Steinblogger

I believe that Network Effects, an economic theory I learned the gist of from Nicholas Economides at the Sern School of Business, is behind the recent gain in Mac market share. And it’s why I think it will continue to gain.

There’s a pretty good explanation of it at wikipedia, but here’s my shot at a plain English version of the concept:

When a good becomes more valuable as more people own it, it becomes more valuable through a Network Effect. The telephone is a perfect example. If two people in the world have phones, only two calls can be made (one to from each phone). Add a third phone, and there are six possibilities. With four it’s twelve; five, 20; six, 30…do you see where this is heading? (The math: if there are n connections, each additional phone adds 2n connections). The amount of calls possible on the network is increased dramatically each time someone joins the network. That increases the value of each phone via Network Externalities — even the first phone purchased is worth more as more people join the network.

I’ll put this into action: a savvy shopper will likely be more willing to buy an ok phone (Phone One) that can talk with a million people on Network A than a superior phone (Phone Two) on Network B that only a dozen people use. It doesn’t matter how Network A became the dominant network. At some point, it hit a tipping point and the Network Effects made the phones that are compatible with it more valuable, even if they are of objectively lesser quality.

The catch is compatibility. If Phone Two was compatible with Network A it could compete and perhaps gain share against Phone One. This is how we ended up with compatible phone and cell phone networks. It’s normal in a Network Economy.

It is in this way that Microsoft became a “natural monopoly,” because it reached a critical mass that made it more valuable to own Windows-compatible PCs simply because that’s what most people owned. More people using Windows meant more support, more software, more peripherals, cheaper parts, etc. For whatever reason you want to pick (cloning, Apple made bad decisions, etc.), Microsoft is the beneficiary of Network Effects.

Another prime example of an arguably inferior product winning through the advantage of Network Effects is the VHS tape (vs. BetaMax).

I believe that, through a combination of culture shifts and some great decisions on Apple’s part, it is now taking advantage of Window’s Network Effects. It’s not just the ability to run Windows. It’s the proliferation of cross-platform standards. Remember when a PC couldn’t read a Mac floppy? When Photoshop on the Mac saved a file format incompatible with Photoshop on Windows? When Windows and Macs couldn’t talk the same network language? The age of web and other standards removes the advantage of the network effects and the better product wins. Why do you think Microsoft is so bent on controlling or damaging as many standards as it can get its hands on? Because it has subsisted as a natural monopoly — not completely because of how the Windows product brings value, but how the Network it exists in makes it more valuable.

Compatibility alone is what allows a superior product to compete with an entrenched Network Effects-driven monopoly.

Macs are essentially compatible with PCs that run Windows. Therefore, Apple stands to benefit from the same network effects.

(A side note: I wrote Professor Economides when Apple announced it’s switch to Intel. I’d read a bit about virtualization and thought it could pave the way for Apple to win serious market share from Windows. He disagreed. I’d still take a bet on it.)