Network Effect

A network effect usually refers to a situation where the value of single membership in something is positively enhanced when additional users join. This, in turn, encourages more users to join, increasing its value further. The term is often associated with the market value of a product, platform, or service.

The effect occurs because of the impact the event creates. When additional members join, they bring extra value with them to the brand, community, and its members. As a result, popularity, trust, and value keep increasing. This, in turn, attracts members furthermore, resulting in an avalanche effect.

• The network effect happens when the value of a product or service to its consumers rises as the number of people who utilize it grows.
• It stimulates the growth of products and services by entangling businesses and their consumers (users).
• Typically, the parties involved in a network effect are the sellers, buyers, and users.
• The three types of network effects are direct, indirect, and two-sided.
• Networking comes with many advantages, such as value addition of goods and services, improvements in terms of quality, customer satisfaction, and sound pricing policy.

The definition of the network effect may sound complex, but it is a simple concept. As the name suggests, the network effect happens when more and more people join the group or community and become invested in the product or service. With each additional person joining, the addition of new experiences and expertise, along with different perspectives and suggestions, happens. This creates or brings in additional value or inputs, making space for improvements.

In the creative space, this effect is valuable as it helps build connections through networks between the members. The community will provide new thinking and ideas. In general, it becomes a growing community that finds utility in the products or services offered and has the potential to cut costs as the numbers increase.

All companies strive to achieve critical mass. It is the number of users it takes for the network effect to occur. Once the number reaches the critical mass, the quality of goods and services increases and the companies aim to become self-sustainable and prioritize customer satisfaction. This way, better and more useful products, and services come into existence. It also helps in determining a pricing strategy. In the initial stages, businesses usually price their products as high as possible without analyzing the customer's capacity or willingness to pay. However, when the network effect works, the focus is shifted to capturing market share in the early stages.

The common types of the network effect are classified into three:

#1 - Direct:

This is a simple type of network effect. This, the increase in users, makes the services and goods offered more valuable to future users. The users here directly benefit from such an addition. They occur when the value of a product, service, or platform rises due to the increase in the number of users, causing the network to expand.

#2 - Indirect:

This type of network effect is complex. It is so because the value of the goods and services increases as the network expands. This arises when two or more user groups, such as producers and consumers, purchasers or buyers and sellers, or users and developers, rely on a platform or service. As more people from one group join the platform, the platform's value increases for the other group.

#3 - Two-sided:

This type of network effect happens when the value of the goods that the indirect network has enhanced adds or creates more value to the original good. The occurrences result in a continuous cycle.

Check out these two examples of network effects:

Example #1

Let's take the hypothetical example of a social media platform, WSM, where stock market news is shared as memes. The idea of sharing the heavy information in a light-hearted tone attracted many users, and those users started using the platform to showcase their creativity. Memes started as videos and later became educational short films. There is a transition of content that happened as the users grew. Their varied likes and dislikes, along with their preferences and choices, guided these options. The quality of content improved through this, attracting more new users and ideas. This is the way network effects work. The users pushed creativity here, which in turn increased the number of people in that community.

Example #2

Google Pay(G-pay) is a present-day digital wallet platform and online payment system developed by the tech giant Google. It was designed to facilitate contactless payments on various devices (phones, tablets, watches, etc.). In the early stages, there was only a transfer of money happening within the community of G-pay users. Now there are options made available for payment on other similar platforms too. Moreover, to increase its base, it introduced cash backs and coupons, where users get exciting returns in exchange for monetary transactions made through that app.

Similarly, G-pay introduced games and competitions, and activities such as collecting tickets through sharing and making transactions increased their popularity. As more and more users became part of it, the extent of its services also grew. From being a platform for monetary transfers, it has grown to include booking boarding passes, event tickets, store cards, health records, and paying utilities for monthly bills.

This has been a Guide to Network Effect & its Definition. Here we explain how the network effect occurs along with types and examples. You may also have a look at the following articles to learn more –

• Business Economics
• Welfare Economics
• Development Economics