Gloria Spittel unearths a phenomenon that has become an integral part of doing business
Network effects became apparent as both a concept and business strategy in the 20th century. Defined as the value that users derive from increased use of a product or service, the effect rose to prominence primarily with the advent of telecommunications – and it spread to related technologies and services such as the now almost obsolete fax machines.
However, not all connected or networked platforms (products and services included) or business models derive these effects. In some instances, this could cause disastrous outcomes when overeager investments in companies based on projected yet inaccurate network effects result in widespread economic bubbles.
While the concept is aspirational in product development, it is apparently hard to achieve for a number of reasons. These could include a mismatch between product and market, nonexclusivity of the product or reliance on network effects for growth without a stimulus. According to some experts, in order to leverage network effects the focus should be on usage and not merely on adding users, which is akin to growing virally.
But even with this in mind, aiming for network effects with a product or service probably needs to start with the creation of a product to serve a market need or gap, or the creation of a market. In these scenarios, there is a competitive advantage; but if successful, the effect is what provides a company with defensibility – or simply the ability to defend its commanding position in the competitive landscape.
This is one reason why network effects are important for business longevity. But even before businesses can think of growth and development, these effects have become an integral part of what it means to do business in the 21st century.
Certainly, if the business model – and the product and service that the business offers – cannot by way of its nature make use of the phenomenon, there’s very little purpose in pursuing this pathway.
However, when the concept was first defined and identified, it seemed relegated to the IT industry. After all, network effects displayed dominance in telecommunications including mobile communications and later, in the ownership of personal computers.
In some ways, this could still be true but here’s the crunch: network effects have evolved into various types that include inexplicable human belief.
The network effect of human belief translated into a product reads that the more people who believe a product is valuable and the more similar products that enter the market, the perceived value becomes more stable. This self-reinforcement sounds like it may lead to an implosion at some point but beliefs in political ideologies have survived millennia.
The philosophical reach of network effects suggests that discounting any business may be premature. Laying aside the philosophy, they’re expected to play a role in autonomous vehicle systems, robotic systems, blockchain and IoT. So there is a good chance that products and services developed in these ecosystems may find themselves to be the beneficiaries of indirect network effects.
And there is yet another consideration, which is that not all network effects provide the same results or value in the same time. And this essentially depends on the type of business, product or service.
In businesses such as e-commerce marketplaces for instance, as the supply side grows so does demand. And this in turn affects supply and so on.
The value here is proportional. But some business marketplaces need to create a supply side of vendors to attract a critical mass of customers before the demand side joins in creating a network effect – all this while other such marketplaces increasing supply after a certain point start to diminish value.
And yet, in other business models that depend on user generated data, how the data is used, the size of the company and relevance of the data collected play important roles in success.
So in short, network effects do help in the defensibility of a company’s position but only if it has utilised effective business strategies.
Once it has achieved network effects – such as those in Facebook, WhatsApp and Airbnb to name a few – little maintenance is needed to retain this premier position.
But even in these examples, not all products have reached this coveted status. An example of this is Google’s attempt to establish a social media platform – Google+ – which was shut down in April, compared to Facebook’s worldwide dominance.
However, there is a lesson to be learnt with Facebook’s dominance – it is one of accountability and responsibility.
In recent years, lapses in user privacy have taken a toll on Facebook including political scandals (such as the Cambridge Analytica fiasco), providing a platform for the spread of fake news and bots, and other global failures to tackle hate speech when it is flagged in various countries.
While they are most important, network effects should remain ethical in practice too.