Network Effects

Extracted Attributes

• Types

  Direct network effects, Indirect (or cross-group) network effects

• Nature

  Positive feedback system

• Definition

  The phenomenon by which the value or utility a user derives from a good or service depends on the number of users of compatible products.

• Prevalence

  Most prevalent in new economy industries, particularly information and communication technologies

• Distinction

  Distinct from economies of scale, which relate to decreasing average production costs

• Alternative Names

  Network externality, Demand-side economies of scale

• Potential Outcomes

  Multiple equilibria, Market monopoly, Winner-takes-all markets

• Potential Negative Effects

  Network congestion, Value decline due to overwhelming users or scale

Network effect

In economics, a network effect (also called network externality or demand-side economies of scale) is the phenomenon by which the value or utility a user derives from a good or service depends on the number of users of compatible products. Network effects are typically positive feedback systems, resulting in users deriving more and more value from a product as more users join the same network. The adoption of a product by an additional user can be broken into two effects: an increase in the value to all other users (total effect) and also the enhancement of other non-users' motivation for using the product (marginal effect). Network effects can be direct or indirect. Direct network effects arise when a given user's utility increases with the number of other users of the same product or technology, meaning that adoption of a product by different users is complementary. This effect is separate from effects related to price, such as a benefit to existing users resulting from price decreases as more users join. Direct network effects can be seen with social networking services, including Twitter, Facebook, Airbnb, Uber, and LinkedIn; telecommunications devices like the telephone; and instant messaging services such as MSN, AIM or QQ. Indirect (or cross-group) network effects arise when there are "at least two different customer groups that are interdependent, and the utility of at least one group grows as the other group(s) grow". For example, hardware may become more valuable to consumers with the growth of compatible software. Network effects are commonly mistaken for economies of scale, which describe decreasing average production costs in relation to the total volume of units produced. Economies of scale are a common phenomenon in traditional industries such as manufacturing, whereas network effects are most prevalent in new economy industries, particularly information and communication technologies. Network effects are the demand side counterpart of economies of scale, as they function by increasing a customer's willingness to pay due rather than decreasing the supplier's average cost. Upon reaching critical mass, a bandwagon effect can result. As the network continues to become more valuable with each new adopter, more people are incentivised to adopt, resulting in a positive feedback loop. Multiple equilibria and a market monopoly are two key potential outcomes in markets that exhibit network effects. Consumer expectations are key in determining which outcomes will result.

Web Search Results

• Network effect - Wikipedia

  In economics, a network effect (also called network externality or demand-side economies of scale) is the phenomenon by which the value "Value (economics)") or utility a user derives from a good or service "Service (economics)") depends on the number of users of compatible products. Network effects are typically positive feedback systems, resulting in users deriving more and more value from a product as more users join the same network. The adoption of a product by an additional user can be [...] Network effects are the incremental benefit gained by each user for each new user that joins a network. An example of a direct network effect is the telephone. Originally when only a small number of people owned a telephone the value it provided was minimal. Not only did other people need to own a telephone for it to be useful, but it also had to be connected to the network through the users home. As technology advanced it became more affordable for people to own a telephone. This created more [...] Network effects are commonly mistaken for economies of scale, which describe decreasing average production costs in relation to the total volume of units produced. Economies of scale are a common phenomenon in traditional industries such as manufacturing, whereas network effects are most prevalent in new economy industries, particularly information and communication technologies. Network effects are the demand side counterpart of economies of scale, as they function by increasing a customer's

• Network Effects | Definition + Examples - Wall Street Prep

  Network effects describe the phenomenon in which the value of a product improves for all users as more users join a platform, even for the existing user base. The concept of network effects is particularly important in the digital age, given continued technological disruption amid rapid globalization. The core premise of network effects is that each new user improves the value of a product/service for both new and existing users alike. [...] Generally speaking, the more users and sellers there are, the greater the network effects are (and the value offered to all sides). In contrast, a “negative network effect” is when a platform’s value declines after growth in usage or scale. For instance, an overwhelming number of users could lead to network congestion, i.e. a noticeable drop-off in product quality and customer service. [...] background Wall Street Prep Wall Street Prep # Network Effects Step-by-Step Guide to Understanding Network Effects ## What are Network Effects? Network Effects refer to the incremental benefits gained from new users joining the platform, which results in the product becoming more valuable for all users. Network EffectsNetwork Effects Network Effects Network Effects ## How Do Network Effects Work

• What Are Network Effects? | HBS Online

  According to the online course Economics for Managers, the term network effect refers to any situation in which the value of a product, service, or platform depends on the number of buyers, sellers, or users who leverage it. Typically, the greater the number of buyers, sellers, or users, the greater the network effect—and the greater the value created by the offering. [...] ## Direct and Indirect Network Effects Not all network effects are the same. They’re often broken into two different types: direct and indirect. Direct network effects occur when the value of a product, service, or platform increases simply because the number of users increases, causing the network itself to grow. Social media platforms primarily benefit from direct network effects because the service's value grows as a direct result of attracting more users. [...] According to Economics for Managers, the underlying principles of network effects imply that the business, website, or platform with the highest market share will be more successful in the long run. This means that its market share is likely to grow more substantially. For this reason, markets in which network effects play a major role are often referred to as winner-takes-all markets.

• [PDF] Network Effects and Market Power

  Back in the 1990s, network effects were looked to as a new source of potential market power, especially in digital mar-kets. Economists use “network effects” to describe contexts in which a good or service offers increasing benefits the more users it has. Network effects can be direct—for example, a fax machine becomes more useful as other people also use fax machines. Network effects can also be indirect, so that they flow across different sets of users. For example, Uber would not be a very [...]
  The shift to personalization and individualization in the provision of digital technologies means that network effects are often very localized and unlikely to be simply a function of the number of users or firm size.
  Network effects may not always be positive. In some cases, having a large network may even act as a detriment, enabling differentiated competition from entrants. [...] Network Effects Are Not Always Positive, But Can Be Negative Usually network effects in platforms are modeled as positive. This means that, from an antitrust perspective, a larger num-ber of users is considered to potentially reduce competitive pressure. However, there are three reasons recent research has suggested that more users may not lead to a sustainable mar-ket dominance (or power).

• What Is the Network Effect? - Investopedia

  # What Is the Network Effect? BW Photo BW Photo:max_bytes(150000):strip_icc()/2G8T0126-BW-5a525a4d8c434885b365bee7b3807f60.jpg) ## What Is the Network Effect? The network effect is a phenomenon whereby increased numbers of people or participants improve the value of a good or service. The more popular a business or product grows, the more the users effectively act as salesmen, spreading the word about the entity or item. ### Key Takeaways [...] The network effect can lead to an improved experience as more people participate. It can also encourage new participants as they look to benefit from the network. The internet is an example of the network effect. Initially, there were few users on the internet with its only traffic from the military and scientists. As more users gained access, they produced content, information, and services. The development and improvement of websites attracted more users to connect and conduct business. [...] There are commonly two types of network effects, direct and indirect. Direct effects occur when a product's value increases as the number of users increases. Telephones were the first example of an item with direct network effects.