Origins
Network effects were a central theme in the arguments of Theodore Vail, the first post patent president of Bell Telephone, in gaining a monopoly on US telephone services. In 1908, when he presented the concept in Bell's annual report, there were over 4000 local and regional telephone exchanges, most of which were eventually merged into the Bell System. The economics of network effects were presented in a paper by Bell employee N. Lytkins in 1917.
The economic theory of the network effect was advanced significantly between 1985 and 1995 by researchers Michael L. Katz, Carl Shapiro, Joseph Farrell and Garth Saloner.
Network effects were popularized by Robert Metcalfe, stated as Metcalfe's law. Metcalfe was one of the co-inventors of Ethernet and a co-founder of the company 3Com. In selling the product, Metcalfe argued that customers needed Ethernet cards to grow above a certain critical mass if they were to reap the benefits of their network.
According to Metcalfe, the rationale behind the sale of networking cards was that (1) the cost of the network was directly proportional to the number of cards installed, but (2) the value of the network was proportional to the square of the number of users. This was expressed algebraically as having a cost of N, and a value of N². While the actual numbers behind this definition were never firm, the concept allowed customers to share access to expensive resources like disk drives and printers, send e-mail, and access the Internet.
Rod Beckstrom presented a mathematical model for describing networks that are in a state of positive network effect at BlackHat and Defcon in 2009 and also presented the "inverse network effect" with an economic model for defining it as well.
Read more about this topic: Network Effect
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