What is a Network Effect?

A network effect is an increase in the value of a service or product in response to growing numbers of users. The classic example is the telephone, a service that became more valuable as more and more people started buying their own, creating a network of users. As more people began to use telephones, people without phones started joining in because everyone around them was using one, and the value of the service kept increasing. The Internet also provides a number of examples of the network effect.

Products and services that benefit from the network effect are of little utility when only a handful of users are taking advantage of them. As those users convert new users, and those users convert people in turn, the value of the concept increases. Eventually, word of mouth will begin to spread exponentially and the concept will trickle through society as a whole. Numerous Internet startups took advantage of the network effect to grow by large numbers of users in a short period of time.

There's a hidden cost to the network effect, embedded in trying to keep pace with a growing user base. This can be seen most starkly with websites, where a flood of new users can overload the site. If the site cannot maintain its servers and keep bandwidth high, it may start failing, leading users to turn to other services with more perceived reliability. The network effect can lead to problems for providers of products as well, as people demand products and they can't keep pace with the demand, leading to delays and consumer frustrations.

For products and services relying on the network effect, reaching a critical mass of users is a challenge. Once the user numbers reach critical mass, they will keep growing even if limited promotion is done, because the concept has started to saturate a society and people will pick it up even if it's not explicitly marketed to them. In the early stages, aggressive promotion and creative techniques like using a limited beta release to create an illusion of exclusivity are used to drum up demand and get users, along with potential investors, interested.

On the Internet, social networking has facilitated the networking effect. Ideas spread very quickly as people communicate through a variety of media, spreading messages to their friends and creating a surge of interest. Influential users on social media sites can contribute significantly to a build in user numbers and some savvy marketers have used this to promote their products and services, offering free products or trials to people with clout online in the hopes that these individuals will talk up the experience to their followers.