Network Effects

Once a network reaches critical mass, it becomes nearly impossible to displace.

A new social platform launches with better features, cleaner design, smarter algorithms. It gains a few million users, then stalls. The problem isn’t the product. The problem is that everyone you want to talk to is already somewhere else.

Network effects explain why some businesses compound while others plateau. A product has network effects when it becomes more valuable as more people use it. The telephone is useless if you’re the only one with one. It’s invaluable when everyone has one.

This creates winner-take-most dynamics. Why use the second-biggest marketplace when buyers and sellers are already on the first? The value is where the people are. Strong network effects tend toward monopoly — one dominant player, a distant second, then everyone else fighting for scraps.

Two Types

Direct network effects: Value increases because more people use the same product. More people on a phone network means more people you can call. More people on a messaging app means more people you can reach. The product itself becomes more useful.

Indirect network effects: Value increases because more users attract complementary products. More iPhone users means more developers building iOS apps, which means more valuable to be an iPhone user. Platforms often exhibit indirect effects — the product doesn’t change, but the ecosystem around it grows.

Both create compounding advantages. The leader attracts more users, which makes the product more valuable, which attracts more users. Trailing competitors face the opposite dynamic.

The Critical Mass Problem

Networks need minimum adoption to be useful. Below critical mass, they struggle — no one joins because no one’s there. Above critical mass, growth becomes self-reinforcing — people join because everyone’s there.

The strategic challenge is getting from zero to critical mass. This usually requires subsidising early users, concentrating on a niche where you can reach density, or creating value that doesn’t depend on the network until the network forms.

Two-sided platforms (marketplaces, app stores) face this twice — you need critical mass on both sides. More buyers attract more sellers. More sellers attract more buyers. But someone has to go first. Most platforms solve this by subsidising one side, often permanently.

Attacking Networks

Attacking an established network is extremely hard. You need a wedge — a niche where you can reach critical mass before expanding. Local networks are more vulnerable because challengers can win geography by geography. Global networks are nearly impenetrable.

Technology shifts sometimes reset the game. Mobile reset social networking. The web reset commerce. When platforms migrate, network effects temporarily weaken. These moments are rare, but they’re when new winners emerge.

The other option is to compete on dimensions that don’t depend on network size. Better experience. Lower cost. Features the incumbent can’t copy because they conflict with the existing business model. You won’t displace the network, but you might carve out a defensible position beside it.

Related: Complements · Real Choices · Reading Guide

Connects to Library: Network Effects