MI021 / CS021Computers in Management

Oct. 3, 2006Network Effects,

eBay case,W.R. Hambrecht’s OpenIPO

www.gallaugher.com

Issues Covered

• Network Effects– Defined– Characteristics of markets & competition when

present– Examples

• Auction Models– liquidation vs. market efficiency auctions

• Priceline vs. eBay

– eBay case – growth, comp. adv., and challenges– IPO markets & struggles of WR Hambrecht

Effect on innovation• Lowers competition with

established standard• Increases innovation within

standard

buyers

sellers

Users (Windows, PS2)

Developers(programs, game titles)

members

Understanding Network Effects(a.k.a. Network Externalities, Metcalfe’s Law)

When present, product or services become more valuable as its installed base expands.

Why? Users crave…• Exchange opportunities• Stability• Extrinsic Benefits

Characteristics: Early competition, bandwagons, monopolistic tendencies

‘Best’ products don’t always win.

Auction FormatsLiquidation Auctions: (e.g. Priceline)

suppliers customersauction

Market Efficiency Auctions: (e.g. eBay)

Seek lowest price on widely available goods and services

auction

disincentives to use auction shrink supply over time

Seek first to maximize existing

channels & reduce inventory

suppliers customersSeek access to unique / rare products or services

incentives to use auction increase supply over time

Auction format is favored over the

inefficiency of existing channels

Leading Global Retailers

Shop, Buy/Transact, CommunicateSearch, Be Entertained

Dependent on paid & natural search

IPO Inefficiencies

The Firm small Investors

small Investors

small Investors

$45/share

Underwriting syndicate

pays a 7% fee $27/share

Institutions& large

investors

Initial Offer First Day ClosePrice Share Price Difference

Under Armour 11/18/2005 12,100,000 $13.00 $25.30 148,830,000$ 95%Electro-optical sciences 10/28/2005 4,000,000 $5.00 $7.71 10,840,000$ 54%IntercontinentalExchange 11/16/2005 16,000,000 $26.00 $39.25 212,000,000$ 51%Saifun Semiconductors 11/9/2005 5,000,000 $23.50 $35.30 59,000,000$ 50%CBOT Holdings 10/19/2005 3,200,000 $54.00 $80.30 84,160,000$ 49%Baidu.com 8/5/2005 4,000,000 $27.00 $122.54 382,160,000$ 354%Salesforce.com 6/23/2004 10,000,000 $11.00 $17.20 62,000,000$ 56%JetBlue 4/12/2004 5,500,000 $27.00 $45.00 99,000,000$ 67%PayPal 2/15/2002 5,400,000 $13.00 $20.01 37,854,000$ 54%

Company DateShares

UnderwrittenPercent

Undervalued

Company Date

Shares Underwritt

en

Underwriting

Share Price

First Day Close

Share Price Difference

Percent Undervalu

ed

JetBlue 4/12/2002 5,500,000 $27 $45 $ 99,000,000 67%

PayPal 2/15/2002 5,400,000 $13 $20 $ 37,854,000 54%

NetScreen Technologies 12/11/2001 10,000,000 $16 $24 $ 77,200,000 48%

Magma Design Automation 11/19/2001 4,850,000 $13 $19 $ 29,051,500 46%

Global Power Equipment 5/17/2001 7,350,000 $20 $31 $ 84,157,500 57%

Simplex Solutions 5/1/2001 4,000,000 $12 $21 $ 36,800,000 77%

Transmeta 11/7/2000 13,000,000 $21 $45 $ 315,250,000 115%

CoSine 9/26/2000 10,000,000 $23 $63 $ 400,600,000 174%

Active Power 8/8/2020 8,000,000 $17 $53 $ 286,000,000 210%

StorageNetworks 6/30/2000 9,000,000 $27 $90 $ 569,250,000 234%

VA Linux 12/9/1999 4,400,000 $30 239 1/4 $ 920,700,000 698%

Red Hat 8/11/1999 6,000,000 $14 $52 $ 228,375,000 272%

mp3.com 7/20/1999 12,300,000 $28 $63 $ 434,343,750 126%

Efficient Networks 7/15/1999 4,000,000 $15 $53 $ 152,000,000 253%

Tibco Software 7/14/1999 7,300,000 $15 $40 $ 182,500,000 167%

China.com 7/13/1999 4,200,000 $20 $67 $ 197,862,000 236%

CommTouch 7/13/1999 3,000,000 $16 $24 $ 24,000,000 50%

eToys 5/19/1999 8,300,000 $20 $77 $ 473,100,000 285%

iVillage 3/18/1999 3,500,000 $24 $56 $ 112,000,000 133%

AutoWeb 3/23/1999 5,000,000 $14 $28 $ 71,250,000 102%

Auto-by-Tel 3/24/1999 3,500,000 $23 $40 $ 60,375,000 75%

Prodigy 2/11/1999 8,000,000 $15 $28 $ 105,040,000 88%

VerticalNet 2/11/1999 3,500,000 $16 $45 $ 102,830,000 184%

Healtheon 2/11/1999 5,000,000 $8 $31 $ 116,900,000 292%

Pacific Internet 2/5/1999 3,000,000 $17 $48 $ 93,000,000 182%

Theglobe.com 11/13/1998 3,100,000 $9 $64 $ 168,950,000 606%