OMIS 3710 Chapter 8: Understanding Network Effects

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Operations Management and Information System
OMIS 3710
Henry Kim

Chapter 8: Understanding Network Effects 8.1 Introduction  Network effects are among the most powerful strategic resources that can be created by technology-based innovation. Many category-dominating organizations and technologies, including Microsoft, Apple, eBay, Facebook, and Visa, owe their success to network effects. Network effects are also behind the establishment of most standards, including Blu-ray, Wi-Fi, and Bluetooth.  More users, more connections, and more communication channels  Network effects: Also known as Metcalfe’s Law, or network externalities. When the value of a product or service increases as its number of users expands.  Switching costs: The cost a consumer incurs when moving from one product to another. It can involve actual money spent (e.g., buying a new product) as well as investments in time, any data loss, and so forth.  Platforms: Products and services that allow for the development and integration of software products and other complementary goods. Windows, the iPhone, the Wii, and the standards that allow users to create Facebook apps are all platforms.  Physical resources: more use will exhaust it  Once you have established network effects, switching costs come into play, and it becomes expensive for customers to leave.  Platform: app developers provide value to themselves, consumers, and for Apple 8.2 Where’s All That Value Come From?  Products and services subject to network effects get their value from exchange, perceived staying power, and complementary products and services. Tech firms and services that gain the lead in these categories often dominate all rivals.  Exchange of information – Facebook, App Store o Every product or service subject to network effects fosters some kind of exchange. For firms leveraging technology, this might include anything you can represent in the ones and zeros of digital storage, such as messaging, movies, music, money, video games, and computer programs.  Staying Power – very important for tech product consumers; directly related to switching costs o The long-term viability of a product or service.  Complementary benefits – add additional value to the network (how-to books, software add-ons, labor)  TCO [Total Cost of Ownership]: An economic measure of the full cost of owning a product (typically computing hardware and/or software). TCO includes direct costs such as purchase price, plus indirect costs such as training, support, and maintenance.  Many firms attempt to enhance their network effects by creating a platform for the development of third-party products and services that enhance the primary offering.  APIs: Programming hooks, or guidelines, published by firms that tell other programs how to get a service to perform a task such as send or receive data. For example, Amazon provides application programming interfaces (APIs) to let developers write their own applications and Web sites that can send the firm orders. 8.3 One-Sided and Two-Sided Markets  In one-sided markets, users gain benefits from interacting with a similar category of users (think instant messaging, where everyone can send and receive messages to and from one another).  In two-sided markets, users gain benefits from interacting with a separate, complementary class of users (e.g., in the mobile-payment
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