{"id":212,"date":"2018-06-14T19:04:29","date_gmt":"2018-06-14T19:04:29","guid":{"rendered":"https:\/\/pressbooks.ccconline.org\/bus3060\/chapter\/ch06-2\/"},"modified":"2026-02-03T15:52:24","modified_gmt":"2026-02-03T15:52:24","slug":"ch06-2","status":"publish","type":"chapter","link":"https:\/\/pressbooks.ccconline.org\/bus3060\/chapter\/ch06-2\/","title":{"raw":"6.2 Where\u2019s All That Value Come From?","rendered":"6.2 Where\u2019s All That Value Come From?"},"content":{"raw":"
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Learning Objectives<\/span><\/p>\r\n\r\n<\/header>\r\n

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After studying this section you should be able to do the following:<\/p>\r\n\r\n

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  1. Identify the three primary sources of value for network effects.<\/li>\r\n \t
  2. Recognize factors that contribute to the staying power and complementary benefits of a product or service subject to network effects.<\/li>\r\n \t
  3. Understand how firms like Microsoft and Apple each benefit from strong network effects.<\/li>\r\n<\/ol>\r\n<\/div>\r\n<\/div>\r\n \r\n\r\n<\/div>\r\n

    The value derived from network effects comes from three sources: exchange, staying power, and complementary benefits.<\/p>\r\n\r\n

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    Exchange<\/h2>\r\n

    Facebook for one person isn\u2019t much fun, and the first guy in the world with a fax machine didn\u2019t have much more than a paperweight. But as each new Facebook friend or fax user comes online, a network becomes more valuable because its users can potentially communicate with more people. These examples show the importance of exchange<\/em> in creating value. 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 movies, music, money, video games, and computer programs. And just about any standard that allows things to plug into one another, interconnect, or otherwise communicate will live or die based on its ability to snare network effects.<\/p>\r\n\r\n

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    Exercise: Graph It<\/span><\/p>\r\n\r\n<\/header>\r\n

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    Some people refer to network effects by the name Metcalfe\u2019s Law. It got this name when, toward the start of the dot-com boom, Bob Metcalfe (the inventor of the Ethernet networking standard) wrote a column in InfoWorld<\/em> magazine stating that the value of a network equals its number of users squared. What do you think of this formula? Graph the law with the vertical axis labeled \u201cvalue\u201d and the horizontal axis labeled \u201cusers.\u201d Do you think the graph is an accurate representation of what\u2019s happening in network effects? If so, why? If not, what do you think the graph really looks like?<\/p>\r\n\r\n<\/div>\r\n<\/div>\r\n \r\n\r\n<\/div>\r\n<\/div>\r\n

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    Staying Power<\/h2>\r\n

    Users don\u2019t want to buy a product or sign up for a service that\u2019s likely to go away, and a number of factors can halt the availability of an effort: a firm could bankrupt or fail to attract a critical mass of user support, or a rival may successfully invade its market and draw away current customers. Networks with greater numbers of users suggest a stronger staying power<\/a><\/span>. The staying power, or long-term viability, of a product or service is particularly important for consumers of technology products. Consider that when someone buys a personal computer and makes a choice of Windows, Mac OS, or Linux, their investment over time usually greatly exceeds the initial price paid for the operating system. One invests in learning how to use a system, buying and installing software, entering preferences or other data, creating files\u2014all of which mean that if a product isn\u2019t supported anymore, much of this investment is lost.<\/p>\r\n

    The concept of staying power (and the fear of being stranded in an unsupported product or service) is directly related to switching costs<\/a><\/span> (the cost a consumer incurs when moving from one product to another) and switching costs can strengthen the value of network effects as a strategic asset. The higher the value of the user\u2019s overall investment, the more they\u2019re likely to consider the staying power of any offering before choosing to adopt it. Similarly, the more a user has invested in a product, the less likely he or she is to leave.<\/p>\r\n

    Switching costs also go by other names. You might hear the business press refer to products (particularly Web sites) as being \u201csticky\u201d or creating \u201cfriction.\u201d Others may refer to the concept of \u201clock-in.\u201d And the elite Boston Consulting Group is really talking about a firm\u2019s switching costs when it refers to how well a company can create customers who are \u201cbarnacles\u201d (that are tightly anchored to the firm) and not \u201cbutterflies\u201d (that flutter away to rivals). The more friction available to prevent users from migrating to a rival, the greater the switching costs. And in a competitive market where rivals with new innovations show up all the time, that can be a very good thing!<\/p>\r\n\r\n

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    How Important Are Switching Costs to Microsoft?<\/h4>\r\n
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    \u201cIt is this switching cost that has given our customers the patience to stick with Windows through all our mistakes, our buggy drivers, our high<\/em>TCO [total cost of ownership]<\/a><\/span>, our lack of a sexy vision at times, and many other difficulties [\u2026] Customers constantly evaluate other desktop platforms, [but] it would be so much work to move over that they hope we just improve Windows rather than force them to move. [\u2026] In short, without this exclusive franchise [meaning Windows] we would have been dead a long time ago<\/em>.\u201d<\/p>\r\n

    Comments from a Microsoft General Manager in a memo to Bill Gates (Parsons, 2004).<\/p>\r\n\r\n<\/div>\r\n<\/div>\r\n \r\n\r\n<\/div>\r\n<\/div>\r\n

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    Complementary Benefits<\/h2>\r\n

    Complementary benefits<\/a><\/span> are those products or services that add additional value to the network. These products might include \u201chow-to\u201d books, software add-ons, even labor. You\u2019ll find more books on auctioning over eBay, more virtual storefronts in Second Life, and more accountants that know Excel, than on any of their rivals. Why? Book authors, Second Life partners, and accountants invest their time where they\u2019re likely to reach the biggest market and get the greatest benefit. In auctions, virtual worlds, and spreadsheet software, eBay, Second Life, and Excel each dwarf their respective competition.<\/p>\r\n

    Products and services that encourage others to offer complementary goods are sometimes called platforms<\/a><\/span>. Allowing other firms to contribute to your platform can be a brilliant strategy, because those firms will spend their<\/em> time and money to enhance your<\/em> offerings. Consider the billion-dollar hardware ecosystem that Apple has cultivated around the iPod. There are over ninety brands selling some 280 models of iPod speaker systems (Hansell, 2008). Thirty-four auto manufacturers now trumpet their cars as being iPod-ready, many with in-car docking stations and steering wheel iPod navigation systems. Each add-on enhances the value of choosing an iPod over a rival like the Microsoft Zune. And now with the App Store for the iPhone, iPod touch, and iPad, Apple is doing the same thing with software add-ons. Software-based ecosystems can grow very quickly. In less than a year after its introduction, the iTunes App Store boasted over fifty thousand applications, collectively downloaded over one billion times.<\/p>\r\n\r\n

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    The iPod Economy<\/h4>\r\n

    Products built to work with the iPod range from automobiles to the iCarta toilet paper holder.<\/p>\r\n

    Apple offers certification programs, where developers of accessories for the iPod and iPhone that meet certain guidelines can use the depicted logo. Each of these third-party products potentially enhances the value of owning an Apple product, while each logo serves as an additional advertisement for Apple. Apple even receives a royalty from firms that use the \u201cMade for iPod\u201d logo in advertisements and on product packaging.<\/p>\r\n\r\n<\/div>\r\n \r\n\r\n<\/div>\r\n

    These three value-adding sources\u2014exchange<\/em>, staying power<\/em>, and complementary benefits<\/em>\u2014often work together to reinforce one another in a way that makes the network effect even stronger. When users exchanging<\/em> information attract more users, they can also attract firms offering complementary<\/em> products. When developers of complementary products invest time writing software\u2014and users install, learn, and customize these products\u2014switching costs are created that enhance the staying power<\/em> of a given network. From a strategist\u2019s perspective this can be great news for dominant firms in markets where network effects exist. The larger your network, the more difficult it becomes for rivals to challenge your leadership position.<\/p>\r\n\r\n

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    Key Takeaways<\/span><\/p>\r\n\r\n<\/header>\r\n

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