– House of Lords European Union Select Committee
Network Effect: “The effect that one user of a good or service has on the value of that product or service to any and all other users”
Network effects are not a new phenomenon, nor are they exclusive to mankind. The social and economic benefits of the network are afforded to bees in the hive, fish in the school, and birds in the flock in much the same way as to violin-makers in 17th century Cremona or to fraught festival-goers desperately hunting for a Glastonbury ticket on eBay today.
In the last two decades, substantial improvements in communication technology (primarily through information digitisation and the Internet) have fuelled an exponential increase in achievable network quality and size. Cloud services now provide computing power and data storage on-demand, which takes the marginal cost of rolling out a digital network to new participants to practically zero.
“From social engagement, transport, and DIY, to Christmas shopping, dating, and private investing, the world is taking advantage of the economies of scale that a digital network can provide.”
As a result, networks are burgeoning and proliferating across all aspects of our lives. From social engagement, transport, and DIY, to Christmas shopping, dating, and private investing, the world is taking advantage of the economies of scale that a digital network can provide. In a single month, almost 2.3 billion users interact on Facebook, nearly 200 million users transact on Amazon, and around 450 million taxi rides are booked through Uber.
Connections grow exponentially with each new node in the network. With each new connection, for all members, there is a new opportunity to buy or to sell, to teach or to learn, to swipe left or to swipe right. As larger networks benefit from enhanced network effects, more users are attracted, growing the network in turn. In this way, networks benefit from a virtuous cycle of growth.
Clearly, size is an important factor in determining the value of your network. However, it is the quality of the network, and of the connections themselves, that determine the valence of the network effect.
If a network grows too broad too quickly, the size of the network may have negative impacts on the value of your service. Consider the consternation caused by the increase of other road-users as you’re driving home for Christmas, or, perhaps more relevantly in the digital economy, bandwidth bottlenecks causing 15,000 Netflix viewers to miss a long-awaited episode of Game of Thrones, the luxury problem of “choice overload” from a digital marketplace, or even criminal activity − “fake news” is all the more damaging due to the extended reach granted by digital networks:
Four key elements determine the existence of a positive network effect: relevance of membership, diversity of membership, navigability of network, and propriety of network use.
Whilst the size of the network amplifies the network effect, a keen eye must always be kept on its quality. Platform and service providers looking to swell their networks must first ensure that their membership is relevant and diverse, their structure is navigable, and their usage appropriate.