How the network effect drives business models

Network Effect is an action in which, through the increase of users, there is an increase in the value of the product. More clearly, the network effect is a strategy in which the product generates profit for its user and, consequently, with the increase of users, there is an increase in its benefits. 

In other words, the persona does not use the platform simply because they like it, but also because they profit from their presence in that environment. This tactic makes your platform stand out and be more widely used compared to your competitors'.

 The network effect generates engagement and faster user growth, because users, wanting to increase their profit, share the platform and its product, making it more used and well-known. Additionally, the people attracted have the same goal, thus keeping your product in constant movement. 

The conclusion is that, with a greater number of participants, the value of a product or service also increases. This happens because with a larger number of users, there is greater content production, which makes the interaction between producers and consumers more frequent.

"After gaining significant market share, you can often sit back and let the network effect take over," says Anand in Economics for Managers. "Your existing buyers and sellers are, in effect, your sales force for attracting more buyers. Often, you have to do very little. This is also why, in markets with network effects, you see companies competing fiercely from the start to get customers — even giving the product away for free — but raising prices later, once they have the network lead."

This happened with the internet and still happens today with social networks. The most recent and most used in our daily lives is TikTok, which enables profit based on the time the user spends on its app and the virality that their content generates. 

In other words, from the awareness that people spend most of their time on social networks, it was necessary to draw their attention to a specific one. The network effect is a business model to attract these people through the gains they will have by spending their time on a specific platform instead of the neighboring network. 

This process has become advantageous for competition between e-commerce businesses and social networks by being able to attract consumers to their product easily and considerably quickly.

But there is still congestion, a negative aspect of the network effect, in which the presence of many users ends up making the platform's navigation slower, which ultimately leads to the loss of users due to this frustration.

Additionally, there is also a critical mass number that must be reached for the platform to be active and interactive, because this way the user can have a voice and express themselves in some way. Otherwise, they abandon it.

But you should not use the network effect at any stage of your business just to make it grow. The network effect is used to accelerate the company's growth and not be the base strategy for it; a foundation is needed before putting it into practice.

Economics for Managers says that one of the fundamentals that should be applied before wanting to generate a network effect on the platform is the principle that your business already has significant market share; this way the probability of the network effect working in the long term increases.

"Companies that can leverage or exploit network effects typically experience rapid growth rates," says Anand, a professor of Business Administration at Harvard Business School. "Not only that: once you're ahead, you tend to stay ahead. Your demand keeps growing even faster as you get bigger."

The user experience and the result of their interaction with others determines how satisfying your platform or digital media is. If it is good, this makes them navigate your channel intuitively. However, over time, as the user dedicates a lot of time to your network, they will have other desires beyond their current ones, and that is when monetization and the real network effect emerge, in order to benefit them as a user.

It is necessary that both sides be pleasant and attractive so that it not only keeps users on the platform but also attracts others. 

 

Advantages and disadvantages of the network effect

The challenge for any brand that aims for the network effect as a business model is the prior attraction of the necessary number of users for it to be applied. This audience is called critical mass. 

This initial group of users is quite relevant, because it is from them that the sharing of your service and the increase in your engagement will happen. In this way, the network effect generates economic help for the company that makes it self-sustainable.

In this context, the platform encourages the user to produce content frequently. This becomes beneficial both for the user who profits from the platform and for their consumer who earns a percentage for consuming their content. 

While you are reading this, you may have already noticed that there is a similarity between the network effect and some social networks you use, right? Like TikTok, for example. If you were able to connect both, it is because you are understanding what a network effect is. 

TikTok provides coins both for those who watch videos and for those who produce them. This makes its users stay even longer on the platform, because they earn something in return for it. TikTok grew mainly among teenagers and young people, who study and are always looking for a way to earn some extra money. That is why we see so many of them engaged in this social network.

But do not confuse the network effect with viral effects, as they are free, unlike the network effect which guarantees a paid percentage to users. Viral effects occur instantly, in addition to having different objectives and guidelines from the network effect.

‍

Types of network effects

The strongest network effects are direct ones, and they are classified as Physical, Protocol, Personal Utility, Personal, and Market Networks. They represent a relationship between the increase in product engagement along with the value presented to its users. 

This means that, for a TikTok content producer to have their production relatively recognized, it is necessary that there be a sufficient and growing audience, because with that their content will be worth even more.

"A telephone — without a connection on the other end of the line — is not even a toy or a scientific instrument. It is one of the most useless things in the world. Its value depends on the connection with another telephone — and increases with the number of connections." — Says Vail.

Direct Physical

These are network effects that are not in the virtual environment but in the physical one where we live. They are strategies of means such as telephones, decoders, the internet, and others. 

They become one of the strongest means because, in addition to being able to incorporate into a virtual world, they have relevance, strength, and presence in the physical world. This makes them stronger and more precise than just a virtual network effect. The physical effect gives rise to a concession, which can turn it into a monopoly and, consequently, into its nationalization. 

Protocol | Direct

The protocol network effect is the creation of a computational standard that becomes the basis for all its consumers, like Bitcoin. It can also be a company's operating system or a control panel. Its owner can change its value or the percentage of relevance, as well as enable control of a channel only for some of its services.

Personal Utility | Direct

The personal utility network arises from the moment a person uses their personal contact network to gain engagement in their professional life. On one hand this is good and on the other it is not. The issue is that, by splitting both accounts, your audience and the care with positioning become more relevant, in addition to the fact of having to be online frequently. 

Personal utility is more of a marketing matter. This is related to the Personal model, in which the person links their identity and reputation to a product. But there is a difference between them: personal utility networks are used for goals, advertising, and marketing tasks that need to be done, in addition to being something more private, which makes social networks less relevant to your routine. But in both cases your image is linked to your product.

The personal network, on the other hand, is for the purpose of building a connection with other people, such as friends, coworkers, and neighbors. Your social mapping is based on your personal relationships, as it is already an audience that follows you. 

 

Market Networks | Direct

The market network is the transformation of a personal network into a commercial network. In this case, there is a change in visual identity and communication that becomes focused on market characteristics. But be careful, this does not classify it as a network effect on both sides.

The two-sided network effect is classified as indirect by many academics, but some disregard this because it also involves direct network effects. This distinction happens because there are two types of users: supply and demand. Their objectives when joining the network are different, but they are essentially complementary, as in a Marketplace. 

Platform | 2 Sides

The platform network effect is similar to the marketplace; the difference is that its offerings are exclusive to the platform, meaning it is not an independent product. The two connections are formed by developers and users, who create value for each other through the platform that generates value for both. 

Another aspect is that the platform forces its standardization and its consumption. For example, Microsoft integrates the Office suite for free in universities so that people get used to using it and become comfortable with it. This creates a habit in which, because they are accustomed to the platform, the user already places their trust in it.

In this way, there is a relationship between producer and consumer, a relationship in which the person, when thinking of visiting another platform, does not feel comfortable leaving their comfort zone and ends up staying on the one they are most familiar with.

Asymptotic Market | 2 Sides

No two markets in an environment are the same. The speed of demand is different, along with its strength in reaching critical mass. This is called the "Value Curve."

In this case, the asymptotic market becomes more vulnerable to competition, because there is a dependence on consumer circumstances, in addition to the time and value it takes to consume. This creates greater competition among competitors, which results in lower product prices so that the competitor does not become a potential choice. 

There are several models of Network Effects and it is up to the company or brand to know how to choose the one that best integrates with their business. Remember that Network Effects are not appropriate to become the foundation of your business, but rather a turbo that propels it. 

The fact that many platforms and social networks already use it forces an evolution or the creation of another strategy. The point is that network effects are unstable; it is up to the brand to ensure other principles so that it does not depend on something so variable.

Want to know more about networkingand business? Access other content on our blog!