Last week Kevin made the case that the new world of parallel programming would lead to a market where the biggest player – most likely Netflix – was going to end up dominating the market for television delivery.
That hadn’t been the way I had anticipated things unfolding. I was expecting the number of distribution platforms to proliferate and that we would all be spoiled with an abundance of high quality viewing options. As one reader pointed out, unlike social platforms like Facebook, the switching costs are almost zero. And if I switch from Netflix to HBO’s new streaming service, or subscribe to both, it’s not going to impact anyone else on either platform. There are no network effects.
But there are more ways to market dominance than network effects.
Kevin’s post got me thinking about a book I read last year called The Second Machine Age by Andrew McAfee and Erik Brynjolfsson. The authors talk about the demolition of physical constraints on distribution, and how this has caused a proliferation in winner-takes-all markets:
“In many markets, buyers with a choice among products or services will prefer the one with the best quality. When there are capacity constraints or significant transportation costs, then the best seller will only be able to satisfy a small fraction of the global market (for instance, in the 1800s, the best singers and actors might perform for at most a few thousand people per year). Other inferior sellers will also have a market for their products.
But what if a technology arises that lets each seller cheaply replicate his or her services and deliver them globally at little or no cost? Suddenly the top-quality provider can capture the whole market. The next-best provider might be almost as good, but it will not matter. Each time a market becomes more digital, these winner-takes-all economics become a little more compelling.”
Google’s search engine is perhaps the best example of this sort of market dynamic. How difficult is it for you to type in the url of another search engine? The switching costs are zero. There are, again, no network effects. Why, then, does it have such a dominant market position?
Because it has the best product. And the best product means the most revenue with which to ensure its product remains the best (in the middle of a recent discussion about how many times rich people get married, I googled “John Singleton wives” and was delivered a chronological list, with photos, without clicking on a link).
I’m not for a second arguing that this sort of competitive advantage is as robust as one in which network effects are prevalent. But the more I think about it the more I question whether I will actually be signing up to more than one streaming service. If Netflix has five times as much to spend as the rest of the industry combined, why won’t it be able to provide me with everything I could ever want to watch?
I’ve no doubt there will be a long tail of alternate viewing. My wife and I are addicted to Scandinavian crime dramas The Bridge and The Killing, and it’s hard to imagine Netflix creating content with Danish subtitles (although they probably could purchase the distribution rights).
And there’s no guarantee, yet, that Netflix will be the winner. But I won’t be the slightest bit surprised if the media world is dominated by one provider in a decade’s time. The rest of the market will be fighting for scraps.
8 thoughts on “There’s more to Market Dominance than Network Effects”
This view is, in some respects, in opposition to Chris Anderson’s views that he expressed in “The Long Tail”.
Basically, Anderson predicted the fracturing of entertainment content into an ever greater variety of niche products. He is a seriously smart guy, and I’d still definitely recommend reading that book.
Your blog post is more about whether a ‘winner takes all’ dynamic will prevail in the gatekeepers to that content. Although your arguments are all very cogent, my intuition is nevertheless that although Netflix may establish market leadership, there is a difference between leadership and dominance.
Furthermore, even if it was to establish competitive dominance, would the lack of network effects prevent the business’ owners from taking abnormally large profits? For example, look at FC Barcelona and Real Madrid for examples of dominant teams that win everything in their domestic competition, make multiples of the revenue that other teams in La Liga make, have enormous pricing power in their TV rights, merchandise and ticket sales, yet that success has hardly shown through to the bottom line. Obviously, there are plenty of differences between Netflix and a football team, but the point is that dominance doesn’t necessarily translate into good returns on capital, especially when a business relies on stars to achieve success.
I think people underestimate the importance of simplicity in using a product. When Google first came out, I said to my friends that this will dominate. Other search engines had news, sport, links everywhere, it was confusing. Google had one line to search and lots of white space. Simple and easy to use.
Are there no network effects at all for Netflix? Surely the platform is more useful to me as a viewer if there is tonnes of content, far more attractive to content creators with tons of viewers?
Whilst I am not as familiar with Google as Forager would be given you are owners of the stock my understanding is that “network” effects have played a large role in Google’s dominance. I was under the impression that Google “learns by doing” i.e. user behavior helps Google improve its algorithms, the relevance of its search results and the efficiency of its advertising. As more people use Google the more these things improve creating the classic network effect.
Interesting, but no…
Google is most definitely the product of and beneficiary of networks effects, as already pointed out. The moat is durable because and only because of network effects. More people search it because it has more relevant content and listings. More content providers (businesses or anything else on the net) spend money to optimize and advertise on Google because more people use Google. Network effect. The strongest kind. Having more money (to re-invest in the core product, or to pursue other lines or complementary business) and being more profitable are a product of this network effect. Its that simple.
The analogy is like any other listings business with a two sided market. Think Seek or Real Estate.com her in Australia. They dominate not because of higher revenues or profits to make the product better – the product is marginally better if at all compared to the next competitor. Its the network effect again – more listings and more searchers, reinforce each other – network effect.
Net flicks has no network effect. More shows doesn’t mean more viewers. More viewers doesn’t mean more shows. Quality shows brings viewers, or popular video bring viewers. Networks don’t add to this. Sure having money and profits are necessary to fund shows, but its not at all sufficient or a given that this will actually produce better shows. You see, cable has the quantity of shows, it has some quality as well. Until someone comes along and makes other good shows. Content. Content is king. Always will be. Netflix makes content. If it makes the best content it will be king. But it won’t necessarily make the best content because it makes the most money. ESPN, makes the most money. Buys the best sport content. But then comes Fox sports, other sports, other sources of funding to bid for sport. Its the sport itself, not the platform that will shape success. Its definitely not a winner takes all dynamic, its not the monopoly newspaper dynamic. Money helps, but it ain’t the network effect baby.
Perhaps this is an unfortunate consequence of an economics degree but the term “network effects” has a very specific meaning to me: “the effect that one user of a good or service has on the value of that product to other people” (from Wikipedia). Yes, a lot of these businesses you mention get better as they get bigger, but adding one additional person to the ecosystem doesn’t immediately improve the value of the product for everyone else. Seek and Realestate.com certainly have positive feedback loops, and those markets tend towards winner-takes-all, but it’s not because of network effects. In fact, if I am looking for a job or a property, the less people looking for the same job the better.
“Seek and Realestate.com certainly have positive feedback loops, and those markets tend towards winner-takes-all, but it’s not because of network effects. In fact, if I am looking for a job or a property, the less people looking for the same job the better.”
I don’t see it that way at all. The more people (users) looking on the network, the more valuable the network is to each user. You see Steve, its not about the number of people looking for the job or property, its about the number of people looking for it on the network. The listing or network is the product, not the actual job or property. Obviously the fewer bidders or candidates the better, but that’s not the point of the network. The fact that most people looking for that job or house are on the same network, makes it more likely that a job advertiser or property seller will use the network, and thus more valuable the the job seeker or property buyer to spend their time, effort or money on that network. Its classic network effect per the definition.
Lets not get lost in the wood though. Network effect leads to market dominance. But market dominance could come about through other means- which is your point, and true enough it is. The other point that is true, is that Netflix does not benefit from substantial network effects. The more users on the network, the cheaper the marginal cost of programming- but this is not necessarily to the benefit of each user, it may simply be to the benefit of the company. Further, the more users on the network, the more revenue, but this does not necessarily improve programming quality. These two points were made in my initial comment. So Netflix, and the like, may experience network effect or network effect like benefits (aka “positive feedback loop”), but they are less robust and more prone to extrinsic interference by other market forces (such as consumer preferences and competitor creativity) than a more traditional network effect based moat business such as realestate.com. This explains why its possible but not probably that Netflix will achieve “market dominance” for any significant period of time.