Reed's Law

Last week I was flying through my blogroll and I saw some cool charts on Bubblegeneration.

I love math and charts.  So I stopped and gave the post a serious read.

Umair said at one point in the post, "This is Metcalfe vs Reed, if you like, although I think several economists were first to these ideas."

I’ve been trying (and sometimes succeeding) to invest in Metcalfe’s law for a long time.  Metcalfe’s law states that the value of a network scales with the square of the number of nodes on the network.

V = A + BN^2

Non linear value creation is a wonderful thing.

So I said, who is this guy Reed?  Gotta go figure that one out.

Well I am pretty late to this one.  Reed is David Reed, of the MIT Media Lab, and he published his ideas around group forming networks (GFNs) i.e Reed’s Law in the spring of 1999.

I am going to simplify this because its a blog post, but Reed pointed out that if each node of the network was itself a network (a GFN) then the value of the network scales with the exponential of the number of nodes in the network.

V = A + BN^2 + C2^N

Exponential value creation is way more cool than non-linear value creation.

And that was what Umair was showing in his graphs.  Umair thinks that Google is showing exponential value creation.  Who knows if they are or aren’t?

It’s too early to tell.

Because the thing is A is normally a lot larger than B which is normally a lot larger than C.

For those math challenged readers, that means that the initial value of a business (A) is much larger than the rate at which a network value goes non-linear which in turn is much larger than the rate at which a network goes exponential.

Or, maybe more simply said, you gotta have a boatload of nodes on the network before the non-linear thing starts to matter and you have to have way more than that before the exponential things starts to matter.

I have to give some credit to my favorite math geek entrepreneur here. Tom Evslin took some time away from launching to send me a long thoughtful email on Reed’s law and its implications for startups.  I know he’s going to blog it, so I won’t frontrun that post, but Tom really helped me think about what this means for startups.

So you’ll be hearing more from me on this topic and hopefully more from Tom too, which I will reblog when he posts it.

Stay tuned.

#VC & Technology