Networks and Network effects

On a platform, the network effect is the extra value the platform achieves with an additional user. This is called network externalities. The principle is that by adding an additional user, the value increases (almost) exponentially, not linearly. The reason is that for each new user, the value in the entire network (n2) increases. Thus, once a network effect has occurred, the platform can enter a self-reinforcing cycle.

Network effects can create high entry barriers, but they live their own lives on the good and the bad. Network effects can be same-side (direct) when the benefits to a user are based on the number of other platform users on the same side. This is like a telephone or Skype network, where many connections give benefits to all. They can be positive in a gaming network or negative in a job-seeker network. With negative network effects, each new user will reduce the value for the rest of the network. It may occur in case of capacity problems or when negative segments grow into the network and reduce the attractiveness of normal users.

Cross-side network effects (indirect) occur when the benefits to users to one side are dependent on the number of users (of another group) on the other side of a platform, like the number of Playstation players increase the benefits for game developers.

Network effects provide a multi-sided marketplace and shape product pricing strategies, revenue sharing, and the competition.

A network is not perfect in practice, and a new user will not always add value to existing users, as envisaged in Metcalf's law. One of the most straightforward explanations is that most network effects are local. So, what counts to a greater extent is whether the network is relevant, which is often referred to as density in the network. The denser the network clusters, the more overlap will occur, and the potential for network power increases with greater density (relevance).

Another aspect is the degree of activity since, in many cases, matching takes place in real-time. The activity level in the group will also determine whether we overlap at the same time. For this reason, most success stories tend to start with a small niche group with high density (relevance) and subsequent high activity, with transactions, and communication and engagement—for example, Facebook, which started at Harvard only as a small niche group with a dense network cluster, overlapping and with high network activity, which quickly spread to similar univerity communities.

On the other hand, many platforms with a fragmented network do not get network effects and cannot scale efficiently. This may be due to differences in language, theme, industry, or geography.  Social networks, on the other hand, are examples with cluster overlaps being scalable. This also has implications for the internationalization of digital platform companies.

Many digital platform businesses have non-location bound clusters like game developers and user groups, which can gain cross-country network effects.

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Network effects must be actively created, and one of the vital management tips is to stay interaction-oriented and not user-oriented when building a platform network. Creating continuing engagement that leads to a core value interaction is crucial to getting the platform users and manufacturers back to the platform. Additionally, Commitmentdrivers should be incorporated into the platform design.

Many digital platform companies stay in the old “linear” focus of being “one-sided customer-oriented.” They do not understand that network dynamics with the platform business model have multiple sides to cater to and that the core value interaction should be the focus, not “the customer needs”.