The More The Merrier: Exploring the Dynamics of Network Effects

Have you ever made a decision based on what others are doing? Maybe you joined a social media platform because all your friends were on it, or perhaps you chose a particular restaurant because it had a long line of people waiting outside. As an Apple user, I've come to realise that we act like professors, except instead of talking about something like the 'beauty of mathematics', we preach the benefits of our devices to anyone who will listen. Apple has created an ecosystem that only becomes more valuable as more people join through its Apple-centric features (or a walled garden, depending on how you see it). And much like the elegant proof of Fermat's Last Theorem, this positive effect of Apple's ecosystem on customer acquisition is a beautiful example of what we refer to as network effects. Simply put, network effects refer to the idea that a product or service becomes more valuable as more people use it.?

This can happen in two ways - either when a product or service becomes more valuable as more people use it or when the value of a product or service increases for one group of users when a new user from a different group joins the network. The former is referred to as 'direct' network effects - social media platforms like Facebook and Instagram become more valuable as more people join since users can connect with more people and have a larger audience for their content. The other scenario comes under the category of ‘indirect’ network effects, and you've probably seen it with ride-sharing apps like Uber or Ola. Here, the platform's value highly depends on the number of drivers who use it. When more drivers join the app, the waiting time for a ride decreases, making the app more convenient and valuable for users. The reverse is also true - the more riders there are, the more likely the app adds value to its drivers.

Bandwagoning is a phenomenon that occurs when individuals adopt a certain behaviour or decision because they believe that it is popular or widely accepted. Interestingly, we discussed the concept of bandwagoning in another post a couple of months ago, where we talked about how advertisers extensively leveraged the idea (remember Sensodyne advertising themselves as the #1 dentist-recommended toothpaste?). The same concept can apply to network effects, where individuals may choose to use a particular product or service simply because they see that many others are already using it. However, it's also important to note that bandwagoning is just one aspect of the broader concept of network effects.?

While bandwagoning can undoubtedly contribute to the growth of a particular product or service, there are many other factors at play as well, such as the quality and usability of the product, the marketing strategies employed by the company, and the overall value proposition of the product (You might probably be one of those who are annoyed by me praising Apple - but Apple's success is attributed mainly to its ability to harness the power of network effects in its business strategy, and makes it beneficial to buy into the ecosystem by incorporating user feedback and improving compatibility across its devices).

A direct result of what we have discussed will be somewhat similar to the saying 'the rich get richer' - where companies that are already successful in a particular market or industry tend to continue to be successful and accumulate even more success over time due to the benefits of network effects. This dynamic can create a situation where the top performers in a market or industry continue to dominate while smaller or newer players struggle to gain traction. As a result, the rich get richer, and the gap between the most successful players and the rest of the field widens over time.

These are just a few examples of the power of network effects in the current business landscape. Whether it's ride-sharing apps, social media platforms, or smartphones, network effects can potentially drive the growth and dominance of products and services in the market. By understanding and harnessing the power of network effects, companies can create products and services that become more valuable over time as more people use them, creating a virtuous cycle of growth and success.

Written by Advaith Krishna A