What Is the Network Effect? The Crash Course we're offering for 2023 |

If your product which relies on the acquisition of a critical mass of users such as a ridesharing platform and your product becomes worth more when more people utilize it. Why? The more customers using your services means that you are able to reduce costs, improve accessibility, and keep an increase in demand.

The network effect is what it's all about. In this post we'll explain the idea of the network effect. We'll explain the origins of the effect network and demonstrate how technology companies use it to hit billion dollar valuations.

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    In this post...

    The effect of networks at a glance

    What exactly is a network result?

    A few examples of the effect network

    What do they all have in common? All of them become important the more customers have them, due to a bunch of different reasons.

    Direct vs indirect network impact

      What exactly is a direct network effect?

      What is an indirect network effect?

      Enhancements to the network

    What is the effect of network aids tech companies to rise.

      How the network effect helps human-centered businesses

      The network effects as well as flywheels for community

      A few examples of the effect network the community flywheel.

    A History of the Network Effect

    Strategies to create the network effect

    Advantages and disadvantages from the Network Effect

The network effect at a glance

• The effect of network is that a platform becomes more valuable because more and more people utilize it.    
  
•         The majority of the biggest and most profitable firms of the last century have grown thanks to the effects of network technology, from phones to railways and social media, to eCommerce.            
  
•         The network effect is what makes community businesses extremely effective, since they have rapid growth led by their members as a community flywheel which produces rapid profits.            
  

What exactly is a network impact?

The term "network effect" refers to how the value of a particular product, platform, or service increases with the increase in users According to economic experts Michael Katz and Carl Shapiro, it's the phenomenon where popular products are inherently more valuable.
They noticed that some products aren't valuable on their own (e.g. nuts without bolts); in the same way, some platforms aren't as valuable (or in any way) without users.

As an example, a social media website as a whole is nothing more than an application. If nobody uses it then it's useless. It's the interaction and presence of their users that make platforms like Facebook, Instagram, LinkedIn and others. their value. You can even put the value of any user who joins the platform such as, for instance that in 2021 Facebook had an average of $43.39 in revenues per user and $13.89 net income.

The network effect can bring value to a business in different ways:

• By user actions or user-generated content: For example, YouTube would be worthless if people didn't show up and create videos. On many social media platforms an effective network effect is only possible if people actually use the program. Meta's most recent Threads launch saw 100 million new users join for the initial month, only to have more than 10 million users active one month following. The release is still in its early stages, but it shows that value isn't in sign-ups, it's in active users.    
  
• by monetizing their network. Social media platforms have the ability to earn money from their audience (selling ads) as well as utilize the massive scale of their networks to charge more for specific targeting, demographics, etc.      
  
• They also produce data that can be monetized too. The more data a collection gets, the more useful it becomes as a data scientist can draw observations from.      
  

    Source: Katz, Michael L., and Carl Shapiro. 1994. "Systems Competitiveness and Network Effects." Journal of Economic Perspectives, 8 (2) 92-155.

Some examples of the network effect

Here are some examples of the network effect working in a variety of diverse industries:

• Communications: Land lines cable TV, land lines, email - These devices become more important the more customers they can serve. A land line can be more useful in case you have the ability to contact anyone using it.    
  
• Scheduling tools: Calendly, Google Calendar - Calendar tools increase in popularity with the networking impact, as once you've sent people an invitation to join a group, they require a calendar to accept.    
  
• Social Media: Facebook, X (Twitter), LinkedIn, Instagram The social media giants generate billions of dollars from the network effect, leveraging the growth of users into advertising revenues (and occasionally directly selling premium services). As an example, the sole reason a job seeker might purchase LinkedIn Premium is due to the fact that there are so many companies on LinkedIn.    
  
• Discussion Forums: reddit, Quora, Reddit - These forums function because of the network influence. If people show up and participate, you can get lively conversations.    
  
• Videos Sharing: YouTube, IGTV, Facebook TV, Vimeo - If you've got a handful of users uploading video on YouTube it is the potential for a fascinating distractor. If you're in the position of having millions in your account, then you've got a platform that could replace TV.    
  
• AI Tools: ChatGPT The technology is new, but ChatGPT quickly increased to reach 100 million users with the help of word-of-mouth, and the greater the number of users it has, the faster the machine can learn information.    
  
• Delivery applications: DoorDash, Uber Eats, Grubhub - It's only due to the huge number of food-ordering customers that delivery drivers are able to earn money from these apps. That's the network effect!    
  
• eCommerce platforms: Amazon, eBay - Amazon only grew as big as it did due to it has a large number of customers. Other online bookstores fizzled. Once it had millions of users It could also expand to merchandise other than books.    
  
• Community of customers: Apple Community, Quickbooks Online Community, Lego Community - These communities become valuable since users log in to share their experiences generally for the sake of having fun. In the event that you're an Apple customer who has issues with a product, you can usually get the solution in Apple Community. Apple Community. It would also be useless for people to not jump in the bandwagon and get it done for free!    
  
• Subscription businesses: Netflix, Amazon Prime Video, Disney+ - The more these platforms expand they generate more subscription revenue. The money can be put back into content.    
  

What do all these aspects have in common? They're all more important the more customers they can attract, and for various motives.

• In some cases, the technology gets better with increasing numbers of users (e.g. ChatGPT)      
  
• In some cases it is possible for the platform to provide content that users can interact with due to more users (e.g. Facebook, reddit)    
  
• In other instances, the more popular user base lets the company offer ads for sale at a price (e.g. Facebook, LinkedIn)      
  
• In certain cases, there's an "real world" benefit to the network impact (e.g. LinkedIn can help you locate an employment ).    
  
• In some instances, the network effect creates a big enough customer community that individuals and businesses can serve a niche (e.g. Uber). We refer to this as indirect network impact.      
  

Example:
Airbnb: Airbnb has quickly become the go-to platform for owners who want to let their homes for short-term stays to traveling clients. They are an illustration of the network effect as the worth of the platform increases as increasing numbers of people sign up to Airbnb seeking to rent their homes, which provides property owners with a steady flow of revenue. Furthermore, the platform creates value for renters as the more homeowners offer their homes to rent, giving renters with more choices to select among. The worth of the platform increases as renters as well as homeowners join the platform.

Direct or indirect network effect

Each of these examples included what economists refer to as direct and indirect network effects. However, the distinction between these two effects is essential to know.

This is a very simple method to comprehend the distinctions between direct and indirect network effect:

What is a direct network effect?

An immediate network effect sometimes referred to a "same-side" also known as a "one-sided" network effect is created in the event that more people of the same kind of members join a particular platform. The network's value can be generated as a direct consequence of the increased number of users joining.

For example, if I'd like to send you a message via WhatsApp but you don't have the app you can do it with a straightforward solution. There's a chance to try downloading WhatsApp! It's just become better because now we're both on the same platform!

The network effect is seen in action all the time when we look at communities on the internet. In communities, there is an immediate effect of the network as members produce content and create value and people on the outside want to join for that benefit! Communities can also offer memberships, courses, premium content, and occasions - and depend on the size of their membership.

This is how this network effect could result in a community flywheel company, which we'll come down below.

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What is an indirect effect of a network?

Indirect network effects, commonly known as an "two-sided" network effect happen when growth in one network results in benefits for the other. As an example, the growing network of customers on Uber brings benefits to another driver's network, which is Uber's drivers. The more customers there are that are there, the better chance exists for the drivers. Even though drivers and customers who use Uber are two different types of users and want different items, both platforms affect each other: The indirect effect of the network.

Enhancements to the network

A different term could encounter in this article called an effect that is a part of the network. The phenomenon of a complementary network occurs when a related product or service increases in value due to the growth of networks of a different network than the company's. For example, LinkedIn grows because of the influx of employers and job seekers. But these enormous networks also hold value for recruiters; LinkedIn serves them as a complementary network.

What is the effect of network aids tech companies to rise.

The vast majority of businesses that we communicate in daily interactions employ the effect of networks to gain advantage. If you take a look at the largest businesses in the world by market capitalization, many of them have used the network effect in order to experience enormous expansion. As an example:

• Amazon (plus $1 Trillion) The company has used the effect of network to launch an online store to become the largest store that on the planet. In addition, Amazon has used its network effect to establish profitable businesses, for instance, AWS provides cloud computing as well as web-based services for app suppliers and for vendors to service their clients.    
  
• Alphabet (and $1.5 Trillion) Alphabet (+ $1.5 Trillion) Alphabet is home to a variety of companies within it, however it began by creating the world's best search engine (Google) that grew quickly due to the effect of network. These searchers helped make Google into the business that it is now.    
  

There's a reason why the network effect has helped tech companies become the most valuable companies on earth. This is due to externalities.

Externalities are the positive or negative outcomes of networks and they may limit network expansion. In the past, externalities were a result of network. For example, railway companies grew due to the effect of networks-with more riders bringing more money. BUT it was still a huge expenses to keep the system running. The railroad had to manage the rail networks, bridges tunnels, stations and bridges and keep their engines stocked with coal.

These externalities slowed network growth.

    Here's how the network effect benefits tech companies.

Technology companies are not awash in externalities. If Amazon has the infrastructure and technology in place, everyone in the world can access the site and make purchases. It would cost a railway millions of dollars in externalities to add more customers; they'd need more engines, cars, tracks and stations. This will cost Amazon more server space-which could cost pennies.

Tech companies can grow nearly endless networks with no additional costs. That's why the network effect has helped push many tech giants to the top of the market.

What is the effect of network helps human-centered businesses

We've been extremely excited about how the network effect works with human-centered software. Are online communities that grow exponentially and transform into profitable businesses because of the network effect. Thus, we've seen thousands flourishing communities, both small and large. They have become enterprises thanks to this trend.

In community building, a network effect describes the phenomenon where the value of a community increases as new members join. Every new member who joins brings with them the unique viewpoints, experiences, and expertise and adds value to your company, its brand and your members.

This can be directly importance to sales of memberships. For example, most generate between $27-$33/mo in membership fees ($240-$319/year).

The effect of the network isn't only related to membership fees, however. The network effect also describes how the value of organisations increases due to the activities of members.

Users create content, and they encourage others to join, adding value to the group. It creates a chain reaction where additional users create additional value. This in turn attracted other users, who give to the value.

This is what we call member-led growth, and once you see it, you'll be amazed at the impact it has on your life. Members-led growth makes use of the effects of network to bring your customers, subscribers, customers, or whatever to become members. The members are part of the network. If your company can prosper through member-driven growth, you'll witness the network effect working.

Being a creator, the network effect is so valuable because as you establish a network of relationships between people who make up your community you can focus less to creating content on a constant basis. In a community that is flourishing, the valuable ideas and experience your members provide to each other will keep the conversation running long after you have released new content for them.

Effects of networks are generally positive and derive from the potential buyer gaining higher value from your item or service due to how many others are making use of it.

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The network effects as well as community flywheels

Last year, McKinsey identified a type of business that they predicted will dominate in the years 2020. These businesses were referred to as community flywheels. Community flywheels are created when a company's brand is able to grow an entire community thanks to the network effect. Usually, there's a powerful narrative that connects the community together. The result is that your members are producing content and participating in the process, which helps your community expand on autopilot.

Then, McKinsey states, these brands introduce hero products which are suitable for their customers, and selling happens effortlessly because supermembers are primed and excited to purchase. There are no funnels. There's no pressure.

Just awesome, organic, member-led growth thanks to the effect of networks.

Examples of the network effect with the community flywheel.

In the Cut: Rae Benjamin founded In the Cut to be an online community centered around connecting people and resources for marginalized artists to break into the television and film business. Through the Cut has quickly grown in its size since its debut in 2020 and now has over 1,000 members. Through the Mighty Network, they offer paid webinars, job postings as well as a group of fellow creators and hosts online gatherings.

Sktchy Art School: Jordan Melnick created Sktchy Art School as a community for artists interested in portraiture to learn new techniques, show their artwork, and gain feedback about their work. Since launching in 2018 Melnick's group has grown to include over 14,000 users. The members of the community are able to take art classes, participate in art competitions for groups and join in the growing art community.

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History of the Network Effect

Here are the most important ways that the effect of network has been working all through history:

1. Telephone networks (19th century) In the years that more people got phones as they grew in popularity, the importance of the network rapidly. It was because of this when in 1908 Theodore Vail, president of Bell Telephone, presented the concept of the network effect in the company's annual meeting.    
   
2. Radio Networks (1920s)  When more people got radios, it made broadcasting more profitable and powerful.      
   
3. Television Networks (1950s on) : Much like radio, mass uptake of TVs within households resulted in higher values for advertising and programming.      
   
4. Fax Machines (1970s-80s) In the 1970s and 1980s, Fax machines were able to grow into a network as more people were using them. There had to be a send and receive side, almost identical to phones. In the year 1980, Robert Metcalfe brought the theory of the network effect into mainstream when he recognized that the worth of a network for communications (e.g. telephone lines) wasn't the real expense of the hardware however, there was an exponential benefit for every added user. He claimed that Ethernet cards needed to reach a crucial mass to achieve their true worth as networks.    
   
5. Personal Computers (1980s-90s) as growing numbers of homes got a Mac or a Windows-based computers, the programs that run them became more valuable. This was what helped make Microsoft and Apple their companies that they have become in the present.    
   
6. Internet as well as Email (1990s): The two merged in the 1990s as communication via digital technology became more prevalent. Between 1985 and 1995, Michael L. Katz, Carl Shapiro, Joseph Farrell and Garth Saloner performed a lot of the foundational work for the network effect as a theory of economics.    
   
7. Social Media Platforms (2000s to) The social media platforms used the network effect to create massive amounts of users creating themselves content. Remember Myspace? It was among the very first!    
   
8. Sharing Economy Applications (2010s) : The network effect meant that sharing apps could expand to dominate our lives, as things like Airbnb and Uber became possible.      
   
9. Cryptocurrencies as well as Blockchain (2020s) A: value of the cryptocurrency and blockchain have suffered, but the technology underlying the cryptocurrency and blockchain relies on the network effect and it's not going anywhere. The promise of Web3 is the ultimate in an effect of network: a decentralized internet.    
   

How to make the network effect

If you're establishing a business that's going to profit from the impact of networks , here are some tips:

• Utilize the power of users-generated content. The massive growth of social media businesses was the result of creating platforms and then letting the human imagination loose.    
  
• Utilize platforms that allow users to create, join, and invite others (ie. social platforms). Giving ownership of platforms (getting away from the process) lets the platform to grow organically.    
  
• Make a service or a product that by-its-nature compels growth and invite others to join (e.g. Calendly).    
  
• Niche down. Members join and participate in networks (esp. social networks) which allows them to connect with those who have similar interests. While the social media giants boast huge numbers of users, they thrive on independent networks. As an example, Facebook thrives on family and close friends. LinkedIn on workplaces and industries. Twitter brings together people who have similar passions (e.g. politics)      
  

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Advantages and Drawbacks from the Network Effect

    Advantages

• Businesses can experience fast growth and profit.        
  
• Human brands could profit from more users engaging and creating (e.g. an online community works on human creativity ).    
  
• More users allow brands to create superior offerings and experience.        
  

    Negatives

• The internet can create negative externalities. As an example, a large number of users on social media websites can open opportunities for predators.      
  

Now Read: 5 Strategies to monetize Your Customers