I wanted to bring this subject to PM101 because it’s extremely relevant to the focus of this blog and also to what we do — product and program management. Metcalfe’s law relates to the value of a network and also the possibilities, which depend on the amount of its users.
A network becomes more valuable after each new user joins, and this happens all the time. With that, the network, its users, and data become a powerful asset. They bring tangible and intangible value to the network, there’s no downside.
Metcalfe’s law states that “the value of a network is proportional to the square of the number of connected users. As the physical cost of the network grows linearly, its value grows exponentially.” — Wikipedia
Why Am I Talking About This?
The value of networks grows exponentially with the number of people using that specific network. Metcalfe’s law says that every time you add a new user to a network, the number of connections increases proportionally to the square of the number of users.
The law says the value of a network is proportional to the square of the number of nodes in the network. Look at the example below. The first network has three nodes, but the last one has 36, and this makes a huge difference in the number of possible connections.
Let’s Start From the Beginning
Robert Metcalfe, one of the co-inventors of Ethernet and 3Com, popularized the network effects. The law Metcalfe created explains that the cost of a network is directly linked and proportional to the square of the number of users it has.
Ethernet is a family of wired computer networking technologies commonly used in local area networks (LAN), metropolitan area networks (MAN), and wide area networks (WAN). Ethernet was developed at Xerox PARC between 1973 and 1974. It was inspired by ALOHAnet, which Robert Metcalfe had studied as part of his Ph.D. dissertation.
3Com Corporation was a digital electronics manufacturer best known for its computer network products. The company was co-founded in 1979 by Robert Metcalfe, Howard Charney, and others. 3Com provided network interface controllers and switches, routers, wireless access points, and controllers, IP voice systems, and intrusion prevention systems.
Here’s an example: the famous audio social network Clubhouse has 2 million daily active users (DAU) since they just launched. While Facebook in 2020 had 1.85 billion DAU. The value of a network can be calculated by the connectivity between the users. If you have more users, you’re going to all those users to connect via your network, and the possibilities become almost endless during those scenarios.
After understanding Metcalfe’s law, it’s interesting to think about the effects on digital business and how successful these businesses can be depending on their network. Also consider how the internet potentialized that so much and made networks much more powerful.
The network effects are a huge intensifier of scalability. As it becomes less expensive to create platforms to connect users, the users are also incentivized to invite their family and friends to join those networks, attracting them in mass, helping the networks to gain a competitive advantage.
Another effect of networks is the immense competitive advantage they can gain, depending on the number of users. Another example of these network effects is a Freemium business model, which involves a basic product provided free of charge, but additional features are available for a price.
How You Can Calculate It
In a hypothetical scenario, every user of a network will value $10. If you just launched this network, and it has two users, the value will be $10 x $10, which is $100. If you acquire another user, the worth of this network will be $1,000.
You might be impressed by this value and get the point of how the users have a lot of power in making a network successful and impacting their value, especially nowadays. Now you can understand more about the power of users and the threat social networks feel when famous people and influencers decide to quit Facebook, for example.
Metcalfe’s Law and Business
As you see, digital businesses gain a HUGE competitive advantage building those networks, and their effects can be extremely lucrative in controlling supply chains, driving awareness, creating transactions, and also developing new habits as their networks grow.
The value of a network is directly linked to the number of users and the number of possible connections. For the business, these numbers will help to determine their value based on those users’ interactions and exchanges.
With all those users and interactions, the network owns this data that can be analyzed to drive even more interactions, of course, including gathering even more users, helping the network to become more powerful.
Different Types of Networks
When we think about the types of networks, we might think only about the direct ones. For example, when you have an increase in the number of users, you’ll have more connections, more possibilities in your network, and also increased utility, such as is the case for Instagram.
There’s also the indirect types of network effects that can create an indirect utility for their users depending on the users. For example, Airbnb became better as it gained more hosts and availability in different locations. If you wanted to go to a remote location at the beginning of Airbnb, I’d say it would be really difficult to find a place. However, now Airbnb has hosts all over the world, so the chance of finding an amazing house in the middle of nowhere is much higher.
Each business model will have a different network effect, based in part on a different type of network that can range from physical products, marketplace, platform, technology, and even personal, which is the case of social media channels between others.
- Most, if not all, networks rely heavily on the existence of the network effects, and this is how they survive and thrive.
- Metcalfe’s law is a concept that can be used in different areas, nowadays it is vastly used by computer networks to present their value.
- The network impact is equal to the square of the number of nodes, which can be the users or computers connected to the network.
- Metcalfe’s law was attributed to Robert Metcalfe, the co-inventor of Ethernet and 3Com Corporation.
- This concept is about the effects of the number of connections and also their value, which is directly influenced by the amount of users that are part of the network.
- The value of a network comprises two main things: competitive advantage and additional value based on the number of users it has.
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