As I start to look past the news, and try to perform some analysis on the web strategies of some of the companies that I tend to be interested in (and write about), it’s important to understand some of the basics of strategy in a Web 2.0 world.

People sometimes use the term "network effects" when they mean "lost of eyeballs" but network effects is more of an economic principle. The Wikipedia credits ethernet founder Robert Metcalfe with it’s origins, but economist Nicholas Economides at NYU has a large body of work in this area.

The classic example is the telephone. If a telephone salesman came to your house to sell you a telephone, you would ask who else has a telephone. If nobody else owns a telephone, there is no value to you. If everybody you know owns a telephone, then a telephone is very useful to you.

A network effect creates value for a website based upon how many other people use the website. As the Wikipedia achieves critical mass and vast adoption, there is a higher probability that whatever I’m searching for has an entry, and therefore Wikipedia has more value to me. As eBay hits 100 million listings, there is a larger chance that the rare coin I’m looking for will be listed. eBay is benefitting from network effects.

It really makes you think about the first person to buy an Ethernet card, post a profile on MySpace, start an eBay auction, or create a Wikipedia entry. It takes guts to be an early adopter!

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