In this piece, I would like to talk about the network effect. It is an interesting concept in the field of economics, business, industry, and services. Basically, it applies to many spheres of our lives and the way we interact and
communicate with each other. Naturally, it also applies to many economic situations and ways we purchase and consume goods or services.
The most simple definition of network effect is the following: it happens when there is more value in using some good or service when the number of users of this good or service increases. In general, it means that the more people connect to some service the more worth they can receive while using it.
The most mundane example here is the telephone network. Historically, when there were just a few telephones installed, only a few people could use them. And if you were to install a telephone at your home, you could only connect to this small group of people. However, as the number of users of the telephone grew, you could connect to much more people. Hence, the value of using telephone services progressed accordingly.
What is important here is that there are several key ideas or concepts that deepen the understanding of the network effect.
First of all, you need to distinguish direct network effects from indirect ones. The direct effect is when you receive more bang for the buck straightforwardly from the product itself: when the density or number of people using this particular service network increases.
Indirect effects are those that are connected to two groups of functions related to some product or technology. They just exploit different angles or aspects of this same technology. The textbook example here is that of hardware versus software: the value of a computer or a smartphone as a piece of hardware increases when the number of applications or software programs grows.
Second, there is the idea about the price. Basically, you can restate the network effect as the price decrease of some good or service as the number of users grows. The price and value are used as opposite concepts here. So either the value increases or the price decreases. In general, it means the same thing and is just a restatement of the original idea.
Third, there is a possibility that the network effects can be negative. Mostly it is related to the idea of congestion or overcrowding. At some points, usually called saturation points, the number of people using the network could lead to a decrease in service or its quality. We all know about this in the example of traffic jams and traffic congestion: the road network can be stuck by the number of cars trying to gain access to this network.
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All in all, the network effect is quite an interesting concept. The three key ideas stated above are just the basics to understand it. There certainly are many more complications and complexities that could describe the network effect. It is interesting to discuss how these could be used in different business applications. And it is interesting to look into what types of ubiquitous goods and services that we are habitually using in reality rely on network effect.
