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October 21, 2005

Bubble 2.0 – Extra Value Networks

Web 2.0 (aka Bubble 2.0) companies are often valued on their network effect.  Skype is a spectacular example of that.  This network effect which is so sought after is a value which grows FASTER than the total number of subscribers to a network AND which gives the company with the largest network an advantage over competitors offering the same or a me-too product.

SOME networks have value which grows faster that the number of users both because the number of possible connections grows much faster than the number of users (Connection Value) and because interesting groups can be created within the network (Group Forming Network or GFN Value).  I call these “extra-value networks”.

The first test of whether a network is an extra-value network is whether subscribers to the network care whether or not the other subscribers they interact with are on the same network.  If subscribers don’t know or care, the network will have neither Connection nor GFN Value.  It won’t be an extra-value network.

The traditional landline phone networks have huge numbers of subscribers.  They have negligible if any Connection or GFN value.  Why?  Because when we use these networks to make a call, we don’t know or care whether the person we’re calling is on the same network we are or some other network.

MCI once tried to create Connection Value for subscribers to its “Friends and Family” plan by offering them a discount for on-net calls but that’s a tough strategy for any but the largest network.  AT&T did think about doing the same thing but couldn’t adapt its antique billing system.  Wireless networks are slightly more successful at creating Connection Value with their free on-net calling plans.  These plans encourage you to sign up with the network your friends are on or the network with the largest number of users so that your bill will be smaller.

VoIP networks also create Connection Value by offering free on-net calling.  This is not a particularly successful strategy for Vonage since that service is used primarily for calling people who have traditional phones but it has been spectacularly successful for Skype whose high value is attributable almost solely to the number of subscribers it has and which has worked its way into a dominant position very quickly.  From a subscriber point-of-view, if you want to make free computer-to-computer calls, why would you sign up with anyone besides Skype?  You can’t get cheaper than free.  Your chance of finding the people you want to talk to on Skype is much greater than finding them on any Skype competitor.  So you sign up with Skype.

Just to repeat: a network has no extra value to its owners if it doesn’t have extra value to its users.

eBay is an extra-value network.  Sellers know that they will find the most buyers there.  Buyers know they will find the most merchandise.  As long as eBay keeps its prices reasonably low, it is very hard for a competing network to succeed.

del.icio.us is another type of extra-value network.  It does have competition such as Furl.  There are other places that users can tag or bookmark web pages which are relevant to them; some even have a better user interface.  But del.icio.us has the advantage of having more users and thus more taggers, more tags, and more web pages tagged.  All of these services are free to the user so price is irrelevant.  In general, users are advantaged by picking the tagging service that most other users have chosen so del.icio.us has an advantage. (full disclosure: I am indirectly a small investor in del.icio.us).

Next: closed vs. open networks or how to keep dominance and how to compete with it.

I blogged an introduction to Bubble 2.0 here.

I blogged about the Long Tail here and the Long, Long Tail here.

And I blogged about the math of Group Forming Networks here.

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