Chapter 4 : Demand-side economies of scale
The supply-side economies of scales described the costs advantages of being large.
This chapter is about the demand-side economies of scales : network effects are network
externalities and describe the value of having many users
Mean drivers behind the dominant players is the demand-side economies of scale.
Positive network effect when the market
feedback causes perceived increase of
value that stimulates further increase in
value. Eg: facebook
More value due to increased interaction
for actual and future users.
Negative network effect when the
market feedback causes perceived
decrease in value that stimulates a further decrease in value. Eg : when the number of players
that leave the game increases, more players are stimulated to leave the game as well. (end-life
of a game). Other examples : negative reviews, few active users, low ratings of a product,..
Fadia Farhat | VUB 2023-2024 87
,Note that in both cases feedback is positive! Feedback is positive when you have more/less of an
input A which produces more/less of B and more/less of B will produce more/less of A
If there is deviation in one or other direction, positive feedback strengthen this, enlarge the
deviation.
Negative feedback tends to bring something to an equilibrium and keep it there to stay. An
increase in input of A will cause an increase in the output of B but the increase of output of
B will cause a decrease in the input of A and brings B back close to his equilibrium (and
vice versa). Deviation from the equilibrium point are always restored. Eg : standard supply
and demand diagrams, standard micro-economics
Things that can emphasize negative network effects are : insufficient advertisement w.o.w. when
product is not feasible enough for user experience, technical issues when a product is launched
Positive network effect can be strengthen by high ratings, high product visibility, excellent user’s
satisfaction, expressed by friends (words of mouth)
Time-dependant : It is not because a
product is subject to positive network
effects, this will last forever.
Effects can switch from positive to negative
when the number of users increases. Eg:
games getting overcrowded what results in
users leaving the game.
Network can be clustered, what means that there exists clusters of network within the network. Eg:
social media network, where residents in a country are more connected with each other than
with people outside their country.
Interaction between users in networks can be asymmetric what means that a user sends more
information than that he receives in return. Eg: in Youtube or Twitter (X): a relative few users create
the content that is spread to the other users.
In case of positive direct network effects, users benefit from other user’s in the network because
they have option for more direct interaction between the users (eg: social network)
In case of indirect network effects, users benefit from other users because they more collectively
provide value that is somehow appreciated by all users in the network without any direct
interaction between users taking place. (eg: improvement in service quality due to user feedback
and product review)
Fadia Farhat | VUB 2023-2024 88
, Same-side and cross-side effects –> in multi sided markets. Eg: hardware-software example. If no
hardware, software cannot run. And without software, hardware is quiet useless => two sides of
the market are inter related and this is an example of cross-side network effects.
4.1 Electronic money and the network externalities theory
Aim of this paper was to show that the network externalities theory provides a useful framework to
provide the introduction and future development of the new electronic payments instruments
that were being launched at that time. Paper present a pragmatic and more selective reading of
the network externalities literature. He was applying an existing theory of network externalities to a
new phenomenon of electronic payments. “No new rules are needed in the digital economy, we
can apply existing theories” (see introduction of the course)
At that time, when launching payment instruments, issuers were faced with “chicken-and-egg
problem”. On one hand the merchants will be reluctant to invest in new equipment or software
that is needed to accept this king of payment unless they know that there will be sufficient
customers that will be interested in this new methods of payment. On the hand, the consumers will
not start to use this new payment method as long as they can only use it in a few places. This
dilemma originate from the fact that electronic money products are network goods. These
products are subject to network externalities.
Read the article of Van Hove, 1999
Direct network externalities are demand network externalities. They are generated through a
direct physical effect of the number of purchases on the quality of the product.
Another important distinctive feature of network goods besides the required complementarity and
interaction: network externalities are more self-contained than other forms of externality.
Fadia Farhat | VUB 2023-2024 89
The supply-side economies of scales described the costs advantages of being large.
This chapter is about the demand-side economies of scales : network effects are network
externalities and describe the value of having many users
Mean drivers behind the dominant players is the demand-side economies of scale.
Positive network effect when the market
feedback causes perceived increase of
value that stimulates further increase in
value. Eg: facebook
More value due to increased interaction
for actual and future users.
Negative network effect when the
market feedback causes perceived
decrease in value that stimulates a further decrease in value. Eg : when the number of players
that leave the game increases, more players are stimulated to leave the game as well. (end-life
of a game). Other examples : negative reviews, few active users, low ratings of a product,..
Fadia Farhat | VUB 2023-2024 87
,Note that in both cases feedback is positive! Feedback is positive when you have more/less of an
input A which produces more/less of B and more/less of B will produce more/less of A
If there is deviation in one or other direction, positive feedback strengthen this, enlarge the
deviation.
Negative feedback tends to bring something to an equilibrium and keep it there to stay. An
increase in input of A will cause an increase in the output of B but the increase of output of
B will cause a decrease in the input of A and brings B back close to his equilibrium (and
vice versa). Deviation from the equilibrium point are always restored. Eg : standard supply
and demand diagrams, standard micro-economics
Things that can emphasize negative network effects are : insufficient advertisement w.o.w. when
product is not feasible enough for user experience, technical issues when a product is launched
Positive network effect can be strengthen by high ratings, high product visibility, excellent user’s
satisfaction, expressed by friends (words of mouth)
Time-dependant : It is not because a
product is subject to positive network
effects, this will last forever.
Effects can switch from positive to negative
when the number of users increases. Eg:
games getting overcrowded what results in
users leaving the game.
Network can be clustered, what means that there exists clusters of network within the network. Eg:
social media network, where residents in a country are more connected with each other than
with people outside their country.
Interaction between users in networks can be asymmetric what means that a user sends more
information than that he receives in return. Eg: in Youtube or Twitter (X): a relative few users create
the content that is spread to the other users.
In case of positive direct network effects, users benefit from other user’s in the network because
they have option for more direct interaction between the users (eg: social network)
In case of indirect network effects, users benefit from other users because they more collectively
provide value that is somehow appreciated by all users in the network without any direct
interaction between users taking place. (eg: improvement in service quality due to user feedback
and product review)
Fadia Farhat | VUB 2023-2024 88
, Same-side and cross-side effects –> in multi sided markets. Eg: hardware-software example. If no
hardware, software cannot run. And without software, hardware is quiet useless => two sides of
the market are inter related and this is an example of cross-side network effects.
4.1 Electronic money and the network externalities theory
Aim of this paper was to show that the network externalities theory provides a useful framework to
provide the introduction and future development of the new electronic payments instruments
that were being launched at that time. Paper present a pragmatic and more selective reading of
the network externalities literature. He was applying an existing theory of network externalities to a
new phenomenon of electronic payments. “No new rules are needed in the digital economy, we
can apply existing theories” (see introduction of the course)
At that time, when launching payment instruments, issuers were faced with “chicken-and-egg
problem”. On one hand the merchants will be reluctant to invest in new equipment or software
that is needed to accept this king of payment unless they know that there will be sufficient
customers that will be interested in this new methods of payment. On the hand, the consumers will
not start to use this new payment method as long as they can only use it in a few places. This
dilemma originate from the fact that electronic money products are network goods. These
products are subject to network externalities.
Read the article of Van Hove, 1999
Direct network externalities are demand network externalities. They are generated through a
direct physical effect of the number of purchases on the quality of the product.
Another important distinctive feature of network goods besides the required complementarity and
interaction: network externalities are more self-contained than other forms of externality.
Fadia Farhat | VUB 2023-2024 89
