Who This Article Is For
- People interested in platform or community businesses
- Owners seeking a structure that differentiates their business
- People who want customer connections to contribute to their business
Network Effects: How More Users Can Create More Value
Learn how direct, indirect, and data-based network effects grow service value, and how smaller businesses can apply connections, partnerships, and examples.
Published
Connections Among Users Can Increase a Service's Value
A network effect occurs when a service becomes more valuable as its user base grows. The users themselves contribute to its value alongside what the provider supplies.
Once this cycle starts, later competitors can find it hard to catch up. The idea extends beyond social networks and marketplace apps to smaller businesses. Customer connections, accumulated examples, and partner relationships can create smaller-scale network effects too.
What Is a Network Effect?
A network effect is a structure in which more users create more value. Think of a telephone: with only one user, there is nobody to call. Two users can converse, and more users make the telephone more useful.
The same principle applies to:
- Social networks
- Resale marketplace apps
- Matching services
- Online communities
- Payment services
Growth in users directly increases usefulness or appeal. That distinguishes this structure from an ordinary service.
How Value Increases
In a conventional business, more customers may increase revenue but also increase the cost of serving them. With network effects, user growth can itself create additional value.
For example:
| Service | What more users contribute |
|---|---|
| Social network | More people to connect with |
| Resale marketplace | More products and buyers |
| Job site | More connections between employers and applicants |
| Community | More information exchange |
The user base becomes part of the appeal, allowing growth to encourage further growth.
Types of Network Effects
There are two broad types of network effects. Both matter, but their mechanisms differ. Accumulated data can also contribute alongside them.
Direct Network Effects
Value increases as more users of the same type join. Social networks, chat, telephones, and online games are examples. More participating friends and acquaintances give people more reason to use the service.
The cycle can look like this:
- More participants join
- More connections become possible
- Frequency of use increases
- More new users are attracted
These steps can reinforce one another.
Indirect Network Effects
Different groups of users increase value for one another. Sellers and buyers in a marketplace, employers and applicants on a job site, and merchants and customers in a payment service are examples.
More sellers make the service useful to buyers; more buyers make it appealing to sellers. Growth on one side increases value on the other.
Value from Accumulated Data
More users can also generate reviews, ratings, examples, and search data that increase the service's overall value. This often overlaps with direct or indirect effects and can widen the gap with later competitors.
More reviews make comparisons easier, while more examples provide reassurance. Accumulated information can be valuable in its own right.
Why Competitors Struggle to Catch Up
Features alone do not determine the outcome for a service with network effects. A similar service launched later still faces a gap in participation, creating a barrier to entry.
The User Base Becomes an Advantage
If identical features are more useful with more users, a newcomer is disadvantaged. People have little reason to move to a social network with few friends or a marketplace with few products.
The number of people already gathered can outweigh feature differences. This is a powerful aspect of network effects.
Switching Costs Increase
Relationships, transaction histories, reviews, posts, and achievements accumulate. Moving elsewhere then involves more effort and more to lose.
Potential losses include:
- Connections
- Track records
- Ratings
- Historical data
These intangible assets can reduce migration to competitors.
The Community Becomes an Asset
Relationships and culture contribute value alongside numbers. An active community, trustworthy reviews, and useful posts are difficult to copy.
Appearance and features may be reproducible, but a community's engagement is harder to recreate. This can create a lasting difference.
Ideas Smaller Businesses Can Use
Smaller businesses can apply the same thinking. Designing customer connections and accumulated information can create a structure that grows in value.
Create Opportunities for Customers to Connect
A place where customers with shared concerns or goals interact can increase the value of a product or service. A tutoring business might enable students to exchange questions, a food seller might encourage recipe sharing, and a B2B provider might host exchanges among adopting companies.
When customers receive value from one another too, retention can change.
For ideas on building such a setting, see The Purpose and Operation of a Community Model. It discusses participation goals and operating rules after considering the value of interaction.
Work with Partners
Broader value can come from partnerships. Builders can work with real estate or interior companies, professional practices with specialists in other fields, and online sellers with delivery or payment partners. More useful connections can make the experience more convenient for customers.
The idea is to create value with surrounding businesses that one company could not provide alone.
Accumulate Examples and Customer Feedback
More customer outcomes and feedback can help the next customer. Case studies, reviews, usage examples, and success stories provide substantial material for a decision.
Publishing cases and testimonials on a website supports both promotion and future judgments. Existing customers' results reassure new customers, creating a chain of value. For publishing these updates regularly, I recommend SpreadSite, the service I developed for building websites from spreadsheets. It helps reduce the effort of updating cases and achievements. Please give it a try! SpreadSite
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About the Author
Thank you for reading!
I develop and operate SpreadSite, a service for creating websites from spreadsheets.
It helps people with limited time and money communicate what makes their work appealing. Consider it if you need a website! SpreadSite
Frequently Asked Questions
Q: Are network effects the same as word of mouth?
A: No. Word of mouth spreads information; a network effect increases a service's value as participation grows. Word of mouth can attract users and then help a network effect develop.
Q: Can B2B businesses create network effects?
A: Yes. Exchanges among adopting companies, case sharing, partnerships, and industry communities are examples. More participating companies can create more value.
Q: What should I do when there are very few users?
A: Establish value within a narrow industry or region first. A satisfied small group gives you a stronger basis for expanding.
Q: Can this be added to an existing business?
A: Yes. Customer interaction, accumulated reviews, more partners, and case-sharing arrangements can be added later. You can begin without building a large platform.
