Network Scale Economies vs Metrics

God, I love blogging. I give cool sh*&t away for free and yet I still get deliberately pissy comments:

"...If you were to plot average CPC (cost per click) * (number of searches) over time, I suspect you would get a plot like the Google one. Both are growing. Maybe just CPC alone is growing like the Google plot.

Rising CPC is in large part determined by scarcity on search engine response pages. Can you give a more concrete explanation of how that is explained by your mumbo-jumbo?"

Ha ha. That was so funny I forgot to laugh. Let's step back for a minute and try and understand the point of my graphs yesterday (I admitted that post was badly written, dude) in this commenters terms.

Google is realizing demand-side (aka network) scale economies. That means it's going to create (and hopefully) capture more and more value from growth in it's user base. In the commenters terms, this means that either searches/user and/or average CPC rises.

But focusing on those metrics is how we often miss what's really going on strategically. This is something I argue at engagements all the time. In this case, if we make an economic argument we can easily and pretty intuitively understand the real drivers of the metrics above.

There's one simple reason - network markets follow natural monopoly dynamics. To make it concrete for metric driven folks like this commenter, first think about Google in two ways. First, as a someone who makes markets between buyers and sellers of ad space. Second, as someone who makes markets between buyers and sellers of information (ie, search consumers).

Now ask yourself: assuming all competitors' network sizes are exactly equal, if Google is the most efficient market-maker in just one (not both) of these spaces, what happens?

Where is the average media buyer likely to advertise? On Google. But if everyone reaches that conclusion, all producers defect to Google, you get scarcity, and average CPC rises. By the same token, searches/user will rise as all producers defect, because competitors won't be able to invest as much in the quality of search results, and so all consumers will defect to Google. You can follow the logic the other way as well; the result is the same.

Note that Google is not initially the 'best' in this case - but natural monopoly dynamics create feedback effects which let Google 'win' regardless. These show up in my graphs yesterday as network economies of scale. So the point is that economics drives all of this - don't focus so much on the numbers, think about what's really happening.

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