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Network effects are the extra benefits that a user gets when someone else joins the network. They can be found in any network, including old-school landlines, the Internet, and platforms like SNS. Network effects refer to any circumstance where the value of a platform, service, or good is determined by the number of buyers, sellers, or users who leverage it. As the number of buyers/sellers/users increases, so does the network effect and the value created by an offering.
What Are NOT Network Effects
Effects Are Not Vitality
The more individuals sign up for a product, the quicker it will expand—up to a certain threshold. Network effects and virality are not interchangeable terms. Something can go viral, like a TikTok or a new and popular product. It means that as more people hear about it and share it, each of those people also shares it, and the rate at which people discover this new thing increases exponentially. Therefore, the rate at which it is considered to be viral increases exponentially.
Network Effects Are Not Economies of Scale
The term “economies of scale” refers to situations where there is a large enough amount of production to save a lot of money. Because of this, the biggest player in the industry can keep making the most money possible. Network effects are not the same as economies of scale because, unlike economies of scale, they provide more value for a given marginal rise in cost. The price goes up when networks get bigger, but the product’s overall value skyrockets at an even faster rate.
Network Effect vs Network Externality
Network Externality is used in economies to describe how the demand for a product is affected by the desire of others to purchase the same thing. That is to say, when people see that others around them are buying a certain thing, it tends to sway their own decisions to do the same.
Network Effect refers to positive network externalities, which happen when the value of a product or service goes up as the number of people who use it grows.
When the product’s value goes down as the number of users goes up, this is called a negative network externality. Congestion is another name for this phenomenon.
Feedback Loop of Network Effects
Feedback is information received as a reaction to a product. This information can be used to modify the original product and create a better one. A feedback loop is, therefore, the process by which the feedback and outputs of the customers are circled back and used as inputs.
The interdependent cycle between producers & consumers is known as a ‘positive feedback loop’. In a positive feedback loop, two events are mutually reinforcing: a change in one can cause a bigger final increase in the other. This is especially useful for multisided platforms.
Despite that, it’s important to highlight that not every platform growth leads to a higher quality service. Because the growth will attract both high and low-quality users. That is why it’s imperative that a high standard for access is maintained.
Direct & Indirect Network Effects
Direct network effects happen when the number of users of a product/service/platform goes up, which makes the value of the product/service/platform go up and the network itself grows. It’s the most important for SNS platforms because the service’s value increases as more people use it. The more people who use a service, the more valuable it is.
Direct network effects don’t work well for platform businesses because two or more user groups exchange value. There are two user groups on most platforms, producers and consumers. The more people who use a network, the more valuable it is to those who make things for that network, etc. When the number of people using a product/service/platform grows, the value of that offering rises directly as a result of the expansion of the network.
Properties of Networks
Nodes & Links
Consumers, devices, customers, buyers, sellers, and brokers, are all nodes in a network. In the same network, different kinds of nodes can play very different roles. Networks are a combination of nodes and links. Nodes have different levels of impact, influence, power, and value, even though they are all part of the same network.
Central nodes are network nodes with many connections to other nodes and are usually more valuable. Most of the time, marginal nodes have less value because they have fewer links to other nodes. The number of nodes in a network is another way to measure its size. Size alone doesn’t tell you how valuable a network is because the amount of activity in a network can vary.
In a network, links are the ways that nodes or groups of nodes can connect to each other. In a network, the links between the nodes are not all the same. The direction of links can be different. Links have different strengths, which depend on how long they last, how close they are, and how often they talk to each other.
Network Density
Density is measured by the number of linkages relative to the number of nodes in a network. In general, the strength of network effects increases as network density rises. When two nodes are linked together, their connections are strengthened by the links between them. Evenly distributed density is rare in a network. In some parts of a network, the population density may be significantly higher than in others. Understanding how nodes link with one another is helpful when designing products that increase network density. Find the densest, active area of your network, or the ‘White-hot center’, and design your offering around that area.
Directionality
Network science’s graph theory allows two nodes to link in either direction. A graph is directed if its nodes are connected. Directed connections indicate one node points to another, but not vice versa. Networks usually have directed and undirected connections. Drawing a map of your network’s links helps you build better products and prioritize features. Interactions between network nodes determine link direction.
Central nodes with one-to-many links can broadcast to marginal nodes but seldom interact back, linking the relationship between a celebrity and their followers on Ins. Central nodes can also occur in one-to-one networks like Facebook, where some users have many friends and others few. However, one-to-many networks allow for more inequality.
One-to-One v.s. One-to-Many
Network nodes can be one-to-one or one-to-many. One-to-many connections are unidirectional, directed links. One-on-one partnerships are mutual, they’re aimless, two-way interactions. In asymmetric-follow personal networks like Twitter/Ins/You2, core nodes have many followers (inbound directed connections), whereas periphery nodes have few followers. Central nodes provide material, whereas periphery nodes watch.
Central nodes with one-to-many links can broadcast to marginal nodes but seldom interact back (think of the relationship between a celebrity and their followers on Ins/TV network and their viewers).
Clustering
Real-world networks have uneven node distribution. They create tighter local groups than the network as a whole. A bridge connects two unconnected clusters via a single link. As a network grows, Reed’s Law, which is explained below, predicts exponential value rises for networks with greater clustering coefficients. A high-clustering network expands exponentially, while a low-clustering network grows slowly. Not all networks cluster, however, you can increase your network’s clustering coefficient.
Critical Mass
A network reaches a critical mass when its value exceeds that of the product and rival products. Network type determines the timing. Most products with network effects need critical mass to fully exploit their defensibility. The product is vulnerable and may not be helpful until the network reaches critical mass. The issue for such goods is to generate enough initial value to incentivize early adopters before the network effects benefit kicks in.
Irregularity
In practice, networks rarely display a single characteristic. It’s exactly how they look in blueprints. They exist in groups, with both active and inactive areas. These replicate the irregularities of complex systems in the actual world. You need to notice those differences, find the “white hot center” in the network, and focus on it first to create a network effect before turning your attention to the larger network.
Real Identity, Pseudonymity, and Anonymity
Creating a public profile is a common need of network effect enterprises. In general, network effects are more robust in systems where each node’s profile is associated with its true identity, such as a real or corporate name. Real identity is essential in two-sided marketplaces and platform firms with a network impact, since trust and reputation are key to the fluidity of transactions. Confidentiality is not the same as anonymity.
Asymmetry
This phrase is used in markets of various sizes (1-, 2-, 3-, or N-sided). Almost always, one side of a market or a certain variety of nodes is more difficult to acquire than the other.
The buyers, on the demand side, can be challenging in particular circumstances. If you can bring in customers willing to pay, sellers will likely appear without much further work on your part. A “demand-side marketplace” describes this type of market. Sometimes the supply side is the more challenging one, but once that is solid, the demand side customers are drawn in naturally. This type of market is shown as the “supply side” market.
Asymmetry within a side or type of node is another kind of asymmetry in a marketplace. In other words, supply and demand are not always equal. Some nodes may be worth as much as a thousand times as much as others to have on your network. Examine the market for these imbalances and decide which forms of demand, or supply you want to focus on bringing in first, second, and third. Then, devote your efforts to devising strategies that would allow you to successfully breach the most valuable target first.
Homogeneous v.s. Heterogeneous Networks
Homogeneous networks are those in which each and every node serves the same purpose. Each user is essentially identical to every other in terms of their primary purpose. The telecommunications networks tend to be quite standardized.
In a heterogeneous network, the nodes are divided into two or more distinct groups based on their purpose. It’s important to note that eBay buyers and sellers have very different motivations for participating on the network.
Asymptotic Network Effects
Asymptotic network effects are those that have declining returns. As a product’s utilization grows, so does its value to each consumer. However, network effects can begin to fade beyond a certain point in the network’s expansion. After a certain size, growth in an asymptotic network no longer benefits the existing users.
Same-Side Network Effects
These are direct network effects that happen on the same side of a network with more than a two-sided or N-sided network. Same-side network effects are the changes in value for users on the same side that happen when more users join that side.
Same-side network effects can be beneficial. This is especially true for Windows users, who profit from adding additional Windows users due to file compatibility. Two Windows users can easily share files with one another, and the number of individuals with whom you can share files grows as more people start to use the same platform.
Cross-Side Network Effects
Cross-side network effects are direct network effects caused by complementary commodities or services in a multi-sided network. Cross-side network effects, which are different from indirect network effects, are when users on one side of a network get a direct boost in value caused by the addition of users on the other side.
Indirect Network Effects
When one type of node benefits another type of node directly but not the other nodes of its own type, we say that there’s an indirect network impact. By increasing the benefits to complementing users on the other side of the network, nodes on the same side of the network indirectly benefit each other.
Negative Network Effects
Network congestion occurs as more people use the network or the network grows in size. There are two types of unfavorable network effects: network congestion (higher use) and network pollution (increased size).
Congestion in a network is easily understood by the ubiquitous phenomenon of rush hour traffic. Each additional vehicle on the road during rush hour reduces the efficiency of a city’s road system. It’s also a problem in the telecommunications network, but it is less common than on the internet network.
Both positive & negative network effects can exist in a network. If there are too many updates in your FB feed, it can get cluttered. Founders need to be aware of this to design their products in a way that maximizes positive network effects while minimizing the impact of any negative ones.
The Dynamics of Network Effects
Network effects are different, the trick is to know what your network effects look like now and to predict how they will change over time. You’ll need to know the following three parts:
- Your Value Proposition: as a company/product grows, its network effects sometimes keep going in a straight line or a line with increasing returns. They could reach an asymptote, hit an inflection point, or even turn around. The most important thing for founders to know is what value proposition drives their network effects, how strong/weak they are, and how they will change, especially as they iterate their way to new value propositions and more layers of product-market fit.
- Users & Inventory: your product or platform’s current users and inventory and the types of users and items you’re adding are keys to understanding and predicting the future of your network effects. It’s important to make sure to reward the users you want and punish the ones you don’t.
- Competition: to understand and predict network effects, you also need to know your market and who your competitors and alternatives are. Businesses that benefit from network effects tend to be more secure as they grow, but new entrants in the market can threaten even the largest of firms. When users have to switch between different platforms to finish their tasks, the network effects are hurt. The economics can be turned upside down when one side of a platform is multi-tenant due to the operator having to deal with additional pricing, features, and liquidity requirements.
Types of Network Effects
Direct Network Effects
The value of commodities changes depending on demand. When someone places an order, the supply increases, and companies change the prices based on how much people think their goods are worth. This is the simplest form of a network effect.
Indirect Network Effects
The worth of a product/service rises when more people or organizations find value in it. Examples of indirect network effects (Windows OS, Android, Linux).
2-Sided Network Effects
It occurs when the value of a product or service rises across multiple user groups. The rise of online markets illustrates this trend. When there are more buyers in an online market, business owners may be more likely to open a store there.
“Social” Network Effects
Social network effects are the final category of network effects. The more people who utilize your product, the more value you’ll be able to build for them. Language, belief, and bandwagon are the most common forms of social network impact.
Local Network Effects
A strong local network can help keep user engagement high and stable. A regional network is a group of people who have come together because they share the same medium (interest, socio-economic class, or physical location). The network will be more resistant to outside threats as a result.
Negative Network Effects
More use of the network or a more extensive network can harm its value in some circumstances. If you follow a lot of Twitter friends, for instance, your News Feed may become cluttered with posts from individuals you don’t care about.
Hidden Network Effects
Slow Networks
It is a type of hidden network effect that takes a long time to show value. They are standard in education, lending, hiring, health care, and real estate, where feedback loops are long, and users interact with the network infrequently. Slow networks can take months or years to reveal their value.
Unfinished Networks
There are unfinished networks in many fields, like social media, online marketplaces, and online communities, where the network is still growing and has not yet reached its full potential. The networks have the potential for substantial network effects. However, they still need to be fully developed or have yet to reach a sufficient saturation level. In short, this means that the network’s benefits haven’t been fully realized yet and might not be evident immediately.
Throttled Networks
One way to describe a “throttled network” is as one in which the network’s growth or participation has been slowed down or stopped on purpose. There can be several reasons for this, such as government restrictions, a lack of funds, or a plan by the company to slow expansion to keep quality in check and ensure stability. There are network effects in throttled networks, but they aren’t fully realized because the network isn’t growing at its natural rate.
Latent Networks
It is called “come for the network, stay for the tool”, are a subset of the Hidden Networks Effect. They are created by establishing a community that functions as a network, connecting people, and providing value to one another. They release a product or technology that boosts or speeds up the engagement of the network.
Hidden Advantages
Businesses with hidden network effects can maintain rapid expansion even when their industry experiences slower growth. This is because when more people join and participate, the network’s value rises, resulting in a positive feedback loop. Entrepreneurs can acquire an edge over the competition and create a more valuable and long-lasting enterprise by discovering and capitalizing on hidden network effects. Additionally, the value of the network rises as more people utilize it, meaning that investors in companies with hidden network effects may experience better profits. Also, scalability and profitability are increased since, as the network expands, the services’ expenses remain constant, allowing for more scalability and profitability.
How The Network Effect Works
Network effect refers to the phenomenon in which the value of a product increases for all users, including the existing user base, when new people join a platform. This creates a cycle of growth and value creation that makes it hard for new companies to enter the market.
Two sources contribute to the value of the network effect: Inherent value & Network value. The inherent value of a product is the benefit the user receives from utilizing the product. While the network value is the benefit the user gets from the network using the product.
The influence of network effects depends on the total number of prospective buyers and sellers in the market and the extent to which the organization can leverage its user base. Nevertheless, caution must be taken with issues such as congestion & saturation. As the scale of the network effect increases, the network itself may become overloaded. This will limit the uptake. Congestion is a result of excessive use. Before the point of congestion, each additional user brings value to the network. But after the congestion point, every additional user diminishes the network’s usefulness. If the system is not expanded, it will crash.
Strategies For Building Network Effects Metrics
To take advantage of network effects and grow your business, you need to build a successful business model that gives each group of users distinctive and differentiated value on your platform. Here are a few strategies firms can use to benefit from network effects.
- First Mover Advantage: an organization or person gains a competitive edge when they are the first to enter a market. Once such benefit is a head start on creating brand awareness and attracting a customer base. To capitalize on the first-mover advantage, businesses would need a clear plan and awareness of the risks.
- Lock-In Effect: it’s when customers become so dependent on a particular product or service that it becomes difficult for them to switch to a competitor. This is evident in the Android/Apple system, where customers are locked in because they have spent time and money on the company’s products and services.
- Create Complementary Products & Services: by creating complementary products, businesses can boost the engagement of their comprehensive platform and attract new customers who may be tempted by one of the complementary products. This strategy can be interpreted as “if you can’t beat them, join them” since organizations can leverage existing networks to acquire more customers and expand their own network.
- Take Advantage of Platform Effects: businesses can greatly benefit from creating a “platform”, which is simply a product or service that can be used as a basis for developing other products and services.
- Subsidize User Adoption to Get a Critical Mass: Subsidize user adoption is a business approach in which a corporation uses its resources to reduce the price of its product/service to attract more customers. It’s effective to gain market share in this manner, but it requires a substantial investment. It’s potentially risky because it does not ensure long-term success.
- Build a Community: building user trust and loyalty through community creation can provide a significant competitive edge for a business. The more people joined, the platform became more efficient, and as a result, it was able to offer reduced costs, which in turn attracted more customers.
- Take Advantage of Tipping Points: a product/trend reaches a “tipping point” when its popularity increases exponentially. Knowing when to take advantage of network effects can be critical for businesses. When demand for a product/service reaches a tipping point, sales go through the roof, and the business proliferates.
- Increase the Economies of Scale on the Supply & Demand Sides: to capitalize on network effects, businesses must offer customers new products and services. Using cutting-edge tech can help a business stand out from the competition by giving customers better service and features. This can boost business by bringing in new clients and keeping existing ones.
- Partner with Complementary Businesses: creating synergistic partnerships with other businesses is another approach to capitalizing on the network effects. It requires a substantial outlay of resources at the outset, it has the potential to be a powerful engine of expansion and a source of sustainable competitive advantage.
- Strive for Operational Excellence: if a company wants to take advantage of network effects, it should put customer service at the top of its list of priorities. If businesses prioritize their customers’ needs, they can start a virtuous cycle in which more business from happy customers drives further improvements in customer service, and so on.
Network Effect Metrics
Network effect metrics provide significant insight into the inner workings of businesses, from monitoring user engagement to identifying critical tipping points.
Acquisition-Related Metrics
Acquisition-related metrics are a company’s lifeblood, the metrics measure the effectiveness of a company’s marketing and sales efforts, providing valuable insight into how buyers discover and interact with a product. The metrics like the number of website visitors and the rate at which leads turn into customers, are essential for determining how a company grows. In addition to giving a snapshot of a company’s performance, the indicators can help businesses find opportunities for growth and make decisions based on data.
Competitor-Related Metrics
For success in the corporate world, staying ahead of the competition is essential. Entering competitor-related metrics provide vital information about how organizations compare to the competition. Competitor-related metrics, ranging from market share to customer retention rates, equip businesses with the means to study their competitors and make strategic decisions.
Engagement-Related Metrics
User engagement metrics can range from relatively straightforward measurements like page views and click-through rates to more complex measures such as time spent on site or user retention rates. The important metrics include User Retention Cohorts, Core Action Retention Cohorts, Dollar Retention & Paid User Retention Cohorts, Retention by Location or Geography, and Power-user Curves.
Marketplace Metrics
Market metrics – you must have a firm grasp of the supply and demand, liquidity, and conversation rates that matter most to marketplace firms. The metrics can be Match Rate, Market Depth, Time to Find a Match, and Concentration or Fragmentation of Supply & Demand.
Economics-Related Metrics
These metrics are the backbone of any successful business, giving you essential information about your company’s financial health & potential for growth. From measuring income and costs to comprehending consumer behavior, these metrics provide businesses with a clear view of their current situation and future direction.
How To Beat Negative Network Effects
Embedded Curation
It’s a way to control how people interact on a network by putting limits on what they can do with a product. This kind of curation is built into the limits of the product, which makes it a flexible method that can be used on any kind of network.
User-Controlled Curation
To combat negative effects, businesses might give users greater control over their platform interactions. This can be accomplished by giving users tools such as filters and prioritized lists that allow them to pick with whom they communicate and what information they view. The filters & curation tools can help users find relevant relationships and content, which increases the positive network effects of the platform.
Manual Curation
It’s a method for a corporation or network owner to actively manage network interactions & participants. It involves enforcing rules & deleting content, supplies, or participants who violate them. The main benefit of this method is that it can have an effect right away and is effective against bad users.
Community Curation
It enables users to promote or demote information or supply units on a network without the product owner’s involvement. It may include ratings, likes, shares, etc., depending on the specific network. The advantage is that it is scalable, can create beneficial network effects, and can, to some extent, minimize network pollution.
Automated Curation
It’s a way for networks to try and find a balance between controlling interactions and allowing users to promote or demote content or supply units on their own. It involves using data from user behavior and engagement, performance metrics, and community curation signals like “likes & ratings” to create a ranking algorithm.
Conclusion
Network effects are a powerful weapon in the business world, and organizations that understand how to utilize them can reap substantial benefits. Businesses like FB & WhatsApp have done very well by using network effects to attract more users.
It also have potential drawbacks, such as negative network effects, which can harm a corporation if not managed effectively. Firms can deal with these problems in a number of ways, including user-controlled curation, manual curation, curation by the community, and automated curation.
Each of these approaches has its own benefits & drawbacks, and the most effective strategy will depend on the particulars of the organization. In the modern economy, businesses that want to grow and succeed must understand and be able to control network effects.