Network Effects
Network effects occur when a product or service becomes more useful as more people use it. Growth can attract further users, though congestion or changing community norms can reduce the benefit.
THE IDEA
Network Effects
Network effects occur when a product or service becomes more useful as more people use it. A telephone is an obvious example: if none of your friends has one, it has little use. Each additional friend who gets one gives you someone else to call.
Network effects can also be indirect. More drivers on a ride-sharing app can mean better availability for riders; more riders can make the app more attractive to drivers.
This can create a reinforcing feedback loop: added value attracts users, whose participation adds further value. Getting started is difficult when a service offers little until it reaches a critical mass. Once established, a network can give a company an advantage over a new entrant, even one with a better product. Users may be reluctant to switch to a service where their contacts or trading partners are absent.
First movers do not always win. Later entrants can learn from their mistakes, and the strength of the network effect varies by market. Strong effects can concentrate users in a dominant service, but continued growth is not assured. Companies often offer early users incentives in an effort to reach critical mass.
The concept also applies outside technology. An area with many skilled workers can attract employers, whose jobs attract more workers. A widely accepted store of value can become more useful because others are willing to hold or accept it; this does not guarantee a stable price.
Growth can also reduce value. A train network may gain revenue to fund more frequent service, yet become overcrowded if capacity does not keep up. A small online forum may attract new members because of its discussions, only to lose that appeal if an influx overwhelms its posting standards. These are negative network effects: further participation makes the service less useful to existing users.
When to use it
A startup trying to reach critical mass for a new social media platform by offering incentives to early adopters.
A city planning public transportation infrastructure to balance user growth without causing overcrowding and reduced service quality.
An investor evaluating the competitive moat of a tech company by analyzing the strength of its network effects.
A product manager redesigning a platform to ensure that growth does not dilute core user experience, preventing negative network effects.
FROM THEORY TO EVERYDAY LIFE
In practice
Telephone
The utility of a telephone increases as more friends get one. If you own one but no one else does, it's useless. With each additional user, the value rises.
Ride-sharing app
Indirect network effects: more drivers joining means more availability and lower wait times for riders, increasing utility for riders.
Public train network
More users can lead to more investment and better service. However, beyond a point, overcrowding reduces value and becomes a negative network effect.
Online forum
A small forum with high standards can be diluted by an influx of new users who change norms, reducing the value for original members—a negative network effect.
A MOMENT TO REFLECT
Put it to work.
Can you identify a product or service you use that benefits from network effects? How would your experience change if many users left?
How might a company mitigate negative network effects as its user base grows?
In your industry, where do you see potential for network effects that haven't been fully exploited yet?
CONTINUE THE CONVERSATION
Source texts
- The Great Mental Models Volume 3 Systems and Mathematics