Network issues and payment systems

Credit & Financial Management Review, First Quarter 1998 by McAndrews, James J

Not only do the benefits increase as the network expands, but the per unit cost of production falls. One reason for the economies of scale is that networks are often set up with centralized switching facilities to route delivery of service. For example, in a local telephone network, rather than stringing wires from each house to all other houses, one line is strung from each house through a series of trunk lines to a central switch. As telephone traffic increases, the cost per call declines, since the fixed cost of the switch can be spread over more calls. This decline in average cost encourages larger networks. In the 1970s and 1980s, economists began to recognize networks as distinct features of certain industries and subsequently outlined various economic issues unique to these industries.

Compatibility One key to extending the size of a network is the compatibility of network components. Networks combine complementary components of a technology that makes possible the creation of goods and services. But the components' compatibility makes possible their complementarity. For many products, compatibility can be achieved only by adherence to technical standards.

Take the case of railroad gauges. U.S. railroads employed different gauges of track - the distance between the rails - for decades, necessitating the use of costly devices (including laying third rails in some cases, and having railroad cars with adjustable axle widths) to transport goods across different rail lines. In the 1830s, at the beginning of intercity rail service in the United States, three gauges emerged as the most popular. The three - 4 feet 8.5 inches, 4 feet 10 inches, and 5 feet - varied only slightly from one another but were sufficiently different to prevent the interchange of rolling stock (railroad cars and engines). Hence, goods typically had to be unloaded and reloaded as they were shipped from one region's lines to another's. As long as the volume of shipments between regions was not too great, the different gauges could survive.

From the 1840s through the 1860s, additional gauges were introduced and survived, resulting in a balkanized railroad system. In a 1991 article, Douglas Puffert identified nine regions of the country that, in the 1860s, used common gauges within the region. By the 1890s, though, U.S. railroads had fixed on 4 feet 8.5 inches (called standard gauge) as the measurement for rails across the country.

Puffert explained the evolution of railroad gauges in the United States in this way: In the early years of railroad development, purely local considerations were paramount. Railroads were built to gain access to ports, rivers, canals, and large regional markets and were not interlinked with other railroads. However, as the industrialization of the United States proceeded in the post-Civil War period, the higher cost of shipping goods across lines of different gauges became more apparent. In the late 1880s, those lines that did not use the standard gauge decided voluntarily to move their rails to adhere to the standard gauge across the United States. After that, an extensive system of car interchange developed among railroads.4