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What are Network Effects?

Network effects are the incremental benefit gained by an existing user for each new user that joins the ecosystem. There are two types of network effects: direct and indirect network effects. For platform businesses, network effects are key since there are two types of users: consumers and producers. As more consumers join the platform, the more useful and valuable it is to producers. You can see network effects at work when a platform attains a critical mass of users, at which point the cost of joining the platform is outweighed by the value of joining derived from the power of network effects. Prior to critical mass, the cost of joining is greater than the value derived from joining, so the platform will need to subsidize initial user acquisition like providing a referral fee, for example.

Two Types of Network Effects: Direct vs. Indirect

The two main types of network effects are Direct (Same-Side) Network Effects and Indirect (Cross-Side) Network Effects. The more basic category is Direct Network Effects, where the value of a service simply goes up as the number of consumers goes up. The classic example of this is the telephone, which is only useful if the people that you need to reach also have telephones. The more people there are who have phones, the more useful it is to have one yourself. These network effects aren’t as applicable to platforms since platforms have two or more user groups exchanging value with one another.

Network effects are demonstrated when the sheer volume of users attracts more users.

More closely related to platforms – platforms being defined as a business model that creates value by facilitating exchanges between two or more interdependent groups, usually consumers and producers- are Indirect Network Effects, which can be described as a symbiotic relationship between consumers and producers who utilize a given platform together. An uptick in consumer use of a platform makes the platform more valuable for producers, leading to a greater number of higher quality producers.

This subsequently generates greater value for consumers, which incentivizes more people to start or continue using the platform. As an example, if there are many developers producing great apps on a given platform – say Apple’s iOS – consumers will be drawn to that platform and will go out and buy iPhones. As the number of iPhone users grows, more and more people will learn how to develop apps on iOS because the market is growing, theoretically opening the doors to a wider array of higher quality apps. This interdependent cycle between producers and consumers known as the “positive feedback loop,” is the bread and butter of successful platforms.

Using a platform business model creates a positive feedback, where use creates incentive for more use.

Emphasizing the “higher quality” nature of this growth is important, for not all growth is created equal. As a network expands to a certain size, it is common for the average user quality to drop, and as such it is important for platforms to maintain a high standard for access.

Facebook can be considered as a very successful case study; the initial user base began as a highly curated group (students at a single university) and they managed to avoid flaming out on the road to becoming an enormous enterprise. As it expanded, Facebook remained highly vigilant in its efforts to maintain user integrity, fleshing out spam accounts, ensuring users are who they say they are, etc. This is a primary reason why MySpace and other social networks like it rapidly deteriorated while Facebook now has 1.5 billion users; growth is good, since it leads to more growth, but you need good growth to have lasting growth.

Often times, the global consumer network of a platform can be better understood as a collection of localized micro networks that function independently of one another. On social media platforms such as Snapchat, Facebook, and Instagram, the larger pool of users is broken up into individualized networks where people interact within their own peer groups. They are part of the whole social media user base, but are more directly impacted by their involvement in their localized network. The local network effect can be a powerful force in keeping user engagement high and consistent, as it emphasizes and accounts for each user’s individuality.

The 5 C’s of Network Effects

There are strategies that platforms can incorporate in order to develop strong network effects that go beyond simply acquiring as many users as possible, and we have broken them down into 5 steps: Connection, Communication, Collaboration, Curation, and Community.

These five tactics are key to building up sustainable network effects on a platform.

Your process begins with Connection, where you get your initial users up and running on the platform. The next step is to ensure that the Communication between users is as seamless as possible, allowing for the greatest ease-of-use so your users are actually using your product as much as possible. Next, Curation comes into play, where you need to maintain the integrity of your platform by keeping the quality of your user network high.

A way to further engage users and provide a more profound experience for them is to incorporate opportunities for deeper Collaboration between users wherein they are able to self-organize into new networks that advance the specific agendas that are important to them individually. The pinnacle of a platform’s success is Community, which implies that users are in a sense taking ownership of the platform, like when someone edits a fact on Wikipedia or flags inappropriate content on Facebook.

Understanding the subtleties of network effects is an integral part of building a successful platform. The growth generated through network effects can be a powerful force in developing a brand, but it must be shepherded so the growth doesn’t run away with itself, taking your platform’s reputation with it.

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