19 Mar 2012

How networks grow and then shrink in value

The move from abundance to scarcity (or non-rivalry to rivalry) does not just happen as the relative balance between demand and supply changes. It can also happen on a network, as it develops and then reaches capacity. That non-linear process is different from the linear process that we see with a resource (value rising steadily as it grows more scarce) due to the benefits of having more people on a network.

The change from increasing to decreasing value of additional demand goes like this:

At first, additional users (from a low user population) make a communication network more valuable since the fixed cost of the network does not change, but its value increases as there are more people to communicate with. From a water perspective, the same holds true, except that additional users lower the cost per user while the network is within capacity. Until this point, the value per additional user is positive.

But after awhile, there are too many users on the network. A communication network will get slow with congestion. A water network will not be able to deliver adequate water to all who want it. From this point, the value per additional user is negative.

Bottom Line: Some customers are good; too many lead to congestion that harms everyone.