Chapter 8: Understanding Network Effects
Network effects are among the most powerful strategic resources that can be created
by technology-based innovation. Many category-dominating organizations and
technologies, including Microsoft, Apple, eBay, Facebook, and Visa, owe their success to
network effects. Network effects are also behind the establishment of most standards,
including Blu-ray, Wi-Fi, and Bluetooth.
More users, more connections, and more communication channels
Network effects: Also known as Metcalfe’s Law, or network externalities. When the
value of a product or service increases as its number of users expands.
Switching costs: The cost a consumer incurs when moving from one product to another.
It can involve actual money spent (e.g., buying a new product) as well as investments in
time, any data loss, and so forth.
Platforms: Products and services that allow for the development and integration of
software products and other complementary goods. Windows, the iPhone, the Wii, and
the standards that allow users to create Facebook apps are all platforms.
Physical resources: more use will exhaust it
Once you have established network effects, switching costs come into play, and it
becomes expensive for customers to leave.
Platform: app developers provide value to themselves, consumers, and for Apple
8.2 Where’s All That Value Come From?
Products and services subject to network effects get their value from exchange,
perceived staying power, and complementary products and services. Tech firms and
services that gain the lead in these categories often dominate all rivals.
Exchange of information – Facebook, App Store
o Every product or service subject to network effects fosters some kind of
exchange. For firms leveraging technology, this might include anything you can
represent in the ones and zeros of digital storage, such as messaging, movies,
music, money, video games, and computer programs.
Staying Power – very important for tech product consumers; directly related to
o The long-term viability of a product or service.
Complementary benefits – add additional value to the network (how-to books, software
TCO [Total Cost of Ownership]: An economic measure of the full cost of owning a
product (typically computing hardware and/or software). TCO includes direct costs such
as purchase price, plus indirect costs such as training, support, and maintenance.
Many firms attempt to enhance their network effects by creating a platform for the
development of third-party products and services that enhance the primary offering. APIs: Programming hooks, or guidelines, published by firms that tell other programs
how to get a service to perform a task such as send or receive data. For example,
Amazon provides application programming interfaces (APIs) to let developers write their
own applications and Web sites that can send the firm orders.
8.3 One-Sided and Two-Sided Markets
In one-sided markets, users gain benefits from interacting with a similar category of
users (think instant messaging, where everyone can send and receive messages to and
from one another).
In two-sided markets, users gain benefits from interacting with a separate,
complementary class of users (e.g., in the mobile-payment