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Network Effects are Not Everything

In class, we discussed network effects and how the value of a product to one user depends how many other users of the product there are. The increase in value comes either for information-based reasons (i.e. the user feels more confident about the quality of the product if there are many others using it) or for reasons of direct benefit (i.e. the product becomes more useful to the user when the number of other users is large). We applied these principles to social networking services like Facebook and Twitter, to show how the number of users on the network affect the value of the network to potential new users. Based on these principles, it may seem like the dynamics of social networks and the internet economy are dominated by these network effects, and thus incumbents like Facebook must be so entrenched that they could never be dethroned.

However, the Business Insider article “How Strong Are Network Effects Online, REALLY?” linked below argues that this is not necessarily the case. It starts by examining how the case of Craigslist. People use Craigslist because everyone else uses it. However, everyone that has used Craigslist knows about their antiquated website design and user interface. However, given the type of service they provide, these things have little to no negative effect on the value provided to the users, as the value comes from the users themselves. Therefore, it is clear that the success of Craigslist depends almost exclusively on network effects.

Despite Craigslist’s meteoric success, the article claims that Craigslist’s traffic seems to be plateauing recently. “While no service has been able to defeat Craigslist head-on, plenty have built ‘niches’ in specific verticals, with a more tailored offering, and now Craigslist seems to be stalling.” Some examples of competing niche services include Etsy, AirBNB, OkCupid, etc. So while Craigslist has the clear advantage that comes from network effects, apparently network effects have their limits. “What the story of Craigslist… shows is that online network effects are strong barriers to entry to FRONTAL competition but not to LATERAL competition.”

Will Facebook remain the social networking king for eternity, or will it eventually meet its downfall like its predecessor MySpace? While nothing can give a definite answer, simply taking a look at the social networking landscape today can provide us some hints. Twitter is wildly successful through a specialized version of Facebook’s status update. Instagram (although it has now been acquired by Facebook), has risen to popularity by improving upon Facebook’s photo sharing features. Snapchat has stolen a significant amount of traffic from Facebook’s messenger. While none of these services is a true substitute for Facebook, each has its own advantages that surpass Facebook’s corresponding features in a key areas, enough to convince Facebook users to switch.

Hence, it would not be unreasonable to imagine a future scenario where Facebook simply becomes irrelevant, replaced piece by piece by niche competitors. If Facebook, with its enormous network effects of 1.5 billion registered users, is not immune from displacement from lateral competition, it is clear that a pure network effects analysis is a far too simplistic way to predict user behavior.

http://www.businessinsider.com/network-effects-2011-5

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