Smart cookies - networking class - This month the word network is everywhere. So what are network businesses and economies and why should you care about them?
Why are networks hot?
Networks - businesses connecting people or places - have existed for many years: for example, road and rail transport, the Royal Mail and broadcast TV.
But recently economists and business thinkers have been applying network concepts to a range of cutting-edge infotech industries (telecoms, software, e-commerce) to understand how value is created, and how firms compete.
They argue that these high-growth, high-tech network businesses may work in new and different ways.
What is an example of new network thinking applied to high-tech businesses?
One axiom of the computing industry is Moore's Law: that the cost of computing power halves every 12-18 months. This has helped companies like Intel and Dell to become massive.
In the 1990s, as computing and communications have converged, Moore's Law has been paired with Metcalfe's Law of network economics: that the power of a network increases exponentially with each additional node.
Take mobile phones. Two mobile subscribers can only talk to each other, so the number of possible communication flows equals one. With three subscribers, there are three possible two-way flows, as well as a potential conference call, so the number of possible flows equals four With four subscribers, number of possible flows (including conference calls) equals 10. So doubling subscribers from two to four produces a tenfold increase in the number of possible flows - and an exponential increase in the utility of the service for any individual subscriber.
That works in telecoms - but what about other businesses?
In software, it is argued that Microsoft Windows and Microsoft Office are network businesses - 80% of the world's PC users use them. If I send a Powerpoint or Excel document to a colleague in San Francisco or Sydney, they will almost certainly be able to work on it and e-mail edits back to me in London. If I arrive at my firm's offices in Tokyo, I will sit down and work on a desktop set up with Windows and Office. Choosing not to use them is a big decision, putting me outside an enormously useful network.
Similarly, if I want AOL Instant Messaging, I need to stay on AOL's subscriber network. If I want access to the largest online auction market, I need to become part of e-Bay's network of buyers and sellers.
Is this different from older network businesses?
Not for telecoms: Metcalfe's Law would have applied in turn to mail, telegraph, telephone and telex. But it is much less relevant for other older network businesses. Heathrow may attract business travellers with its transfer connections, and airline alliances may offer them global networks with frequent-flyer benefits - but the value of British Airways does not increase exponentially with the number of routes and destinations. Nor does the value of NBC or Carlton with the number of TV viewers.
What characterises these new high-tech networks?
Most have very high fixed costs and very low marginal costs - it costs Microsoft very little to deliver one extra copy of Windows, and Orange very little to handle one extra subscriber or phone call. With e-commerce businesses such as e-Bay, the marginal cost of an extra transaction or customer is close to zero. (This is another difference versus older networks: there are significant marginal costs for BA or FedEx to add a flight, or for NBC to add a programme.)
The combination of Metcalfe's Law and high fixed/low marginal cost means there is greater pressure to become, and richer rewards for being, an entrenched and dominant market leader. Barriers to competitive attack, and to new entrants, should be high: customers will be hard to switch, and the market leader will have deep pockets for a price war.
So these new network businesses are potential gold mines, in perpetuity?
Microsoft shows how profitable they can be - but Microsoft is a very unusual case.
Metcalfe's Law creates enormous value for a firm if connectivity can be kept exclusive - but that is usually impossible to achieve. Mobile phone operators and e-mail or ISP networks have to interconnect, so customers can switch easily.
More importantly, technology changes and competitive substitutes emerge.
Rail networks lost out to roads. Fixed-line phones can be substituted by wire-free. Microsoft feels besieged by non-PC devices, new operating systems, and the internet. Networks can be very valuable, but they don't last for ever.