The underlying strategy and benefits of building a network of users isn’t anything special, or particularly nuanced. The biggest social platforms in the world are built on this idea – that the more users there are in a network, the more valuable that network becomes. 

But in reality, the “network effect” is much more complex, and has far more power than simply adding benefits for users. A startup strategically using network effects with purpose can create better products, create harder barriers for competitors, and ultimately, succeed. 

Back to basics

Network effects, or what some call “demand-side economies of scale”, are created when a network’s value increases alongside the number of users. This is simple stuff, and has existed for centuries. The first telephone lines only became valuable when more people had telephones. These effects, (which can be negative, too – think of congestion), also come in a variety of forms.

For instance, in one economy of scale, such as something like Skype, the user benefits from every individual user who joins the service. But benefits can be more general. The more people use Skype, the more it appears on popular services and integrated into other products.

(It’s important to distinguish a network, which is an interconnected group of users, or objects, with a platform or a marketplace. A platform provides an opportunity for others to create content, or to connect two different groups of people – for example, Uber customers with Uber drivers).

Of course, network effects can become far more complex.

In a software business model, network effects aren’t linear. That means the benefits that a digital company gains from an interconnected group of users is far more than a non-digital business would see. 

But the strength of network effects isn’t purely determined by the number of participants in a network. It’s the engagement that counts. As Robert McMillan explains here in Wired regarding the decline of Friendster in 2003, “Friendster still had tens of millions of users, but the bonds linking the network weren’t particularly strong”.

Facebook knows this, even today. Algorithm changes have favored pages with higher engagement rates rather than those with the biggest follower counts. Facebook itself has encouraged connections and bonds between users – knowing that as long as the increased activity of the network survives, so will the network itself.

Eventually, businesses want to reach critical mass – a point where enough users jump on board that the network becomes self-perpetuating.

Network effects reinforce each other

The biggest tech businesses in the world are using network effects to their advantage, but not all of them are using them in the same ways.

For instance, Google is a beneficiary of its own two-pronged approach: the network that has people search for information, and the other that is built on advertising. Both these networks integrate together and learn from each other, becoming stronger as more searches are undertaken. Such a large economy of scale means Google has created such a wide barrier to entry – or a “moat” – that toppling it is a fool’s errand.

HBR - what airbnb uber and alibaba have in common

What Airbnb, Uber and Alibaba have in common. Source: Harvard Business Review.

Airbnb’s network effect is two-pronged. As its network of users grows, so do the number of people who list their accommodation, and so on. However, Airbnb is an example of how a network effect can be difficult to start – how does it gain momentum if no one lists their homes? Eventually after gaining traction in cities with limited capacity, Airbnb began growing – with new users eventually becoming locked in to the service through its reputation system. (Thus creating its own “moat”).

Network effects exist at the feature level. Netflix creates a network effect with its own recommendation engine. The more users who input their data provide more accurate recommendations to others, theoretically leading to product loyalty.

And, above all, simply a better product.

There are other types of network effects. Data network effects, for instance, refer to when products become better by the type of data generated by its networks’ users. The more users, the more data they are encouraged to provide, the better the product – as long as that data is baked back into the experienced and provides valuable information for the user.

How can startups utilize network effects?

The question remains, though, how startups can utilise network effects to their advantage. While the basics of creating a thriving network stay the same – create a place where people want to be – there are principles startups should follow in order to more effectively incubate possible network effects.

More importantly, these types of strategies should be adopted so startups can create barriers to entry for competitors. Having engagement in a network is fine enough, but a network should also develop environments that make it harder for people to leave.

Make them be loved

It’s always harder to leave when you’re loved. Create a network around the idea that users can influence reputation, and ideally users will become embedded in that environment. This isn’t new – eBay did it first, Airbnb does it now. But it will help.

Startups should also think about how that reputation can also be leveraged through influence to other users. The term “influencers” exists for a reason – people on a network with a significant following provide value for others. But that potential for influence has to baked into the product itself. Private Facebook accounts are influential to a degree, but the ideal situation for a startup would be to create an environment for influencers with unlimited scale.

Content is also king. Being able to provide users with the ability to create unique content, in combination with these other traits, can also provide a busy platform which will make users less likely to leave.

Key takeaway

While many businesses might opt to simply focus on creating a good product, that isn’t enough to contain a competitive advantage. By adopting these principles within your business, a network transforms from good to essential. 

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