Tool Box
Issue No. 11 - June/July 2003
Growth for Survival - the Network Effect
What is the Network Effect?
Recognising the network effect — and being able to identify a product operating within a network effect — is vital for companies developing technology-driven products and entering new markets.
In most industries, there will be at least several competitors sharing the marketplace and its profits. In certain technology sectors the network effect allows one or two players to dominate a market and capture most of the profits. Despite repeated attempts by rivals to introduce differentiated products or services, these dominant players continue to maintain and even increase their lead over time.
What is the network effect?
Q: what was the value of the first fax machine?
A: It had no value at all!
A fax machine on its own has no value. However, as this product was more widely adopted its prevalence became a critical value proposition of the product itself. This is the essence of the ‘network effect’. Simply put, the network effect means that the value of a product or service increases with the number of users.
For example, if a product or service is ahead of its rivals in securing a critical mass, new users will be drawn to this product because the total value of the product is stronger. This effect allows products to dominate market segments with a market share usually in excess of 70%, as well as enjoy premium profitability over rivals, with early market penetration leading to sustained growth, despite competitor attempts to enter the market.
Strategic Implications
The strategic implications of the network effect have considerable impact on how managers plan their business.
Once a new market leader emerges and has captured sufficient critical mass to tilt network effect to its advantage, it is very difficult for other competitors or new entrants to catch up.
When the market is still young and there is no clear leader, customers evaluate products based on traditional attributes such as ...
