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New Companies, New Tricks: Network Effects Just Aren’t Enough

Nowadays, we use multiple platforms in our daily lives, like Amazon to find the perfect stocking stuffer, the Microsoft suite to get our assignments done, and an Uber to get home without having to wait for sometimes-slow public transportation. But the question really is, how did Amazon get to be so popular in the first place? Since the dot-com bubble, companies like Amazon, eBay, and Netflix have risen to dominate popular culture today. And the fascinating thing is that some economists believe that network effects could have contributed to this fantastic rise but could also cause the downfall just as quickly. 

From our basis of network effects, the main strategy of companies is to draw in a lot of customers as quickly as possible, to acquire enough of a crowd who feels like the company will succeed in order to get a self-fulfilling equilibrium in which the company will succeed. Before the rise of this “platform economy,” most companies used this strategy, so the first-mover advantage was very potent in this scenario. Just like with our understanding of network effects, it is very difficult to make a new idea popular without some indicators of this new object’s value, find a way to convince key people in the network, or somehow increase the range through which this product is received. Because of this, the problem for new emergent competitors was being able to match the original company’s capital investment and then some to almost reverse the effects of the original company’s advertising in order to employ their own. Similar to a change of seasons, the rise of the new company in the industry may be subtle, but it will tend to dominate until it falls due to some new “disruption” into their industry.

However, because the new wave of advertising is online, and now companies are selling intangible items, like social networking through apps like Twitter, Facebook, and Instagram. One of my favorite quotes from this article was, “[the] magic elixir of network effects and winner-takes-all advantages are about as reliable as cures for baldness”; not only was it witty, but it also captured the change in the winds that is happening for these new tech companies, start-ups that can suddenly take on the big companies. This is like the fall of MySpace as Facebook started to rise, and as we have mentioned in class, the fall of Orkut for the same reason. Because of the Internet and advertising based online, it is easy to reach both main-stream and more niche consumers, with less “overhead” required to pursue them. It makes it easy for apps like TikTok to enter into the already crowded social media industry; I remember seeing a few ads before YouTube videos a few years ago, and now they have created a name for themselves and for us millennials. Power is in the hands of consumers than in the hands of marketers, so the table has really shifted away from the reliability of these network effects since the consumer base could easily shift from year to year. 

The takeaway here is that though a castle of a company can soar because of early network effects, customers can easily be swayed by a newer, better, more innovative company just coming, making that castle crumble as easily as it had come.



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November 2019