The Most Powerful Economic Force of the 21st Century - Collaborative Networks
What makes one business “better” than another? Ebay is the world’s fastest growing business and promises to continue as such for many years. Instinctively we understand that they have a better business model and a brighter future than, for example, China Textile Factory # 5 the world’s fastest growing apparel supplier to the world. But why?
The best explanation I have ever heard was put forth by Kevin Kelly, the founder of Wired magazine in his book “New Rules for the New Economy”. It is out of print but you can read it for free online at www.kk.org/newrules/newrules-1.html. He makes a very compelling argument that there are important differences between the economics of industrial businesses like China Textile Factory #5 (hereafter fondly referred to as #5) and network based businesses like Ebay.
#5 and other industrial economy investments benefit from economies of scale, which benefit investors through arithmetic increases in value, during the good times, where success is self limiting and obeys the law of diminishing returns. Typical examples are businesses like maritime shippers or chemical producers who because of long lead times associated with adding new capacity are always out of sync with demand resulting in exaggerated boom and bust cycles. It is emotionally difficult to build new capacity at the bottom of the cycle or to sell when business is good but it has been the best strategy for investors in these sectors.
Ebay and other network economy companies’ benefit from economies of connection that result in exponential increases in value as you add members to the network. The network economy benefits from the law of increasing returns. Metcalf’s Law says that the sum value of the network increases by the square of the number of members. In other words, as the number of members of a network increase arithmetically, the value of the network increases exponentially.
Understanding Kelly’s “New Rules for the New Economy” is as important for investors as understanding the miracle of compound interest. Investors can give themselves a huge advantage by investing in network businesses that have proven their significance “cheaply” before the compounding effects take the company to the point of runaway growth or “tipping point.”
My favorite example of this is Microsoft which became the standard for the PC network. It took Microsoft 10 years (1975-1985) to grow to $100 million where we all had a chance to buy in on the IPO. I remember where I was and what I thought of the Microsoft IPO, “It's great but probably too expensive”. The next ten years saw sales grow from $100 million to $5 billion and the value of a $10,000 investment turn into $6 million. I (sob!) had $10,000 in 1985 but instead was investing in financially troubled manufacturing companies.
The best investments of the past 20 years have been companies that understood and harnessed the power of the network economy like Google, FEDEX, UPS, Ebay, Yahoo Amazon and Cisco.
Future Opportunities
Each successful network business creates new opportunities as part of its ecosystem (see below). If you are like me and missed out on the IPO of Ebay and are looking for the next ground floor opportunity, your best bet is to figure out who is facilitating Ebays growth and provide the early stage capital for them. The rise of Ebay was aided by facilitators like Paypal, the online payment system (acquired by Ebay for $1.5 Billion in 2002) and Skype, the voice over internet protocol provider (acquired in September 2005 for $3.6 Billion with only $7 million in sales). Investors made exponential returns. Clearly there is a huge economic opportunity to figure out the third wave facilitator that will be acquired by Ebay. My big bet on the Ebay ecosystem is a dropshop chain, Paketeria which are adding dramatically to the growth of Ebay.
Each new network creates a space from which several more networks can be created. And from each of those new innovations comes yet more spaces of opportunity.
My next post will explore the dropshop phenomena.
The best explanation I have ever heard was put forth by Kevin Kelly, the founder of Wired magazine in his book “New Rules for the New Economy”. It is out of print but you can read it for free online at www.kk.org/newrules/newrules-1.html. He makes a very compelling argument that there are important differences between the economics of industrial businesses like China Textile Factory #5 (hereafter fondly referred to as #5) and network based businesses like Ebay.
#5 and other industrial economy investments benefit from economies of scale, which benefit investors through arithmetic increases in value, during the good times, where success is self limiting and obeys the law of diminishing returns. Typical examples are businesses like maritime shippers or chemical producers who because of long lead times associated with adding new capacity are always out of sync with demand resulting in exaggerated boom and bust cycles. It is emotionally difficult to build new capacity at the bottom of the cycle or to sell when business is good but it has been the best strategy for investors in these sectors.
Ebay and other network economy companies’ benefit from economies of connection that result in exponential increases in value as you add members to the network. The network economy benefits from the law of increasing returns. Metcalf’s Law says that the sum value of the network increases by the square of the number of members. In other words, as the number of members of a network increase arithmetically, the value of the network increases exponentially.
Understanding Kelly’s “New Rules for the New Economy” is as important for investors as understanding the miracle of compound interest. Investors can give themselves a huge advantage by investing in network businesses that have proven their significance “cheaply” before the compounding effects take the company to the point of runaway growth or “tipping point.”
My favorite example of this is Microsoft which became the standard for the PC network. It took Microsoft 10 years (1975-1985) to grow to $100 million where we all had a chance to buy in on the IPO. I remember where I was and what I thought of the Microsoft IPO, “It's great but probably too expensive”. The next ten years saw sales grow from $100 million to $5 billion and the value of a $10,000 investment turn into $6 million. I (sob!) had $10,000 in 1985 but instead was investing in financially troubled manufacturing companies.
The best investments of the past 20 years have been companies that understood and harnessed the power of the network economy like Google, FEDEX, UPS, Ebay, Yahoo Amazon and Cisco.
Future Opportunities
Each successful network business creates new opportunities as part of its ecosystem (see below). If you are like me and missed out on the IPO of Ebay and are looking for the next ground floor opportunity, your best bet is to figure out who is facilitating Ebays growth and provide the early stage capital for them. The rise of Ebay was aided by facilitators like Paypal, the online payment system (acquired by Ebay for $1.5 Billion in 2002) and Skype, the voice over internet protocol provider (acquired in September 2005 for $3.6 Billion with only $7 million in sales). Investors made exponential returns. Clearly there is a huge economic opportunity to figure out the third wave facilitator that will be acquired by Ebay. My big bet on the Ebay ecosystem is a dropshop chain, Paketeria which are adding dramatically to the growth of Ebay.
Each new network creates a space from which several more networks can be created. And from each of those new innovations comes yet more spaces of opportunity.
My next post will explore the dropshop phenomena.
