Network Effects

Value that is generated by widespread adoption of a technology. The term was coined by the American technologist Robert Metcalf, a key pioneer of the Internet, who coined Metcalf’s law, that states that the value of a network is approximately equal to the square of the number of users of the network (i.e., n²). Recent analysis has postulated that the real value of a network is in fact:

n.logen (i.e., n x n.logen or n.ln(n))   (this equation may not render correctly on all browsers, loge is log subscript e, i.e., “natural log” or log base e.)

In any event, the basic point is that the value of a network rises dramatically as the number of users increases.

The classic example used to describe this effect is the advent of the telephone and later the fax (tele-facsimile) machine, or e-mail. Assuming, arguendo that only one person has a fax machine, it would be useless; once two people owned fax machines, the value would increase substantially, but each machine’s utility would be limited to sending messages to just that one other machine. However, as more people acquire a fax machine, the value of a fax machine to the owner of each existing machine rises because of the rising number of potential communication partners their device has. Standards are said to be particularly valuable when they drive network effects.