The network effect of Web platforms has now come into light which has been existing long. This term has been coined from economics also known as the demand side economics of a scale and it is the effect created by the value of a product upon a user. With a network effect in action - the value of the platform depends on its users.

A network effect is comparable to a telephone connection, where positive connections are categorized as network effects and negatives as congestion.

The stability of a platform comes from a loop of the positive connections as the network effect.

The beginning

Network effects was a central theme in the creation of the first Telephone. But the monetized advancements came more into effect with the researchers.

Uses of this effect

The network effect comes into action once the platform/service gains a large percentage of subscribers. This tipping point of the number of subscribers gives a value of the service or the product which is better than or as good as the price paid for the making of the service. Which means that the value of the platform can be well defined by the number of signups and user bases. The more the number of user base the more the value of the service or platform is.

One of the key aspects of the growth, therefore, lies in luring customers and the underlying force would be the value that the service or product is providing. This essentially means that value and customers are directly proportional and entirely depends upon each other. To build a loyal band of customers will give the need to build a natural system without the presence of this network effect - who are known as early adopters. This can be done by giving additional values, sneak peak into more premium features otherwise known as the freemium now. More accessible the system is to the wider base of the targeted users, more will be the sign up adding valuation to the platform.

In some of my previous writings, I have established Why a Platform Enabled Business Model over Traditional Business Model? and How is the ecosystem of a Platform Strategy?

Beyond the tipping point of a number of subscribers, networks tend to become congested or stop adding value. This can be again compared to a telephone network. As long as the number of users is below the limit of the network capability, is is a win-win, but as soon as the number of nodes in the network tops the number of possible slots, call drops. At this point, each new user decreases the time duration for call drop increasing the decay and rate of decay of the network.

Same happens with the analogy of a number of the device to the capability of routers in a network connectivity or a host connection. New technologies like peer to peer connectivity solves issues of the kind and defies congestion. This P2P system is used by torrents where each user adds value to another user.

Classical economies of scale are on the production side, while network effects arise on the demand side.

The network effect of web platforms has similarities with the torrent networks where word of mouth can be a leading example of a user based value addition to the network. The network effect positively affects the society in forms of Creative Commons, Open Source development network and non-profit businesses.

A classic example of user based value creation is Facebook where the company does no work to add value to a user but to maintain the platform. It is through network effect that a group of like-minded individuals could connect and be present where each one of them adds to the value of another.

Types of network effects

Broadly, there are two kinds of networks effects:

Direct network effects: An increase in usage leads to a direct increase in value for other users. For example, telephone systems, fax machines, and social networks all imply direct contact among users. A direct network effect is called a same-side network effect. An example is online gamers who benefit from the participation of other gamers as distinct from how they benefit from game developers.

Indirect network effects: Increases in the usage of one product or network spawn increases in the value of a complementary product or network, which can, in turn, increase the value of the original. Examples of complementary goods include software (such as an Office suite for operating systems) and DVDs (for DVD players). This is why Windows and Linux might compete not just for users, but for software developers. This is also called a cross-side network effect. Most two-sided markets (or platform-mediated markets) are characterized by indirect network effects.

Additionally, there are two sources of economic value that are relevant when analyzing products that display network effects:

Inherent value: I derive value from my use of the product

Network value: I derive value from other people's use of the product”

Some of these concepts have been studied from the ideas of Sangeet Choudary and in my next knowledge sharing about the studies of the Network effect - I will deal with the negative impacts of the Network Effect.


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