Metcalfe`s Law Network Effects

The basis of his law of the same name is the observation that in a communication network with n members, everyone (n to 1) can establish connections with other participants. If all these connections have the same value – and this is the big “if” for us – the total value of the network is proportional to n (n â1), i.e. about n2. So, for example, if a network has 10 members, there are 90 different possible connections that one member can make with another. If the network size doubles to 20, the number of connections doubles not only to 180, but to 380. Instead, we propose that the value of a network of size n increases proportionally to n log(n). Note that these laws are growth laws, which means they cannot predict the value of a network based on its size alone. But if we already know its valuation at a certain size, we can estimate its value at any future size, all other factors being equal. Metcalfe was ideally located to observe and analyze network growth and profitability. In the 1970s, first in his doctoral dissertation at Harvard and then at the legendary Xerox Palo Alto Research Center, Metcalfe developed the Ethernet protocol that now dominates telecommunications networks.

In the 1980s, he founded the highly successful networking company 3Com Corp. in Marlborough, Massachusetts. In 1990, he became editor-in-chief of InfoWorld magazine and an influential high-tech columnist. Most recently, he was a venture capitalist. The mechanics of Metcalfe`s law are simple. As a network gains new nodes that can connect to all existing nodes, the number of connections grows much faster than the number of nodes. Each new node adds as many connections to the network as there are existing nodes. Physical networks consist of physical nodes connected by physical connections. These include power grids, roads, railways, sewage systems and broadband Internet services.

While experts in network economics and computer science continue to question whether the correct formula for calculating network effects should be exponential, logarithmic, or some other function, Metcalfe`s general point is clear. The overall value of a network tends to grow much faster than its size. ρ = c / ( n − 1 ) {displaystyle rho =c/(n-1)} which is approximated for large networks by ρ = c / n {displaystyle rho =c/n}. [8] The network effects of this value indexation tend to be both direct and indirect. Metcalfe`s law attempts to quantify this increase in value. This is after none other than Robert M. Metcalfe, the inventor of Ethernet. During the internet boom, the law was an article of faith for entrepreneurs, venture capitalists, and engineers because it seemed to offer a quantitative explanation for the various now curious mantras of the boom, such as “network effects,” “first-mover advantage,” “internet time,” and, most poignantly, “build it and they`ll come.” This difference will be critical as investors and network operators plan their growth better. In North America alone, telecom operators are expected to invest $65 billion to expand their networks this year, according to analyst firm Infonetics Research Inc. in San Jose, California.

As we will show, our rule of thumb also has implications for companies in the important area of managing connections between large networks. Metcalfe`s LawThe value or utility of a network is proportional to the number of users of the network. indicates that the value or utility of a network is proportional to the number of users on the network. At one point, Metcalfe pointed out that utility is a quadratic function (utility = n2). For example, a telephone network of 10 people has a utility of 100 and a network of 100 people has a utility value of 10,000. It has since reduced this and the advantage of a network is based on a log function (utility = n × log(n)). VC MIKE (2010). The protocol model is shown in Figure 1.7 “Network size increases network value.” Thus, for a network of 100 users, this would give a utility = 100 × 2 = 200 or 200 utility units. The equation is not the important question. It`s the idea that if you have more people using a phone, fax, railway, Web 2.0 application or whatever, your network becomes more attractive and attracts even more users.

Consider whether to opt for a local cable TV network or a satellite TV network. When individuals think about the network that other people choose, there is a network externality or network effect that influences the decision. Ethernet is a family of wired computer network technologies commonly used in local area networks (LANs), urban networks (MANs), and wide area networks (WANs). Ethernet was developed at Xerox PARC between 1973 and 1974. It was inspired by ALOHAnet, which Robert Metcalfe had studied as part of his doctoral thesis. The PARC complex built and used some of the first personal computers. Metcalfe and fellow engineer David Boggs designed Ethernet when asked to develop a network system to connect PARC computers. The value of networks increases exponentially with the number of people using that specific network. Metcalfe`s law states that every time you add a new user to a network, the number of connections increases proportionally to the square of the number of users. The law applies to any type of communication network, be it telephones, computers or users of the World Wide Web.

While the term “value” is inevitably a bit vague, the idea is that the more people you can call or write, or the more web pages you can link, the more valuable a network has. As a starting point, network effects can be direct or indirect. Metcalfe correctly sized A as a “per-user value”. Affinity is also a function of network size, and Metcalfe correctly stated that A must decrease as n becomes large. In a 2006 interview, Metcalfe explained that marketplace networks combine the identity format of personal networks with the transactional orientation of markets to facilitate mass transactions for many buyers and sellers. Instead of optimizing for quick trades, marketplace networks typically promote long-term projects that allow users to improve their reputation with every successful purchase or sale. Economists also talk about network outages, a situation where the technology or network chosen is not the best technology, leading consumers and businesses down a path that is not optimal. This is a situation where the chosen technology or network is not the best technology and thus leads consumers and businesses down a path that is not optimal.