The Chicken and the Egg

The Network Externality Effect for Internet-based Services

Network Externality

• Definition: Network Externality is an economists notion that the value of a product of service is proportional to the number of others using that product or service. (e.g. Fax Machines)

Network Externality in the Internet

• Exchange Points

Cost of Svc

Value

Number of participants

Value of the Internet ExchangeVExchange

NParticipants

CostOf Coming In(Circuits+Routers+StaffTime)

VCapacity

The Exchange Startup Hump

First Carrier(s)First ISP(s)First CP(s) Critical Mass Point (Vexchange=CostExchange)

Lar

ge F

acili

ty S

calin

g

C o nte ntPro vid e r

C o nte ntPro vid e r

C o nte ntPro vid e r

ISP ISPISP

C a rrie r C a rrie r

C irc uitDe m a nd sTric kle Do wn

C =num b e r o f c o nte nt p ro vid e rs

I=n u m b e r o f I S P s

N =n u m b e r o fc a r r ie r s

Drop the Cost of ParticipationVExchange

NParticipants

CostOf Coming In(Circuits+Routers+StaffTime)

VCapacity

The Exchange Startup Hump

First Carrier(s)First ISP(s)First CP(s) Critical Mass Point (Vexchange=CostExchange)

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ge F

acili

ty S

calin

gC2

Incent (Buy) Providers InVExchange

NParticipants

CostOf Coming In(Circuits+Routers+StaffTime)

VCapacity

The Exchange Startup Hump

First Carrier(s)First ISP(s)First CP(s) Critical Mass Point (Vexchange=CostExchange)

Lar

ge F

acili

ty S

calin

g

Lower Cost of ParticipationVExchange

NParticipants

Cost(1)Of Coming In(Circuits+Routers+StaffTime)

Cost(2)

VCapacity

The Exchange Startup Hump

First Carrier(s)First ISP(s)First CP(s) Critical Mass Point (Vexchange=CostExchange)

Lar

ge F

acili

ty S

calin

g

Incent 1st, then Make it up when value exceeds cost

VExchange

NParticipants

CostOf Coming In(Circuits+Routers+StaffTime)

VCapacity

The Exchange Startup Hump

First Carrier(s)First ISP(s)First CP(s) Critical Mass Point (Vexchange=CostExchange)

Lar

ge F

acili

ty S

calin

g

Incent 1st, then Make it up when value exceeds cost

VExchange

NParticipants

CostOf Coming In(Circuits+Routers+StaffTime)

VCapacity

The Exchange Startup Hump

First Carrier(s)First ISP(s)First CP(s) Critical Mass Point (Vexchange=CostExchange)

Lar

ge F

acili

ty S

calin

g

Increase price as value increasesVExchange

NParticipants

CostOf Coming In(Circuits+Routers+StaffTime)

VCapacity

The Exchange Startup Hump

First Carrier(s)First ISP(s)First CP(s) Critical Mass Point (Vexchange=CostExchange)

Lar

ge F

acili

ty S

calin

g

Guarantee Cost Savings from Peering VExchange

NParticipants

CostOf Coming In(Circuits+Routers+StaffTime)

VCapacity

The Exchange Startup Hump

First Carrier(s)First ISP(s)First CP(s) Critical Mass Point (Vexchange=CostExchange)

Lar

ge F

acili

ty S

calin

g

Key points on the value curve