Network Effects in Theory and in Reality
In the article, the authors point out five properties of networks that help explain why “some platforms thrive and others don’t”: strength of network effects, network clustering, risk of disintermediation, vulnerability to multi-homing, network bridging.
The arguments made by the authors connect to the theory of network effects discussed in class. For instance, the article mentions that the majority of digital platforms rely on network effects to develop their business. As is entailed by the concept of network effects, the value of a platform depends on the number of users that are already on the platform. This is how social media as well as online platforms in two-sided markets work. Moreover, the authors introduce Didi, a company that provides ride-sharing service in China, in the introduction as an example: when another ride-hailing business started to enter the market, Didi had no choice but to lower its price and increase subsidies to its drivers and passengers. Didi’s actions can be well explained by the mathematical model of network effects. Through lowering the price, Didi attempted to reduce the population fraction of its tipping point. As the tipping point (z’) became smaller, it was easier for Didi’s actual number of users to surpass the tipping point, which then altered the direction of convergence (to z’’ instead of 0). Thus, Didi involved itself into a fierce price battle with various competitors to maintain its market share and retain users.
In addition to its reference to the basic concept and the mathematical model of network effects, the article also includes viewpoints that go beyond the scope of our course materials. One idea that I find inspiring is the strength of network effects on different platforms. According to the authors, platforms with strong network effects, such as Facebook, are more likely to result in a winner-take-all situation, compared to those only exhibit weak network effects, such as video game consoles. The comparison enriches my understanding of network effects and demonstrates its real-life application to multiple platforms rather than the single isolated case shown in class. Another argument that strikes me is authors’ opinion about the minimum barrier of entry in digital platform industry—“the advantages that allow the platform to expand quickly work for its competitors and anyone else who wants to get into the market”. Unlike traditional firms, platform firms can scale up quickly. However, the dominant status of a platform is so vulnerable that it can be destroyed overnight by another firm, using the same strategy that makes the incumbent succeed in the first place.
https://hbr.org/2019/01/why-some-platforms-thrive-and-others-dont