Network Externalities

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When the value of a technology, product, or service depends upon the number of other entities using it, the phenomenon is called network externality. Direct network externalities involve the value aspect of things like telephone systems, computing platforms, and especially the Internet and e-commerce. Additionally, indirect externalities involve related items like devices (telephones, fax machines, or software applications) becoming cheaper and more accessible as the number of overall users increases. This may also extend to things like service or parts.

Simply put, e-commerce in general becomes more valuable for both sellers and buyers as the overall number of connected entities grows. This kind of growth also means that information can be distributed to more entities for less money. One example of where network externalities play a role in e-commerce is the insurance industry. Certain kinds of insurance have low face values and high overhead costs associated with them. Among these products are travel and burial insurance. By selling these forms of insurance online where sales transactions cost less, insurers are able to offer them at lower prices.

Electronic billing is another area where network externalities have played a central role. In the early 2000s, it was possible for consumers to handle banking and pay many of their bills online. However, the practice of electronic bill payment and presentment (EBPP) was not widely used. Findings from the Gartner Group indicated that in order for consumers to become interested in and use EBPP, it was necessary for banks or bill consolidators (third parties who gather bills from different billers present them to consumers) to offer consumers the ability to pay most or all of their bills at one, convenient online location. Information from Jupiter Research indicated that less than one million U.S. households took advantage of EBPP in late 2000, but projected that number to reach 40 million by 2005. As the number of billers and payers grows, the value for all parties will likely increase.

Network externalities also have a large impact on the international aspect of e-commerce. Although there are many Internet users, which creates significant value for all, infrastructure issues prevent this value from being distributed evenly throughout the world. According to InformationWeek, in March 2001 approximately 100 million computers were connected to the Internet. However, the total accounted for less than two percent of the world's population. Additionally, the publication indicated that most (88 percent) Internet users resided in industrialized nations.

Part of this problem can be attributed to quality issues. In some developing nations like India, the telecommunication systems are not pervasive, and those that do exist often are in poor condition. However, these types of issues even challenge more developed nations. For example, Newsbytes cited a report from the Australian Productivity Commission that indicated the nation's outdated copper wire network limited the speeds at which most Australians connected to the Internet. The report revealed that, at both home and work, only 73 percent of Australian Internet users connected at speeds of at least 28.8 kbps.

In many ways, the heart of the Internet's infrastructure resides in the United States. As Kenneth Neil Cukier explained in Communications Week International, "The high demand for U.S.-based content, the lack of regional infrastructure such as low-cost and high-speed international circuits, and the lack of dominant interconnection points to exchange traffic all serve as both causes and embodiments of the underlying problem: an Internet that is not global, but centered in the United States. This leads to inefficient Internet traffic routing between countries outside the United States, and results in requiring ISPs that handle e-commerce traffic to pay U.S. carriers for access to the Internet."

Although it was improving in the early 2000s, this situation means that the value of the Internet is disproportionately greater for U.S. residents than it is for consumers in many foreign countries. Because the United States has been the center Internet activity and e-commerce, many foreign companies have opted to host their e-business operations there because of superior Internet connections. This allows more global consumers to access the company's Web site in more optimal ways than if it were hosted abroad, where the infrastructure is not as good.


Au, Yoris A., and Robert J. Kauffman. "Should We Wait? Network Externalities and Electronic Billing Adoption." Working paper. University of Minnesota Management Information Systems Research Center, 2000-2001. Available from

Cukier, Kenneth. "Bandwidth Colonialism? The Implications of Internet Infrastructure on International E-Commerce." Communications Week International, 1999. Available from

"University Technology TransferQuestions and Answers." The Regents of the University of California, 2001. Available from

SEE ALSO: Internet Infrastructure