Monday, March 24, 2008

Network externalities, increasing returns to scale and transportation infrastructure

A new company has launched a product called Dash Navigation that promises to provide real time traffic information to subscribers. This is a great idea, but as a network application it exhibits standard network effects. One of these effects is increasing returns to scale, meaning that the more members there are in the network the better the overall quality and usefulness of the system.

With Dash Navigation, drivers install a GPS device in their cars that transmits travel data back to a central computer. The more drivers there are with the device, the better the overall experience because of better inputs. The idea of harnessing actual information from vehicles rather than infrastructure (such as magnetic loop detectors embedded in roadways) is a promising data set. However, how should this company build the network in order to realize increasing returns to scale? If not enough people sign up the data will be weak and the service will not inspire new customers.

Network development presents challenging ideas about the most efficient way to deploy the system. Typically the infrastructure investment precedes users. This was true with cell phones, cable TV and in many ways the transportation system. One reason Los Angeles has always been dominated by the car is that by the time cars came around LA had a well maintained road system that cars could easily use.

Even the internet required substantial upfront investment in cables, wires and routers to deliver services to those who wanted to pay for it. At this point in the internet's development countries that have nationalized infrastructure development have more extensive systems than countries (like the US) that have private network development.

I think the company is counting on enough people getting fed up with traffic so they will buy the devices. One way they can move ahead is to focus on a few metropolitan areas rather than the entire country. This is a case where higher density of adoption in a concentrated area will benefit the overall system. Another option is to give the devices away or subsidize them (sort of like what Sony did with the Blu-Ray PS3s). This may be something that employers should give away at company picnics.

But like the PS3, user side networks are open to heavy competition that can cannibalize the overall market for a product. Sony won the new DVD war. This is also why satellite radio is consolidating. The classic example is Betamax versus VHS, though the idea the Betamax was superior is wrong. Betamax was only superior at things that consumers didn't put a priority on.

Back to the Dash Navigation, hopefully this will take off, though it is worrisome that cell phones, which are already in most cars, are quite capable of delivering similar information at less cost. We'll see what is VHS and what is Betamax this time around.

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