Contents - AL-Tax

12.1 Summary of Key Facts 163the infrastructure (an interconnector) that enabled subscribers of one local exchangeto connect to subscribers of other local exchanges. The more such cross-connectionsindividual subscribers could make (equivalently, the larger the network), the morevaluable the service. Hence the birth of a monopoly: Because individual localexchanges were worth far more as part of AT&T’s growing network, it could paymore than their value on a standalone basis to acquire them.The analogy to the Internet is so straightforward that it is barely an analogy atall: The Internet has rapidly become an integral part of the world economy, and ofthe way in which individuals communicate and socialize, because it is a massivenetwork of networks that facilitates billions of cross-connections at minimal cost.If it were only half as large, it would be much less than half as valuable and influential.The same observation applies to user networks on the Internet: eBay, Flickr,YouTube and Face Book are extremely valuable companies primarily because theyhave very large user communities. It is very difficult for new entrants in the sameproduct space to attract users, because the size of a user network generally determinesthe desirability of joining in the first instance. (Hence Microsoft’s aggressivepursuit of Yahoo.) Large begets larger, and smaller firms fall by the wayside. Thisdynamic, while applicable to certain companies and industries without a presenceon the Internet, is amplified in cyberspace, as has long been recognized. Thus, forexample, Morgan Stanley Dean Witter equity researchers made the following observationin June 1999:Even as Internet companies grow at torrid speed, many have yet to generate positive earningsbecause they are spending heavily now to build market leadership for the future. Thelesson is clear to us: first-mover advantage and the law of increasing returns are more pronouncedon the Net than anywhere else in the economy. 1While USP was the first mover in its product space in the United States, othercompanies in non-U.S. markets were quick to duplicate its business model, as noted.Largely because of network effects and the resulting first-mover advantage, USPexpanded into foreign markets where there was a clear market leader through acquisitions.It rebranded the acquired sites and migrated users to its own IT platform,to eliminate duplication in network assets and costs. USP also entered into severaljoint venture partnerships in key non-U.S. markets.Shortly before USP’s first major acquisition, FS was established, and USP contributedthe shares of the acquired company thereto on a cost-free basis. USP andFS also entered into a joint venture (JV) agreement, which set out the followingdivision of labor: USP contributes its existing IT platform. USP has sole responsibility for maintaining and upgrading the IT platform atits own cost and risk. Servers are located solely in the United States, for useworldwide. USP agrees to customize individual foreign sites based on specifications providedby FS.1 Morgan Stanley Dean Witter, The European Internet Report, June 1999, p. 181.