Modeling the Economics of Internet Companies

In this paper, we build on previous work and analyze the economics of Internet companies in an agent-based model. Our goal is to understand how Internet markets develop over time. Our model has two types of agents: Internet companies and consumers. Internet companies produce web sites and consumers visit these web sites. There is free entry and exit in the market and the companies compete for the attention of the consumers. The companies receive revenue and their market value increases whenever a consumer visits their web site. Over time, the consumers exhibit brand loyalty, thus making them more likely to view a web site they have visited before. In addition, through a process of social communication, consumers who visit web sites tell other consumers about their experience, thus increasing the number of internet users. Initially, there are few companies in the market but the number increases over time as entrepreneurs enter the market. Concomitantly, the number of internet users increases as cutting edge users tell others about the web sites they have visited. When much of the consumer population has begun to visit web sites, the number of entrants into the market declines. Eventually brand loyalties become established and the total number of companies begins to decline because consumers abandon some web sites. As expected, when brand loyalty is high and social communication is low, the number of companies quickly declines as web sites that fail to capture the interest of consumers are quickly driven out. Likewise, when social communication is high and brand loyalty is low, the number of companies declines rapidly because social communication allows users to experience web sites vicariously. However, under certain conditions, brand loyalty and social communication interact in non-intuitive ways. For example, if both brand loyalty and social communication are high, a loyal user can be convinced to switch web sites, thus causing large and traumatic changes in the fortunes of the internet companies. Because of the low entry cost in the Internet space, companies can easily enter a market, thus upsetting established consumer patterns. This model provides economists, venture capitalists, entrepreneurs, and Internet users with a way to understand the quickly changing fortunes of internet firms.