"Imagine that each of your five best friends has a party on the same night. Assuming you like each equally well and have invitations to all five events, how do you decide which to attend? If you're like most people, the answer is you'd probably head for the party everyone else is going to. But how do you figure that out?

"What if you somehow knew which fete was at the moment most fun and had the most people? And what if you knew these things quickly and without cost? Finally, what if you could tell when your current party's ranking fell out of favor and could beam straight to a better one? The result would likely be one soiree with swarms of people and four functions with hosts munching Doritos alone.

"This sort of scenario underlies what economists call a network effect or a winner-take-all effect. It is a feedback phenomenon that says whenever it is in people's best interests to be where everyone else is, then that's where they'll be. So far, we have seen simple examples: Amazon.com (AMZN) gets oodles of visitors because people hear about it more than other online booksellers. E-Trade, too, gets big traffic because it is better known than many of its competitors. And because both are widely recognized, the process feeds back on itself.

"But these are not subtle effects, what we might call first-order feedback. Why? Because I get no direct benefit from buying at Amazon or trading at E-Trade just because other people do. The feedback effect, in other words, doesn't really feed on itself for very long.

"There are, however, instances in which the feedback effect operates on another plane altogether. Consider, for example, eBay (EBAY).

"There is a fundamental reason for eBay's popularity: Consumers are not rubes. We like to buy and sell things where we think we can get the best prices. And we know, at least intuitively, that we can get the best prices, whether buying or selling, where there are the most buyers and sellers. The result is a classic feedback effect: We all go to eBay because that's where everyone else is. We avoid other auctions because we can see right on eBay's front page, which now boasts 2,367,156 items for sale in 1,627 categories, that it is far more popular than also-ran auctioneers like Amazon and Yahoo (YHOO)." Almost 4 years old, but still relevant. A very good thing that Industry Standard left their archives up, IMHO...
Comments 10:32:56 AM    

Chris Gulker's view from Silicon Valley - in words and pictures