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Network effects are a phenomenon when a product or service becomes more valuable when more people use it. Because it is more valuable, it causes the number of users to continue to grow. So, in this case, the value of the product or service depends on how many people use it.
What are examples of network effects?
Network effects are typical for digital services today. You can see how a large number of social media like Facebook, Twitter, Instagram, and Linkedin continues to grow over time. All three are among the most valuable companies as their users reach hundreds of millions of people.
Besides social media, some examples of network effects are:
- Internet service. The internet is increasingly valuable because more and more people access it. That not only promotes new business models but also brings up new sources of economic growth. People are increasingly online and leaving the conventional world.
- e-Commerce such as Amazon and Alibaba. Amazon has the benefit of more and more people buying digital books through it. The company also develops an effective shipping network. All that makes it hard for new competitors to match it.
- Multimedia messaging apps like Whatsapp. When many of your friends use Whatsapp? You will think twice about changing to a new application. Whatsapp helps you communicate with them. And when you switch, you cannot communicate with them, unless you recommend a new app to your friends.
- Online video services like Youtube. Many people make money from Youtube. And as more people try to get money from this channel, the more video content they upload on Youtube. For users, that means more alternative videos that they can watch. Content-rich channels make it difficult for newcomers to match.
What is a network effect, and why is it valuable?
Network effects become a source for fast growth. Developers can become valuable companies in only a short time. That is why companies like Google, Facebook, and Amazon (established around 1994-2004) have become potential competitors for Microsoft (established in 1975) in terms of market capitalization.
So, network effects also provide a better experience for many people. The more people take part, the more people look for new benefits from the network. You can see, many people earn money by utilizing users of online channels that are growing.
For marketing, more and more users join and take part; it is an opportunity to reach them. Online channels are a new source of marketing and advertising channels. Marketers also get better insights about users since they can exploit users’ digital data from various platforms.
How do network effects work?
Tissue effects first appear and spread by word of mouth. Then, the market expands exponentially as more and more people recommend it.
Consider, a company is launching a new application. One person uses it. He is happy and recommends it to four of his colleagues. They are also satisfied with the new app and recommends it to other colleagues. This phenomenon continues to increase at an exponential rate.
The critical point is the number of initial users. When there are many initial users, it will speed up the growth of new application users.
Imagine, one person recommends to two of their colleagues every month. At the end of the fourth month, with 2 initial users, the number of users will reach 512 people. Meanwhile, if the initial user is 4 people, then the user at the end of the fourth month will reach 1024 people. The following table shows you the difference:
| Month | Number of users | Number of users |
| 1 | 2 | 4 |
| 2 | 8 | 16 |
| 3 | 32 | 64 |
| 4 | 128 | 256 |
| 5 | 512 | 1,024 |
| 6 | 2,048 | 4,096 |
| 7 | 8,192 | 16,384 |
| 8 | 32,768 | 65,536 |
| 9 | 131,072 | 262,144 |
| 10 | 524,288 | 1,048,576 |
| 11 | 2,097,152 | 4,194,304 |
| 12 | 8,388,608 | 16,777,216 |
When it reaches the user’s critical point (reaching a large portion of the world population), it is difficult for new players to emulate them. Some new companies might try to launch new service alternatives. But the question? Are consumers willing to switch? That is the reason why Google Plus cannot compete effectively with Facebook or Twitter.
Open source is one way to increase the speed of growth. In a sense, creators open up opportunities for users to enrich content. They just provide a platform for users to fill it.
Consider Youtube. This channel has grown to 2.00 billion active users because users can share their videos. The more users who upload videos, the richer the YouTube content.
Pros and cons
Some of the benefits of network effects are:
- Improving a better experience for many people. Not only can they access various services, but they also get benefits from the platform, such as earning income.
- Offering an exponential growth rate for the company. Companies do not need to advertise their products or services more intensely.
- Becoming a source of economic growth. For example, eCommerce services increase the activity of buying and selling goods. It also encourages price transparency, allowing us to compare prices of various similar products.
- Bringing up broader and more specific marketing channels. Marketers can exploit user data from various platforms to get better insights about consumer behavior. Not only that, but they can also develop new products or services that are more in line with consumer needs.
But, it also has some criticisms, including:
- Exposing negative network effects and congestion. It happens when too many people use goods or services. For example, the more people access the internet, it can slow down network speeds. To overcome this, it requires technological innovation.
- Shortening product life cycle if everyone in the world has used it, how else to grow it.
- Vulnerable to changes in technology and consumer tastes. That can reduce the market power of the company from time to time.
