What is the network effect?
We’ve all heard about the network effect. A network effect is a phenomenon where the value of a good or service for a single user increases or decreases relative to the number of other users on its network. We often cite that faxes were only useful if most / all of the other organizations we dealt with also had a fax machine. Conversely, we can also juxtapose the decline in fax use with the network effect. We use the network effect to describe the benefits of the global telephone network. We also use it to describe the rapid growth in the number of users / subscribers after a certain inflection point. The more users join the network, the more useful the network becomes, which encourages more users to join. This is sometimes described using the hockey stick growth chart.
What are the benefits and risks of the network effect?
The success stories of the Internet age were driven by the network effect. If you look at the biggest companies in the world by market capitalization, you will see that many tech companies have hit the wave of the network effect. The primary benefit of the network effect is the increase in value for all other users as each incremental user is added to the network. But what often gets lost in the positive aura of the network effect is that it also has significant potential pitfalls.