Network Effects
Network Effects
Network effects are a phenomenon whereby a product or service becomes more valuable as more people use it. This creates a positive feedback loop, where user growth begets more user growth, leading to a rapid expansion of the network.
Types of Network Effects
- Direct Network Effects: The value of the service increases directly with the number of users. For example, a telephone network is more valuable if there are more people to call.
- Indirect Network Effects: The value of the service increases for one group of users as another group of users joins. For example, the value of a video game console increases for gamers as more game developers create games for that console.
Implications of Network Effects
- Winner-Take-All Markets: Network effects can lead to winner-take-all markets, where a single company comes to dominate a particular sector.
- High Barriers to Entry: Once a company has established a strong network effect, it can be very difficult for new competitors to enter the market.
- First-Mover Advantage: The first company to achieve a critical mass of users in a market with strong network effects often has a significant and durable advantage.