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Negatives of Network Effects in e-Commerce

Since the rise of the dot-com era, there has been a proliferation of multi million dollar corporations, to fill the originally empty sector of e-commerce. Think of companies like e-Bay, Craigslist, or Ali-baba. These companies have held market share since their inception, some more than 15 years ago. Despite the size of the markets currently, it is incredibly difficult, especially now, to break into these somewhat established markets. Part of the reason being, the existing company’s control such a large proportion of the business that the remaining market is not even enough to get over the tipping point to allow your company to grow given the effects of network effects.

The existing companies have a well established user base, and have extremely high returns given their low overhead costs. This allows them to retain customers very easily since they can exist at a stable equilibrium point, and maintain their consumer base.

One cautionary tale, of how to avoid the disaster that could be network effects is smaller companies work too aggressively towards growth in the beginning, rather than company stability. Often companies get over the initial tipping point to early, and as their market share increases, the find they are unable to meet the demands of customers and subsequently, they will take their business elsewhere.

Another realistic concern is given the fact that the majority of these interactions take place is some kind of digital market place, there is nothing preventing two parties from engaging in repeat business outside of the established market place. Think someone renting the same air bnb by directly contacting the the seller etc. This is called disintermediation, where they essentially cut out a middle man. This is especially nasty side effect for smaller companies because the users don’t gain much from being in that network, so would rather save money by brokering their own business deal.

As we see, networks effect can have both positive and negative effects for the buyer and the seller and it is worth analyzing the effect of the network effects more closely to determine its worth to the buyer, seller and middle man.


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