Economic sense of Metcalfe’s
Law
Gangmin Gary Li
OMII, ECS, University of Southampton
University Road
University of Southampton,
SO17 1BJ United Kingdom
+44 (0)23 8059 8814
[email protected]
22nd April 2008 Beijing
web: www.omii.ac.uk
email: [email protected]
Outline
• Introduction
• Metcalfe’s law
• Transaction cost theory (TCT)
• Consistency between the two laws
• How to define values
• Web future explained
• Conclusion
22nd April 2008 Beijing
web: www.omii.ac.uk
email: [email protected]
Introduction
• Diverse explanations and predictions
• An model is needed
• Most citied model is Metcalfe’s law
• There are some critics recently
• Economic view point
• Extend and support Metcalfe’s law
22nd April 2008 Beijing
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Metcalfe’s law
• It is named after Bob Metcalfe by George Gilder
“The value of a telecommunications
network is proportional to the square of
the number of users of the system
(n^2).”
22nd April 2008 Beijing
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Metcalfe’s law
22nd April 2008 Beijing
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Metcalfe’s law
• The cost of cards was proportional to the
number of cards installed
• the value of the network was proportional to
the square of the number of compatibly
communicating devices.
• A critical mass after which the benefits of a
network grow larger than its costs. N=C/A
• The second critical mass N’, when it is reached
the value of the of the network starts to head
down and overwhelming N’^2. N’=C/A
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Transaction cost theory (TCT)
• First attempt to define firm theoretically in
relation to the market
• The core unit of analysis in TCT is the
transaction, which “occurs when a good or service
is transferred across a technologically separate
interface”
• Two human factors and three environment
factors that affect cost
• The higher a TC a tighter of a structure is used
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Two human factors affect transactions costs
1. Bounded
rationality: Humans are unlikely to
have the abilities or resources to consider
every state-contingent outcome associated
with a transaction that might arise.
2. Opportunism: Humans will act to further
their own self-interests.
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Three environmental factors
1. Uncertainty: Uncertainty exacerbates the problems that
arise because of bounded rationality and opportunism.
2. Small numbers trading: If only a small number of players
exist in a market place, a party to a transaction may
have difficulty disciplining the other parties to the
transaction via the possibility of withdrawal and use of
alternative players in the marketplace.
3. Asset specificity: The value of an asset may be attached
to a particular transaction that it supports. The party
who has invested in the asset will incur a loss if the
party who has not invested withdraws from the
transaction. The possibility (threat) of this party acting
opportunistically leads to the so-called “hold-up”
problem.
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Transaction cost theory (TCT)-continue
It is interesting that the “Bounded rationality”
and “opportunism” lead to a so called
“flocking” or “herding” behaviour, which is
when one person moves, other will follow,
even if it is not a good idea. This can explain
the “recommendation” phenomena.
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Connection between TCT and the Metcalfe’s law
• Both trying to explain a business behaviour
• Both connect volume, value and specificity
• Both expose the human “bounded rationality”
and “opportunism”
• In explaining the “web effect” and “social effect”,
both point out that due to massive reduction of
transaction cost
• both fallen in a category of “rule of thumb”
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The value things
• What value? Connect device vs. connect people,
connect, connect documents (html), connect
contents (Semantic web), connect services (SOA)
and connect abilities (Grid).
• Who’s value? Which end? Owner vs. Users
• How to value? The measurement.
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Some web effects explained
• Pattern one: “Niche”-“Critical
Mass”-“split”
QQ, MSN, and Skype
Digg
MySpace, Facebook,
Flickr and YouTube
• Pattern two: Enabling
• Pattern three: Reduce the cost
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Conclusion
• Metcalfe’s Law was widely accepted and used to
explain internet boom.
• It has drawn a lot of criticism in explaining Web 2.0.
• This paper connects Transaction Cost Theory (TCT)
with Metcalfe’s Law.
• It not only proves that they are consistent but also
makes economical sense of the Law by introducing
the second critical mass in to Metcalfe’s Law.
• Exiting Web effect and future of Web evolutions are
explained .
• Any format of the future Web evolution has to have
cost reduction in its core.
22nd April 2008 Beijing
web: www.omii.ac.uk
email: [email protected]