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The Power of Network Effects

The article points out the power of network effects, the creation of network effects, and the defeat of a network. The power of network effects lies in the value that increases along with an increase in the number of people using the product. For example, the value of yelp increases with the increase in the number of restaurant reviews; the value of Facebook increases with the increase in the number of users; the value of Wikipedia increases with the increase in the number of contributors. People choose to uses these products because of the extensive user base. It can be related to the concept of externality, which refers to situations in which the welfare of an individual is affected by others. In a case like airbnb, when a new host joins airbnb, the traveling user experiences positive externality, because his/her welfare increases as he or she has more selections of hosts to choose from.

The creation of network effects relies on Community, Empowerment and Norms. With community, the product has a number of initial users who want to engage in the product; with empowerment, these initial users can then share their opinions with others, and potentially convince more users to join, and norms should be there to ensure that users can get the most out of their experiences.

Similar to how network effects can be created, it can also be defeated. The first entrants into the market usually has a head start, and makes it difficult for second entrant to capture the market share due to switching fees for users. However, if a competitor develops a superior product with a lower cost, it is likely to attract a numbers of early adopters. The increase in the number of users will then convince more people to switch to the new product. Once the fraction of users reach the tipping point, people who would like to try the product have not tried; the upward pressure will then drive the fraction to a higher equilibrium. The superior new product then gradually replaces the original product.


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November 2015