Has eBay Reached the Limit of the Network Effect?

| About: eBay Inc. (EBAY)

The network effect, an effect famously exploited by AT&T’s (NYSE:T) predecessor Bell Telephone’s president, Theodore Vail, to achieve monopoly power (one telephone is useless, but if everyone has one, it’s priceless), has been a dominant business model for internet companies for over a decade. eBay (NASDAQ:EBAY) is no exception, owing its success of its online auctioning business to that same effect (the more buyers and sellers trade on eBay, the more valuable the site becomes to its users, and the less inclined they are to go someplace else), and earning “de facto monopoly” status—or so it seems. However, it appears that the only thing that is keeping eBay alive anymore is that network effect, which may be drowning it at the same time.

I have been an eBay member myself for eight years, and have noticed how increasingly cumbersome and error-prone its web site has become. But my personal experience pales in comparison to the dissatisfaction users have voiced all over the Internet on blogs and discussion sites (amazingly, this includes eBay’s own blogs: go to blogs.eBay.com and search blog titles for “eBay sucks”).

Many blame the management, but eBay may also be a victim of its popularity: by trying to accommodate their hundreds of millions of users, eBay may have ended up displeasing many of them. Indeed, the site is so bloated and feature-laden that its programmers seem unable to manage it anymore, and its customer service has become overextended as a result. A recent decision to limit the ability to leave feedback on the site about the experience of a transaction with another user to buyers only, an attempt to solve an inherent problem with its previous feedback system (since feedback went both ways, users may have refrained from leaving negative feedback out of fear to also receive negative feedback in return), was not very well received by sellers (to put it mildly; another recent outcry was caused by fee increases).

It appears that the very same network effect that caused its success may now cause its demise. eBay can either offer the same service to all (leaving many dissatisfied), it can continue to expand its user interface to offer ever more choices to customize the individual experience (which has already complicated the site to the brink of unusability), or it could split it into subsections (auctions versus fixed price, commercial “power” sellers versus individual sellers, local markets, etc.). The earlier options seem to have failed, while the latter gives up at least part of the benefits of the network effect.

Indeed, eBay has already (and always) compartmentalized its site to some extent, namely by dividing the marketplace into categories. While this may be unavoidable if one wants to effectively enable users to find the items they seek, it also creates an opening for competitors: For example, someone looking for jewelry doesn’t really care whether and to what extend the same site also offers consumer electronics. This is exactly where some sites, like Silkfair.com (popular among users who like to buy and sell jewelry, while offering a very meager amount of listings in their consumer electronics section), have started to encroach. Other competitors include wigix.com, etsy.com, and oddle.com, to name just a few.

And then there is good old Amazon.com (NASDAQ:AMZN), which went online around the same time eBay did thirteen years ago. With a web site not riddled with errors and other issues, Amazon.com also offers an increasingly popular marketplace for individuals and smaller merchants to sell their items at their site.

eBay’s troubles are aggravated by its ties to PayPal, which it bought in 2002. Indeed, eBay’s payment system is so closely tied to PayPal that it has drawn antitrust lawsuits, and PayPal is also known for its own legal problems, including allegations of improperly freezing customer accounts to derive economic benefit, which have made it widely unpopular (see, e.g., www.paypalsucks.com, or www.aboutpaypal.org).

The Economist may have summed it up best when it wrote the following about eBay in a recent issue:

“[R]ecognizing that its business... had potential network effects... [t]he firm became a de facto monopoly, but with that came a culture that left many of its users disenchanted, and growth slowed. Some measures, such as the number of new listings of items for sale, are even in decline. Buyers and sellers increasingly rely on Google’s (NASDAQ:GOOG) search model, or online social networks, to find things and one another. eBay’s new boss, John Donahoe, is not facing a crisis like Yahoo’s (YHOO)—but neither does he appear to have a big idea for the future.”

Disclosure: None

Mylene Mangalindan, “Irked by eBay, Some Sellers Trade Elsewhere,” Wall Street Journal D1-D2, Aug. 12, 2008.

“Yahoo!, eBay and Amazon – The three survivors,” The Economist 75-76 (week of June 21st-27th 2008).

Kimberly Palmer, “Boycotting eBay? Here Are Three Alternatives,” USNews.com, Feb. 11, 2008.

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