Network Effects 101 | Summary and Q&A

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March 11, 2020
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Stanford eCorner
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Network Effects 101

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Summary

In this video, the concept of network effects is explored, where the value of a product increases as more users join the network. This phenomenon can be seen in communication-driven platforms like Skype or Whatsapp, where the more users there are, the more valuable the platform becomes. The concept of Metcalfe's law is introduced, which states that the value of a communication platform is proportional to the square of the number of nodes. Additionally, the video discusses how businesses with network effects can grow exponentially in terms of revenue, as seen with Facebook. On the other hand, single-player mode games like Angry Birds do not have network effects, resulting in linear revenue growth.

Questions & Answers

Q: What is network effect?

Network effect refers to the situation where a product becomes more valuable as its user base increases. This is especially true for communication-driven platforms like Skype or Whatsapp, where the value lies in the network itself. As more users join the network, the value of the platform increases for each individual user.

Q: Can you give an example of a product with network effects?

Yes, Skype is a classic example of a product with network effects. If there is only one person on Skype, they cannot make any calls. However, as more people join the network, the number of possible connections increases exponentially. This exponential growth is often described by Metcalfe's law, where the value of a communication platform is proportional to the square of the number of nodes.

Q: How does network effect contribute to the growth of a business?

Businesses with network effects can experience exponential growth in terms of revenue. Take Facebook as an example. The impressive user growth of Facebook is matched by the exponential growth of its revenue. This is because each additional user adds value to the network, and as the user base expands, so does the overall value of the platform.

Q: How does network effect differ from single-player mode games?

Single-player mode games, like Angry Birds, do not have network effects. The value of an individual's Angry Birds experience does not increase with the number of users. As a result, the revenue growth of such games is linear and directly tied to the number of downloads.

Q: What types of businesses can have network effects?

Network effects can occur in various business models. They can be present in communication-driven platforms like Skype or social networks like Facebook. Additionally, marketplaces such as Craigslist or Ebay can exhibit network effects due to the liquidity of buyers and sellers. Finally, platforms like the Apple operating system, where developers build on top of the system, create a type of marketplace with network effects.

Q: How can businesses leverage network effects?

Businesses can leverage network effects by understanding the positive feedback loop that occurs within their product or platform. By focusing on communication, creating marketplaces, or building platforms, businesses can encourage more users to join the network, thus increasing the overall value for all users involved. This can lead to exponential growth in revenue and a stronger market position.

Takeaways

Network effects play a crucial role in the success of businesses. By understanding and harnessing the power of network effects, companies can create products and platforms that become increasingly valuable as their user base grows. This exponential growth can result in significant revenue increases and a competitive edge in the market. Businesses should consider incorporating network effects into their strategies to take advantage of the benefits it brings.

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