The Boom in Network Business Models

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The Boom in Network Business Models

Almost 30 years ago, Robert Metcalfe, who invented Ethernet and founded 3Com, proposed a principle that would have far-reaching implications. This principle, which is now known as Metcalfe’s Law, states that the value of a network increases in proportion to the square of the number of people using it.

In other words, the more people who plug into a network, the more useful it is to everyone who uses it. If 100 people are buying and selling goods on an online auction site like eBay, the network has very little value. If 100 million people join the network, its value to each of those users explodes.

More sellers equal more variety, and a better likelihood that each buyer will find what he or she wants. More buyers equal more bidders for each item, and a better likelihood that each seller will receive a higher price.

Moreover, the value of the network increases in a viral feedback loop: More buyers attract more sellers, who attract more buyers, and so on.

Even better, if a network business model is used successfully, it can “lock in” users. Once they’ve invested their time in joining one network, listed their goods for sale, and allowed it to learn their preferences, they will not want to start over again with another network.

In the gold rush days, Internet entrepreneurs used Metcalfe’s Law to justify their strategies to build large networks as quickly as possible so they could connect people before the competition did.

Unfortunately, for many would-be dot-com tycoons, Metcalfe’s Law was merely an excuse to pursue bad business strategies. For many others who had good strategies, there weren’t enough users in those days that could be linked profitably as buyers and sellers in a network.

However, as the Trends editors predicted more than 10 years ago, some business models did flourish. One was eBay. Others included employment services like Monster.com, classified ads sites like Craigslist, travel sites such as Expedia and Travelocity, and dating services like Match.com and eHarmony. Many of these businesses simply could not have existed prior to the Internet because transaction costs were too high. So, there was no cost-effective way to link buyers and sellers efficiently.

Also, as the early networks grew larger, it often became more difficult for users to find what they needed with their old 56k modems and limited search capabilities. So, ironically, some early networks actually decreased in value as they grew in size.

Skip ahead to 2007, and the world has changed...

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