The popularity of a digital service, in most cases, is dependent on how many people ultimately wind up being customers. Metcalf’s Law states that the value or utility of a network is proportional to the number of users of the network (utility = n2). As the costs of building a network grow linearly, the value of the network grows exponentially. Excellent investment opportunities can be found by understanding the power of Metcalf’s Law and network effects.
Robert Metcalf, the co-founder of 3Com and the Ethernet, realized that the number of possible connections a network can grow into occurs very rapidly. A recent example of this is Facebook. What started out as a small college network about 15 years ago grew into a 1.8 billion daily active users (DAU) network in 2020. The rate of user growth Facebook experienced was exponential, especially as it was a “free service”. Once the company figured out how to monetize the business, shareholder value grew exponentially as well. Facebook is now valued as one of the most valuable companies in the world, nowadays with a market capitalization of around $1 trillion.
In economics, a network effect refers to a change in the positive benefit that a consumer receives from a good when the number of consumers in the good increases. As human behaviors & tastes change, the benefits of goods change. Take for example newspapers and magazines. As more and more people migrated towards reading their news online the value of advertising on these platforms diminished in value. Advertisers, for example sticking with Facebook’s business, are enticed to utilize a huge platform to promote their brand. Facebook can leverage its large platform as a competitive advantage. The vast amount of data people share about themselves is used by Facebook, and the ads they sell, to target specific audiences advertisers are trying to reach.
Metcalf’s Law and network effects can be a great tool in evaluating an investment opportunity. The digital businesses of the 21st century are going to benefit from the continued growth of the internet and experience exponential growth much faster than a typical business could achieve in the past. A skilled financial advisor will make the extra effort to find these opportunities for their clients, such as at Musser Financial Planning. Most non-financial professionals do not have the time or expertise to find such opportunities. If you would like help managing finances utilizing state-of-the-art financial tools and models, contact David Musser for a FREE 30-minute consultation at musserfinancialplanning.com.