When the telephone first came out, it was a marvelous technology. For centuries, communication was limited by distance. How fast your love letter gets to your fiancé in the Wild West depended on how fast your horse was. Surprisingly, when the telephone came out it didn’t catch on as soon as one would think it would. We can’t imagine our life today without it and we can’t imagine even more nothing having one and not using one after it becomes available. However, a telephone is only as valuable as the number of people you can communicate with. When the telephone first came out, it wasn’t available to the mass market. Only a few, the rich and the curious, had access to it and few of them even bought one. So if you can only communicate with your rich neighbor next door, a telephone is only as valuable as a cool gimmick. It was only after the mass market realized of its potential and once a certain percentage of the population had it, it wasn’t long until everyone owned a cellphone.
This phenomenon here is called network effect. In the economic terms, the network effect is a result of a positive externality which is an unintentional increase in your own utility caused by someone else’s consumption. As more people bought and used the telephone, your utility or happiness increased and the value of your telephone to you increased as well. When you align your behavior with others, especially if there are a significant number of others, you also align your self-interest and gain a direct benefit from carrying out that behavior. And we see that happening in many different markets and microcosm of society. We also learned in class that there is an inflection point or tipping point. Where enough people in the market are using the product, there is an upward pressure for more people to use it until it hit equilibrium where supply and demand match. This technique is used in marketing strategies where prices are cut below reservation prices to entice more users to buy the product until the network effect does the rest. In most cases, network effect has proved very effective, but we’ll see that they aren’t always enough.
A Harvard Business Review article, “Network effects aren’t enough”, looks into real life examples where network effect was not enough to carry businesses even once it gets past the so-called tipping point. First evidence of this is by the lack of successful first movers startups. Uber was not the first peer-to-peer car sharing company. Alibaba was the second online e-commerce company to hit China. AirBnb was founded almost a decade after VRBO. If the network effect is truly enough, then these first movers should have the ultimate advantage in reaching the tipping point the fastest and smooth sailing thereafter. However, we see that that is not the case. What these studies failed to realize was that although network effect may help lower the acquisitions and barriers to reaching the masses, it does not guarantee that the users will stay. It failed to realize that users are more willing to switch to a different product with a similar purpose. Brand loyalty don’t exist for the early users as much as they thought. Second, growing too early has caused problems. And in these cases, the network effect does more harm than good. In their words, “Growing too early amplifies flaws in the business model, making them harder to fix.” And by marketing the products well, the network effect can make it seem that their product is desirable and because companies see an increased demand they try to meet that demand without much forethought or preparing their infrastructure to handle the increased demand. And once the quality of the products or services decrease, users jump ship and the nosedive, also due to the network effect, is a lot faster than one anticipates.
This Harvard Business Review demonstrates that the network effect is a strong influence into increasing market share for companies. However, the company must have the right infrastructure, strong vision, and most importantly, customer focused paradigm in order to maintain that growth that stems from the network effect. Relying on the network effect to increase the desirability of their products alone has often proved futile and has lead to the demise of many hot companies.
https://hbr.org/2016/04/network-effects-arent-enough
Comments
Leave a Reply
