities We are part of many networks. For example, Network of same company car users. Network of same telephone service. Network of people using same social network. Network Externality is a phenomenon in which entry of new user into the network, has either benefit or cost to the other user of the network. If the entry costs something to other users, then it is Negative Externality. If the other users are benefited, it is Positive Externality. Sumant Kulkarni Externalities and Network Effects 35/54
  36. 36. Externality Part 1: Some Interesting Facts, Laws and Observations Network Externalities Part 2: Externalities and Network Effects Network EffectsNetwork Externalities In the networks showing network externality, the users have two separate sub part in the value he receives by being a part of the network13 . 1 Autarky value: The value from the product/service he is using (consumer has paid for it). User gets this even if there is no other person using the same product/service. 2 synchronization value: The value from the network as the result of joining it (complementary but not optional). The latter part of the value decides whether it is Positive Externality or Negative Externality. 13 Network Externalities (Effects) by S. J. Liebowitz and Stephen E. Margolis Sumant Kulkarni Externalities and Network Effects 36/54
  37. 37. Externality Part 1: Some Interesting Facts, Laws and Observations Network Externalities Part 2: Externalities and Network Effects Network EffectsNegative Externalities If the entry of a new user into the network costs something to other users of the network, then it is Negative Externality. A classic example is the traffic congestion. The negative externalities can often be seen in the later stage of networks, where resources are finite. What other reasons can be there for a network to have negative externality? Can their be a network which is having negative externality from the first user of the network? Is negative externality a manifestation of the indication of resource crunch? Sumant Kulkarni Externalities and Network Effects 37/54
  38. 38. Externality Part 1: Some Interesting Facts, Laws and Observations Network Externalities Part 2: Externalities and Network Effects Network EffectsPositive Externalities If the other users are benefited by the entry of a new user into the network, then it is Positive Externality. In positive externality, “The value of the service or product will increase as its installed base expands14 ”. Positive externality is many times known as Network Effect. Though many networks have Network Effect initially, once they start facing resource crunch and once they scale above a level, they might start showing negative externality. 14 Network Effects and the Impact of Free Goods: An Analysis of the Web Server Market Sumant Kulkarni Externalities and Network Effects 38/54
  39. 39. Externality Part 1: Some Interesting Facts, Laws and Observations Network Externalities Part 2: Externalities and Network Effects Network EffectsSubtle differences between Network Effect and Externality Network Effect may not be Positive Externality always15 . Network Effect becomes positive externality only when other members of the network reap some benefit out of a new member joining. In other terms, old members should internalize the benefit of new member joining. If the benefit is reaped by only a centralized entity like owner of the network, then it is not externality. But, it is Network Effect. 15 Network Externalities (Effects) by S. J. Liebowitz and Stephen E. Margolis Sumant Kulkarni Externalities and Network Effects 39/54
  40. 40. Externality Part 1: Some Interesting Facts, Laws and Observations Network Externalities Part 2: Externalities and Network Effects Network EffectsTypes of Network Effects Direct network effects Indirect network effects Two sided Network Effects Local Network Effect Sumant Kulkarni Externalities and Network Effects 40/54
  41. 41. Externality Part 1: Some Interesting Facts, Laws and Observations Network Externalities Part 2: Externalities and Network Effects Network EffectsDirect network effects Increase in size of network directly increases the value16 . Indirectly, increase in usage of network directly increases the value. They are most influential Network Effects as the addition of the value is evident. In terms of economics, they can also be defined as the value generated through a direct physical effect of the number of purchasers on the value of a product. Examples: Fax and Telephone Connections. Social Networks17 and Email. 16 http://oz.stern.nyu.edu/io/network.html, Network Externalities (Effects) by S. J. Liebowitz and Stephen E. Margolis 17 http://en.wikipedia.org/wiki/Network_effect Sumant Kulkarni Externalities and Network Effects 41/54
  42. 42. Externality Part 1: Some Interesting Facts, Laws and Observations Network Externalities Part 2: Externalities and Network Effects Network EffectsIndirect network effects Increase in size of the network increases the value of another complementary network18 . Increase in the value of complementary network, in turn increases the value of the original network. There is a indirect increase in the value of the network. This is also called market mediated effects. Both the network is usually formed due to same good/service. 18 http://en.wikipedia.org/wiki/Network_effect, Network Externalities (Effects) by S. J. Liebowitz and Stephen E. Margolis Sumant Kulkarni Externalities and Network Effects 42/54
  43. 43. Externality Part 1: Some Interesting Facts, Laws and Observations Network Externalities Part 2: Externalities and Network Effects Network EffectsIndirect network effects Examples: DVD ⇔ DVD Player. Program ⇔ Channel. Player ⇔ Sports. Jobs ⇔ Schools Sumant Kulkarni Externalities and Network Effects 43/54
  44. 44. Externality Part 1: Some Interesting Facts, Laws and Observations Network Externalities Part 2: Externalities and Network Effects Network EffectsTwo-sided Network Effects Increase in size of one network increases the value of another network19 . These two networks need not be not formed due to a single Good/Service. But, they have found a common platform in which both networks can gain. There is a indirect increase in the value of both the networks. 19 http://en.wikipedia.org/wiki/Network_effect, http://oz.stern.nyu.edu/io/network.html Sumant Kulkarni Externalities and Network Effects 44/54
  45. 45. Externality Part 1: Some Interesting Facts, Laws and Observations Network Externalities Part 2: Externalities and Network Effects Network EffectsTwo-sided Network Effects Examples: Hardware ⇔ Software. Reader Software ⇔ Writer Software. New Technology ⇔ New Social Needs Credit Card Holder ⇔ Merchant Students ⇔ University Sumant Kulkarni Externalities and Network Effects 45/54
  46. 46. Externality Part 1: Some Interesting Facts, Laws and Observations Network Externalities Part 2: Externalities and Network Effects Network EffectsLocal Network Effects Members of the network may not always be benefited by the addition of more members globally. They might get benefited only by the connected members. Here, members get benefits if one more member gets added to their local connection. Example: Gtalk (or any other messengers). Chain marketing (like Amway). Students registered from same course (get benefited only when they are in same institute/university). People travelling to same destination (localized by the medium they use). People joining Facebook. Sumant Kulkarni Externalities and Network Effects 46/54
  47. 47. Externality Part 1: Some Interesting Facts, Laws and Observations Network Externalities Part 2: Externalities and Network Effects Network EffectsImportance of Compatibility between Networks Compatibility increases the benefit from network effect. If multiple networks are compatible, then they will be able to deliver better network effect. Examples: Email, Telephone, Mobile We observe some value missing out in Social Network due to their incompatibilities Sumant Kulkarni Externalities and Network Effects 47/54
  48. 48. Externality Part 1: Some Interesting Facts, Laws and Observations Network Externalities Part 2: Externalities and Network Effects Network EffectsImportance of Shared Standards between Networks There is always a trade off between openness of the technology and core proprietary technology. Development of open standards help to build better Network Effect. But, that will also make firms to loose on their monopoly. Open standards will help in building bigger stable markets compared to the many small markets built by proprietary technologies. How much of the technology standers should be open for a firm to exist as well as to make maximum of of network effects?? Sumant Kulkarni Externalities and Network Effects 48/54
  49. 49. Externality Part 1: Some Interesting Facts, Laws and Observations Network Externalities Part 2: Externalities and Network Effects Network EffectsCompensated Effects Diet Coke example Is it really compensated? Who compensates for the resources used? Who compensated for the trust built in Coke due to the number of consumers? Is there something which can be absolutely compensated? Sumant Kulkarni Externalities and Network Effects 49/54
  50. 50. Externality Part 1: Some Interesting Facts, Laws and Observations Network Externalities Part 2: Externalities and Network Effects Network EffectsAdvantages of Network Effects Can be used to promote a product. Can make a market sustainable for a product/service. Encourages a community to grow and stay together. .... Sumant Kulkarni Externalities and Network Effects 50/54
  51. 51. Externality Part 1: Some Interesting Facts, Laws and Observations Network Externalities Part 2: Externalities and Network Effects Network EffectsDisadvantages of Network Effects Believed to be endemic to new, high-tech industries20 . Markets may adopt an inferior product or network. Barrier to Enter the Market. 20 Network Externalities (Effects) by S. J. Liebowitz and Stephen E. Margolis Sumant Kulkarni Externalities and Network Effects 51/54
  52. 52. ExternalityPart 1: Some Interesting Facts, Laws and Observations Network Externalities Part 2: Externalities and Network Effects Network Effects End Of Part 2 Any Questions? Sumant Kulkarni Externalities and Network Effects 52/54
  53. 53. Externality Part 1: Some Interesting Facts, Laws and Observations Network Externalities Part 2: Externalities and Network Effects Network EffectsReferences Network, Crowds and Markets - book Network Effects, http://www.moreno.marzolla.name/ teaching/CS2011/NetworkEffects.pdf The Economy with Network Effects, http://www.systems.ethz.ch/education/fs11/ struct-social-inf-networks/lectures/Lecture%209. pdf Reverse Network Effect, http://www.readwriteweb.com/archives/is_there_a_ reverse_network_effect_with_scale.php Sumant Kulkarni Externalities and Network Effects 53/54
  54. 54. Externality Part 1: Some Interesting Facts, Laws and Observations Network Externalities Part 2: Externalities and Network Effects Network EffectsNetwork effects: related pages Barriers to entry - Anything that makes it difficult for a new entrant to break into a market. First mover advantage - The competitive advantage that the first company to launch a new type of product should have over those that start later. Natural monopoly - A monopoly that arises from the nature of the industry, rather than being imposed by law or resulting from anti-competitive practices. Product differentiation - Making a product or service look different in the eyes of consumers. Submarine patent - A patent that is deliberately kept quite, in the hope of extracting money later from those who use an idea believing it not to be patented. Cross licensing - Exchange rights to patent portfolios, which reduces litigation and R & D costs, while simultaneouslyand Network Effects 54/54 entry. Sumant Kulkarni Externalities erecting barriers to

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