The Implications of Network Effects Within Business Strategy
Several years ago, a fierce competition between Chinese ride sharing apps arose. This fight included high profile ride sharing platforms, as well as some newer ones. Ultimately, a crowd favorite and seasoned company, Didi, failed in the face of newer, smarter and more innovative competitors. Why did this occur? And more specifically, how? How is it that a company — who had seen extraordinary success in the past — lost to a newbie in the industry? The answer is simple: network effects.
When one thinks of a network, they see their friend groups and families or, perhaps, the list of people that they know through school or work. While this, in part, is true of most, networks extend far beyond this scope, and have proven to have enormous implications in almost every single aspect of life. In the case of the Chinese ride sharing app example, the failure of ride sharing mogul Didi fell back on five main determinants. As detailed by the Harvard Business Review, they are as follows “network effects, clustering, risk of disintermediation, vulnerability to multi-homing, and bridging to multiple networks”.
While the success of a platform relies heavily upon its structure, interface and the administration’s business strategy, a good portion of its success rate lies in the hands of its network. Metcalfe’s law insinuates that “the usefulness or value of a network is proportional to the square of the numbers of its users”. By this, in the context of platform user-ship, this means that the platform becomes more and more beneficial to both the user and platform itself as more user-ship increases.
Another influential factor in a platform’s success is the physical structures that the networks are composed of. By this it is meant that, the more isolated the platform’s users are in respect to one another, the less likely the platform is to succeed. For example, social media platforms like Facebook and Instagram have proven to be powerhouses in their industry. This is because, despite having users from all around the world, the platform allows and facilitates interaction between them, thus decreasing isolation of smaller networks.
Another large issue that platforms face connected to network effects is the issue of users building networks though the platform and then substituting the platform out as a whole afterwards. This has been seen in platforms that have connected users, and once a relationship has been established between the two, the platform is no longer used. In order for a platform to fight against this, they must use special tactics such as a withholding of user information from other users so that networks can be built via the platform, however not strong enough ones that the platform itself can be deemed useless. In determining risk factors within industry, platforms also must worry about the issue of users utilizing multiple platforms contained within one industry. Such an issue is known as “multi-homing”. This is a key reason for the downfall of Didi, for the reason user-ship was declining was much in part due to the fact that its users were utilizing other ride sharing applications while also using Didi, thus decreasing the possible revenue the platform could attain.
The final, and quite possibly the most important, piece to the puzzle is the concept of network bridging. While seemingly parallel to previously discussed topics, bridging is unique to itself in the fact that it is the technique that platforms use in order to leverage upon the network effects that are inherent upon user-ship. Bridging relates to a company’s facilitation of networks between users, and furthermore, the collection of data that it is able to achieve once those networks have been facilitated. Without these crucial bridges, companies have no basis upon which to form decisions to progress strategy.
In today’s technology driven world, the success of online platforms relies almost entirely upon network effects. Although seemingly unimportant to most, a platform’s ability to leverage upon its network can allow it to sequester power, thus beating out its fierce competitors.
Sources:
Article: https://hbr.org/2019/01/why-some-platforms-thrive-and-others-dont
https://www.lexico.com/en/definition/metcalfe’s_law