Network effects over-rated?

A new book by Stan Liebowitz, called “Re-Thinking the Network Economy“, has some interesting insights. This article discusses one, namely that the principle of “first to market” was completely bogus.

The “network effect” describes the condition that a product’s value increases with the popularity of the product to consumers. The typical example is the telephone; one is useless, and the more people have a telephone, the more useful one is.

First to market is the principle that, because of network effects, the first person to produce a product in a given space wins. Superior late-comers cannot gain market share, because “using what everyone else is using” is more important than a superior product.

In refuting this, Mr Liebowitz emphasises the distinction between two kinds of lock-in. The question of compatibility is central to both. One kind of lock-in arises simply because switching to a new product involves a cost beyond the purchase price: costs of learning how to use it, for instance, or the difficulty of using it alongside products you already own. Mr Liebowitz calls this self-incompatibility, or weak lock-in. But there is also strong lock-in. This arises if a new product is incompatible with the choices of other consumers – and if, because of network effects, this external incompatibility reduces the value of the product.

Liebowitz claims (and I agree) that real strong lock-in is nonexistant. Consumers are capricious beasts, and are perfectly willing to adopt a superior product even in the face of incompatability; witness the ongoing success of the Macintosh platform.

Long before the Internet, consumers had plenty of experience adopting better technologies despite network-effect obstacles: cars (you need petrol stations), telephones, fax machines and, most recently, generation upon rapidly succeeding generation of network-dependent consumer-electronics devices. If a new product offers a clear margin of improvement over a competing one, consumers not only want to take it up themselves, they expect others to do the same. In this way, even where network effects apply, a sufficient margin of improvement achieves the necessary co-ordination among consumers.

I’ve always believed that the “first to market” principle was false; it’s nice that someone agrees with me.

posted at 12:31 pm on Monday, September 30, 2002 in General | Comments Off on Network effects over-rated?

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