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Electronic Commerce

was not feasible, let alone economic, before. Today it is the
site of choice for anyone looking for the most unlikely of The three factors and illustrations
items that previously could be found only by searching
through obscure shops. But eBay is far more than a boon Technology World Wide Web
for collectors, as it exploits a key driver of e-commerce:
the economic externality of the network effect.

NETWORK EFFECT
When a good or service possesses a network effect, then its
value to a consumer depends on the number of other con-
sumers who also purchase that item. Indeed, Metcalfe’s
Business Model Services
law states that the total value of a good or service that pos- E-Catalog Delivery
sesses a network effect is roughly proportional to the Auctions Escrow
Name your price Price Comparisons
square of the number of customers already owning that
good or using that service. When eBay brings together
potential consumers for one product, then they also serve Figure 2
as a potential market for other products. One conse-
quence of this effect is that there is a tendency for a natu-
ral monopoly to be created, with anyone wishing to ping online. Moreover, e-commerce is now the subject of
auction a product having little to gain and a lot to lose extensive academic research, which is archival rather than
from going to an auction site other than the one with the speculative as it was in the late 1990s.
most customers. EBay is now widely used by large busi- One of the most interesting findings of this research
nesses for B2B, as well as by auction houses for rare art is that relating to why consumers buy books from Ama-
and such high-value items as automobiles, boats, and even zon. Professor Erik Brynjolfsson of the Massachusetts
real estate, a far cry from its garage-sale origins. Institute of Technology has shown that the reason is not
Many dot-coms during the Internet boom of the predominantly lower prices. Rather it is the variety of
1990s claimed to be exploiting network effects, even to books that Amazon sells, especially of hard-to-find titles
the extent of sacrificing current profits in order to buy the that dwarf on all dimensions what can be found at even
“eyeballs” needed to reach a critical mass of users. While the largest brick-and-mortar bookstore. “[Consumers] got
much of that turned out to be illusory, there is little doubt about 10 times as much value from the selection as they
that network effects are a fundamental driver of e-com- got from the lower prices and competition.… more value
merce, taking advantage of the Internet’s abolition of time was created from the increased choice and selection,” said
and distance to bring together large numbers of customers Professor Brynjolfsson (quoted in Postel, 2004, p. C11).
in one place. Sites such as Amazon.com take that effect In other words, value comes not just from the lower
into account when they use buyer recommendations as prices that more transparent competition allows on the
the selling point for their products. Allowing for the Internet, but from the combination of greater choice and
inclusion of such comments creates an online community easy searching. These effects, Internet-based versions of
in which potential buyers and owners can compare expe- economies of scale and scope, undoubtedly exist for many
riences. Similar practices are used to police buyers and other e-commerce applications, from business-to-business
sellers on eBay, or to rank the integrity of sites and prod- marketplaces to online recruiting, music downloads, and
ucts on epinions.com, illustrating again the tremendous even Internet dating. Evidently the dot-com collapse in
variety of the Internet when driving commerce. 2000 has fulfilled its Darwinian purpose in winnowing
out from e-commerce those firms that had no coherent
A MAINSTAY OF THE ECONOMY business plan for the Internet, leaving behind firms that
have a compelling logic in being online.
As e-commerce has matured and become ubiquitous, it
has attracted attention as a mainstay of the economy
rather than as a novelty. Thus e-commerce sales are B2B E-COMMERCE
watched as closely as in-store sales for the health of the Although this discussion has focused thus far on examples
retail economy, with the traditional “black Friday” (the from B2C, businesses are some of the most highly valued
day after Thanksgiving) sales being followed by the “black users of eBay and even Amazon. It needs to be kept in
Monday” the following week when workers allegedly use mind that B2B is really where all the action is, even if it
their office Internet connections to do their holiday shop- does not receive the publicity of B2C. In 2003, 94.3 per-

ENCYCLOPEDIA OF BUSINESS AND FINANCE, SECOND EDITION 231