Network Effects and Information Cascades in Real Estate
Network effects are widely study in the space of social media networks. In this context, value is added to the platforms when more users participate on the platform. For example, increased participation makes it easier for users to virtually connect with individuals and provides a central stage for an individual to post relevant information. While the integral connection between network effects and social media sites have dominated the research field, studies are emerging which consider the non-social implications of network effects. Specifically, how network effects, in addition to information cascades, influence and enhance a person’s business behaviors. Such is evident by studying the real estate platform Zillow. An analysis of the Zillow platform and business model reveal how the impact of network effects extends beyond social media networks.
Zillow’s primary function is a search engine for real estate listings in the United States. The site also stores listing data which can be used to predict market trends and inform fair market values. This data, in part, informs the Zestimate function which predicts a property’s selling price in a real-time market. Thus, the Zestimate is more accurate when it has more comparable data to reference. According to tech scholar Mike DelPrete, this is where network effects can influence the accuracy of the Zestimate. When the site has greater participation, or more listings are added to and tracked on the site, Zillow obtains valuable market information. It then incorporates this new information to generate a better prediction; the improved accuracy of the prediction ultimately pleases website users. Thus, more users begin using the site, because of the prediction’s accuracy, and subsequently the cycle repeats itself. In this way, network effects inform the informative value of a site as more users and information generate more accurate predictions.
One should also note that prioritizing networks effects can inhibit business growth and subsequently impact the flow of quality information to users. In order to catalyze network growth, sites must be accessible and relevant to many potential users. In the case of Zillow, the website must be able to return listings and data for a wide variety of markets. In this way, Zillow must appeal to a broad group of potential users, and therefore cannot prioritize information or features which would be relevant to a small pool of potential users. In one way, this is detrimental to the users in that small pool since they could be receiving more valuable information. However, this valuable information is restrained in order to promote network effects.
The control of information flow, and the quality of that information, can have serious consequences in the housing markets. Robert Schiller, of the New York Times, summarized how the perpetuation of misinformation contributed to information cascades which ultimately led to the 2008 housing crisis. For reference, an information cascade is when multiple people make the same decision in sequence. One’s decision is often influenced by the decisions of those ahead of them in their sequence, regardless of whatever private information one receives. In this case, major banks and mortgage brokers led the cascade when they began granting generous mortgages to homebuyers, and thus encouraged homebuying. Homebuyers and smaller firms, who were further down on the cascade line and whose behavior was thus influenced by earlier actors, acted accordingly. They opted to “follow the leaders” despite receiving private information that a housing bubble might form and their investment would lose value. In this way, those actors elected to follow others’ behavior rather than be informed by their own private resources. This example exemplifies how information cascades can form in real estate markets and ultimately produce disastrous market effects.
Ultimately, this blog post demonstrated how network effects are impactful beyond social media platforms. Such demonstration is crucial to understanding how network tactics can be utilized to sustain business models dependent on relying accurate information. Furthermore, this post discussed how the flow of information, particularly via information cascades, is critical to a market’s health.
Sources:
https://www.nytimes.com/2008/03/02/business/02view.html