Demand Analysis and Optimal Pricing 105In all these instances, positive network externalities imply that customer values
and, therefore, underlying demand curves shift outward over time as the cus-
tomer network expands.^18
What are the strategic implications of network externalities for information
providers? Clearly, there is a potential “first-mover” advantage in enlisting the
greatest number of users of the information good in question. (We will say
more about first-mover strategies in Chapter 10.) Users “in hand” are valuable
to the firm not only for the revenue they directly generate, but also because
they enhance the value of other current and future users (from which the firm
also gains revenue). Well aware of this dynamic, e-business firms have aggres-
sively sought customers, not only via advertising and promotions, but also by sig-
nificant price cuts. The extreme cases of cutthroat competition have bred free
information services of all kinds: electronic greeting cards, e-mail, Internet
connections, and online newspapers and magazines. Interestingly, offering free
services is a viable business strategy as long as the expanded customer base gen-
erates revenue through advertising or from any of the avenues mentioned ear-
lier. In numerous instances, free downloadable versions of stripped-down
software or Web content have enticed consumers to trade up to “professional”
or “deluxe” versions, for which dollar fees are charged. In other cases, infor-
mation providers have been locked in savage price wars or battles over free
content that have decimated company revenues, thereby degenerating into
“wars of attrition.” National newspapers have been especially hard hit by
younger demographic groups that prefer to get their news for free from online
sources. After much internal debate, in 2011 the New York Timesset its digital
subscription price at $15 per month (print subscribers have digital access for
free) significantly above the $10 threshold thought to capture what the typical
customer would be willing to pay. To date, the identities of information sup-
pliers with business plans capable of earning consistent and sustainable rev-
enues are still being sorted out in the market.(^18) Let there be n members of a network and suppose that each member’s value is proportional to
the number of other network members (n 1). Then, according to Metcalf’s “law,” the total value
of the network (summed over all members) is proportional to (n)(n 1) n^2 n. In short, net-
work value increases geometrically and rapidly as the square of the number of members. By this
reckoning, a mega-network enjoys an enormous value advantage over a smaller network.
The Economics
of Groupon
Launched in November 2008, Groupon, the purveyor of carefully chosen and
promoted discount coupons at local businesses, is one of the fastest growing
Internet companies, now operating in over 500 markets and 44 countries.
Profitable in just its first 7 months, in 2010, the company spurned a buyout by
Google valued at $6 billion. In each locality, Groupon promotes discount
coupons for a single business each day—for instance, a $50 coupon for an $80
facial treatment at a local spa. The deal is on only after a critical number of
people, 150 let’s say, click to buy. Otherwise, the deal dies, no coupons are
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