The Ripple Effect: How Network Dynamics Propel E-commerce Marketplaces to Success
The impact of network effects on e-commerce marketplaces is incredibly huge especially in today’s digital age as we see this phenomenon shaping the success and growth of many platforms. The network effect refers to where the value of a product or service increases as a direct result of more people using it. This effect is particularly interesting in the context of e-commerce marketplaces since it manifests in the relationships between the number of buyers and sellers, aside from just one-dimensionally users. In essence, the more sellers there are, the more attractive the marketplace becomes for buyers, and vice versa.
A prime example of this are the huge platforms such as Etsy, eBay and in particular Amazon. these platforms all thrive as a result of the network effect which has allowed them to grow their user bases exponentially. Looking at Amazon in particular, we see this platform exemplifying the two-sided marketplace, bringing together huge amounts of buyers and sellers. In the case of Amazon, we can view buyers and sellers as nodes. However, what is interesting is that the links between these buyers and sellers are indirect as they each rely on Amazon as an intermediary. This results in a highly dense network with many links which benefits from the network effect to an even larger degree than those of low-density networks.
A business model like Amazon’s is incredibly appealing for the reason that it can generate profit as a result of facilitating transactions between buyers and sellers without directly having to handle the products themselves. This can allow for incredibly high profits of up to 70% especially if platforms are home to a large number of buyers and sellers as sellers are willing to pay a premium to access a larger consumer base, and on the flip side, consumers are also willing to pay a premium in order to access a more diverse array of options. Hence, the amount of buyers and sellers a platform has, and by extension how much it benefits from network effects, can directly affect the profitability of a platform.
That being said, obviously, there is a catch with how able marketplaces can create and hence benefit from these network effects and that is overcoming the initial hurdle of attracting a sufficient number of users. Interestingly, this brings into discussion what some see as a chicken-and-egg problem as a marketplace first needs a large base of sellers to attract buyers, however, to have a large base of sellers, a marketplace also needs a large base of buyers. The point at which platforms can experience rapid growth from network effects is called critical mass, which can be thought of as when the “value produced by the network exceeds the value of the product itself and competing products”. That being said, once critical mass is reached, a marketplace will grow exponentially quickly. New marketplaces employ various strategies such as discount pricing in order to quickly increase their customer base to the critical point. However, this is often non-sustainable as companies are often operating at a loss when this happens.
That being said, sometimes excessive network effects can also lead to challenges and be counterproductive. When too many sellers join a platform, we see this resulting in buyers and infrastructure being overwhelmed, diminishing the overall user experience. This overcrowding also intensifies competition among sellers, leading to price competition and driving down profits as a result. More sellers can also introduce the problem of quality control as the chance of encountering a low quality seller and risking the marketplace’s credibility increases. These issues can also be applied to buyers and the amount of them for example the case of Ticketmaster during the Taylor Swift “Eras” tour ticket presales in November 2022. The immense demand for tickets in addition to a number of bot attacks overwhelmed the platform leading to delays, payment issues and crashes causing widespread frustration among fans and significant negative media coverage.
Overall, network effects play a crucial role in the e-commerce industry, dictating the rise and dominance of marketplaces and shaping the strategies new entrants must employ to compete effectively.
Sources:
https://www.shopify.com/blog/network-effects
https://www.sitecore.com/blog/commerce/online-marketplaces-network-effects