Network Effects in eCommerce
The article discusses the popularity of online marketplaces such as eBay and Etsy. The business models behind these marketplaces make it a highly attractive venture – the businesses simply facilitate transactions between buyers and sellers without taking responsibility for the products or services. In addition, online marketplaces enjoy high gross profit margins – up to 70%. It is no surprise that entrepreneurs attempt to enter the industry, but network effects make it difficult for new marketplaces to succeed.
The problem arises as a chicken-and-egg problem: in order to attract buyers, the site needs to have a large seller base, but in order to get a large seller base, there must be a large number of potential buyers. This is where network effects come into play – once the business gains enough customers, it grows exponentially. In addition, buyers and sellers are unlikely to move to a competing site once they are satisfied with one marketplace, increasing the importance of network effects.
The article links to the network effects discussed in class. Once a product audience reaches a “tipping point”, the audience grows exponentially. In this case, once an online marketplace becomes popular to a certain point, it continues to gain buyers and sellers exponentially past that point. This applies to sites that are already dominating the industry (such as eBay, Craigslist, and Airbnd) as well as sites that are trying to enter the industry. In order to quickly increase the customer base of these new marketplaces, they must gain users up to the critical point. The most common tactic is discount pricing, as discussed in class. Although the article lists the disadvantages of discount pricing (as it compromises the sustainability of the marketplace), it acknowledges that network effects play a major role in the success of the online marketplace industry.
Link: https://hbr.org/2016/04/network-effects-arent-enough