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Beyond Metcalfe's Law to the Power of Community Building

by David P. Reed   (dpreed@reed.com)

Summary Version - Edited by John Veitch

Source: External LinkThat Sneaky Exponential.

Bob Metcalfe, inventor of the Ethernet, is known for pointing out that the total value of a communications network grows with the square of the number of devices or people it connects. Because Metcalfe's law implies value grows faster than does the (linear) number of a network's access points, merely interconnecting two independent networks creates value that substantially exceeds the original value of the unconnected networks. Thus the growth of Internet connectivity, and the openness of the Internet, are driven by an inexorable economic logic, just as the interconnection of the telephone network was forced by AT&T's long distance strategy. This strategy created huge and increasing value to AT&T customers, based on the same (then unnamed) law of increasing returns to scale at the beginning of the 20th century. In the same way, the global interconnection of networks we call the Internet has created huge and increasing value to all its participants.

But many kinds of value are created within networks. While many kinds of value grow proportionally to network size and some grow David Reed proportionally to the square of network size, I've discovered that some network structures create total value that can scale even faster than that. Networks that support the construction of communicating groups create value that scales exponentially with network size, i.e. much more rapidly than Metcalfe's square law. I will call such networks Group-Forming Networks, or GFNs.

In networks like the Internet, Group Forming Networks (GFNs) are an important additional kind of network capability. A GFN has functionality that directly enables and supports affiliations (such as interest groups, clubs, meetings, communities) among subsets of its customers. Group tools and technologies (also called community tools) such as user-defined mailing lists, chat rooms, discussion groups, buddy lists, team rooms, trading rooms, user groups, market makers, and auction hosts, all have a common theme&they allow small or large groups of network users to coalesce and to organize their communications around a common interest, issue, or goal. Sadly, the traditional telephone and broadcast/cable network frameworks provide no support for groups.

Law: Sarnoff Metcalfe GFN (Reed)
Optional Transactions Tune In Broadcast Connect Peers Join/Create Groups
Examples OnSale,
Remote Access
Yahoo! Classifieds, EMail eBay,
Chat Rooms
Social Networks
Value of N member net N N2 2N
Combined Value of N, M member nets N + M N2 + M2 + 2NM 2N x 2M

This exponential law of GFNs, like Metcalfe's Law, creates increasing returns as scale increases, which has surprising economic results.

Both laws give a powerful bonus to interconnection; mergers and partnerships of networked companies should be able to extract a premium resulting from these laws.

What we see, then, is that there are really at least three categories of value that networks can provide: the linear value of services that are aimed at individual users, the "square" value from facilitating transactions, and exponential value from facilitating group affiliations. What's important is that the dominant value in a typical network tends to shift from one category to another as the scale of the network increases. Whether the growth is by incremental customer additions, or by transparent interconnection, scale growth tends to support new categories of killer apps, and thus new competitive games.

In "real" networks, it is important to note that although the total value of optional transactions that involve pairs and groups grows faster than linearly, the total price that can be paid cannot grow that fast. Typically, the consumers of the value have money and attention resources that scale linearly with N. So the law of supply and demand will kick in, lowering prices until the available resources (dollars and attention) are saturated. What's interesting is that this saturation process affects all types of optional transactions-so GFN value, peer transaction value, and broadcast content value all compete for the same resources. Once N grows sufficiently large, GFN transactions create more value per unit of network investment than peer transactions, and peer transactions create more value per unit of network investment than do broadcast transactions. So what tends to happen is that as networks grow, peer transactions out-compete broadcast content in the arena of attention and return on investment. And remarkably, once N gets sufficiently large, GFN transactions will out-compete both of the other categories.

The chart in Figure 4 is based on a simple model of saturation and competition for dollars and attention. As N grows, first peer transactions start to gain "market share" at the cost of broadcast, and the GFN transactions gain share.

Reed's Law

I'd like to close with a speculative thought. As Francis Fukuyama argues in his book Trust, there is a strong correlation between the prosperity of national economies and social capital, which he defines culturally as the ease with which people in a particular culture can form new associations. There is a clear synergy between the sociability that Fukuyama discusses and the technology and tools that support GFNs-both are structural supports for association. As the scale of interaction grows more global via the Internet, isn't it possible that a combination of social capital and GFN capital will drive prosperity to those who recognize the value of network structures that support free and responsible association for common purposes?

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