Metcalfe’s Law was the mantra of the dot-com generation. With it, spawned dozen of more mundane but more digestible corollaries: winner takes all, network effects, first mover advantage, time-based competitive strategy, time to market advantages, etc. While it certainly lost some of its luster, its impact on the technology industry can not be understated. Entire venture capital firm, read Benchmark, has made innumerable billions investing in “network effects” or as Bill Gurley calls it “Increasing Marginal Utility” ventures. Companies like eBay, Keen, uShip, Zopa, Betfair, Dropshop, Shopping.com, WorldWinner, Ingenio, Open Table (wow thats long list) were founded/funded based on the “law” by Benchmark.

So what happened to Metcalfe in China? Before Taobao, EachNet had 80% of the market. Before Baidu, Google had similar domination. A few years later, both former leaders are losing market share and fighting teeth and nail to recover its former glory. Both companies were typical network effects business models - eachNet with its marketplace, Google with its advertising network. Certainly Metcalf law does tilt the scale in favor of the incumbent, but it doesnt mean the game is over. In fact, what happened in China deserves deep introspection for entrepeneurs working at Web 2.0 companies taking on Web 1.0 incumbents. Here are some of the things I gleamed (I’m sure there are more, especially for those on the inside)

1. Metcalf’s law is less powerful when the incumbent owns a large percentage of a small nascent market. Overall Internet penetration was/still very low in China when eachNet and Google achieved its leading position. With a large percentage of the total addressable market still up for grabs, late entrants still have an opportunity to gain marketshare and match the critical mass achieved by incumbents in a short (or even shorter) amount of time based purely on the fact that adoption rate are often expotential. This is key, in that, given an exponential growth rate of a small emerging market, late entrants can actually “catch-up” to the incumbents quickly if they are able to acquire these new users (which is still hard to do given Metcalf’s law). So how can they capture these novice users? That brings me to the next point.

2. More importantly the total addressable market is highly heterogeneous- that the market is segmented into various groups which is very different on a attitudinal, behavioural, and demographic basis. This allows new entrants to creat tailored solutions which offer a particular segment more bundled value than that offered simply through network value. (think localization & more) In China, these new users were different enough from the early adopter that using Taobao or Baidu’s solution made much more sense than eachNet or Google. In fact, the brand awareness of the incumbents was low enough in the total addressable market, that the “law” conferred much less advantage than previously thought.

3. Heterogeneity must also exist in the way users make their purchase/adoption decision. In typical marketing parlance, the awareness-consideration-purchase funnel must be decidedly different in the target segment for the late entrants (from the segment which the incumbent owns) to enable them to effectively market/sell to that segment. In China, the later adoptors were much less affluent, much less web-literate, and live in less urban areas outside of Beijing and Shanghai. By putting more feet on the ground, being more scrappy, and messaging in a decidedly different channel geographically/offline/online, late comers were able to convince users to use their solutions instead.