The Network Effect: How and Why it's Important

The goal of platform firms is to create a network of users who all desire the same thing. Assume your platform is only available to one person. Other groups are unlikely to join the movement in that situation since there is nothing in place for them - but with more individuals on board, everyone has room to grow exponentially. This concept is known as the "Network Effect."

Before adopting any growth strategies, platform designers must first understand what network effect entails. For example, if you were the only one with an email address, it would be of little use to you. However, when more people sign-up for email accounts and communicate via email, it becomes increasingly useful.

What is Network Effect?

The network effect is a phenomenon where the value of a product or service increases the more people use it. Some examples of network effect include Facebook, Google Maps, and Skype. The more people use these products, the better they become.

Because they want many users on their platforms, network effects are usually free to use. It's no coincidence that these three companies have grown exponentially.

Not only do they all offer high-quality services, but they each have an incredible amount of network effects going on behind the scenes! Network effects can be seen in many other industries, such as manufacturing, banking, and telecommunication; however, online industries are most prevalent.

The network effect has indisputable significance. It's what makes social media so powerful; it can take a little concept with no mass appeal and transform it into something millions of people are interested in because they know others will be as well!

The early days of network effects were difficult; the network effect needs that the network develops to a particular extent in order for it to be effective because the value of a network is determined by the number of connections that can be made with that network such that the network is above critical mass. Simply put, in the early days, there were several obstacles in setting up infrastructure that enhances network effect, and another was that most people were not using or contributing anything online, resulting in poor value.

This idea can be applied in economics when products or services depend on buyers and sellers who leverage them more. The greater the number of people who want to use a business, the more value it creates because customers are essential for the revenue. The business then further grows in value due to increased demand.

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Examples Of Network Effects

The network effect has significantly influenced most companies today. Below are a few front-line companies:

  • E-Commerce: eBay, Amazon, Alibaba Etsy,
  • Ticket Exchange: Ticketmaster, StubHub, SeatGeek
  • Delivery: Uber Eats, Instacart, Grubhub, DoorDash, Postmates
  • Social Media: Instagram, LinkedIn, Facebook, Twitter, Snapchat, Pinterest
  • Rideshare: Lyft, Uber

Each of these companies has a unique value proposition as they scale up. For example, Etsy offers exponentially more benefits when one million users are on their platform rather than 100.

By the same token, Lyft and Uber provide greater convenience by increasing the number of drivers with new platforms such as Facebook Driver Pool or Cabify Plus app (allowing passengers access without having bookings).

Additionally, social media sites have become increasingly popular among people, because there are constantly new trends to follow on the platform.

The Principles Of Network Effect

The underlying principles of network effect imply that a website, platform, or business known to have the highest market share eventually becomes successful. The market share has a better possibility of increasing exponentially. Markets in which network effects play a substantial role are referred to as "winner-take-all markets."

Network effects are powerful mechanisms that can improve the experience for those already using the network and encourage new participants.

History Of The Network Effect

Network effect is a powerful tool for facilitating communication. The first network effect was created in the early 20th century with telephones, and it played a key role during Theodore Vail's presidency at Bell Telephone Company. He used this principle to argue why Bell Telephone should have a monopoly on telephone networks.

Years later, Robert Metcalfe, the inventor of the Ethernet, further popularized the idea by introducing a law that states that the value of a telecommunications network is directly proportional to the square of the total number of connected individuals in a system.

Presently, the network effect is a powerful, real-world application of this theory. Facebook, Twitter, and LinkedIn have all experienced exponential growth in popularity as more people create accounts daily, which drives up their value even higher because of large crowdsourcing potentials from an increased population.

Some of the fastest-growing and leading companies around achieve success from the right application of network effects. Examples of such companies are Airbnb, Facebook, LinkedIn, Google App Store, and more.

Types Of Network Effect

There are different network effects; however, they are often grouped into two categories: Direct and Indirect:

Direct Network Effect

Social media platforms benefit from direct network effects. The service's value grows to attract more users, causing the network itself to grow.

However, their products might not offer any tangible benefits for consumers beyond what can be done on other platforms or browser extensions (sometimes).

Indirect Network Effect

The term "indirect network effects" refers to the idea that a platform or service depends on two user groups: producers and consumers. As more people from one group join in, it creates an increased value among both parties because they must rely upon each other's presence on this shared resource - the Internet.

The most well-known application of indirect networks would be e-commerce sites that depend heavily upon buyers and sellers when selling products online through their site.

A Bilateral Network Effect

The number of people who use smartphones for browsing will increase with more users because they offer a complementary service: those using computers also need some form or another of technology like this to be productive at work (or school).

Network Effect vs. Network Externality

So, what exactly is the distinction between network effects and network externality? In this situation, we can narrow it down to knowing how each phenomenon influences your behavior. Network externality is an economic phrase that means that when one person purchases something else based on their perception of its quality or just desiring another product, they know would be good (i.e., peer-driven opinion), others purchase more because of their influence.

The Internet has become a staple of modern life, and it's no wonder that people are constantly looking for ways to make their online experience more engaging.

When you share content on social media sites like Facebook or Twitter, people in your network (friendships) may like what YOU have shared with them, creating externalities where both sides benefit from each other's actions.

This concept may be found in many businesses today, particularly those involving digital interactions, including but not limited to blogging and video sharing platforms.

Perfect Example
The Internet is a perfect example of the network effect. The increase in adoption by users has led to the creation of more social media platforms and companies offering products and services.

Advantages Of The Network Effect

Provide Utility Among Its Customers

With the network effect, a company can thrive and succeed with minimal input from investors. As this catches on to more people in society and consumers of goods or services that use them, the networks become increasingly valuable for any business because it helps provide more utility, prompting new users who want what these companies offer.

It Encourages Entrepreneurs

The network effect is a powerful force in today's society. It motivates entrepreneurs and intellectual property producers, such as musicians and software developers, to commit more time to their craft because the success of these crafts inevitably draws more subscribers. YouTube content creators are a fantastic illustration of this, since they devote countless hours to generating entertaining videos for their subscribers, while constantly innovating.

Disadvantages Of The Network Effect

The network effect can be a double-edged sword. On one side, it allows companies with critical consumers to maintain efficiency and innovate since they know there is still a market for them.

In contrast, those without this benefit could decrease innovation because they have already been successful in their niche.

A potential downfall of The Network Effect arises when an organization becomes less efficient because it knows its primary target audience will always remain on board. However, these same features help firms establish themselves more quickly than usual. Early risers may reap the rewards from basic consumer acceptance before most competitors even start.



It encourages creators of intellectual property and entrepreneurs to get the best results.

Too many people on a network can lead to congestion.

It provides enough benefit to users by increasing the value of the services in line with participation. 

Service providers must be ready to increase their services sufficiently to create more room to accommodate users, which is often considered expensive.

It stresses more the importance of reaching out to a critical mass.

Most companies become less innovative after massive success is achieved.

Frequently Asked Questions

What Are Network Effects?

The network effect is a notion that explains how the value of a service or product increases when more people subscribe to the service or product.

What Are Some Examples Of Network Effects Platforms?

Some examples of network effect include mobile phones, landline networks, the internet, and social media websites.

What Are Positive Network Effects?

A service or product exhibits a positive network effect when the service or product exponentially increases as users increase.

What Are Examples Of The Network Effect?

Social media platforms, such as Twitter and Facebook, are perfect examples of the network effect. As more people subscribe by signing up for an account, the value of the website increases.

What Is The Main Benefit Of Network Effects To Users?

Network effects scale business and generate more profit by increasing market share, product value proposition, and overall customer base.

The Network Effect Remains Vital

It's clear that the Internet is becoming an increasingly important element of our daily lives. As technology expands, so will its influence on how we work and shop. Perhaps most essential, as more people use the internet for their goals, they need to educate themselves on what makes this technology tick in order to enjoy all of its benefits.

To reap its benefits, you must first understand how your customers use your product or service in their daily lives.

*This communication is intended as strictly informational, and nothing herein constitutes an offer or a recommendation to buy, sell, or retain any specific product, security or investment, or to utilise or refrain from utilising any particular service. The use of the products and services referred to herein may be subject to certain limitations in specific jurisdictions. This communication does not constitute and shall under no circumstances be deemed to constitute investment advice. This communication is not intended to constitute a public offering of securities within the meaning of any applicable legislation.