THE NETWORK EFFECT

Presented by:Chandan Kumar JhaSaptadip SahaKumar AniketDeepti TripathiAmruth Pavan DavuluriNeha Kasana

GROUP - 4

The Network Effect Defined A network effect is a phenomenon when a service/product becomes more

valuable as the number of people who use it increases, thereby encouraging the numbers of adopters

The Classic example is the Telephone. The more people own telephones, the more valuable is the telephone to each owner

It has got fundamental importance for business strategy, intellectual property, and technical changes in a wide range of industries

Metcalfe’s Law

Network effects were first studied in the context of long-distance telephony in the 1970's

But it was popularized by Robert Metcalfe, stated as Metcalfe's law.

The law says that the value of the network is proportional to the square of the number of users

The network effect is quite often the result of word-of-mouth activities

Network Effect: Examples

Telephone: The more the people owns the telephone, wider will be the network and hence greater will be its value. In fact the study on the network effect started with the study on telephony

Social Network: Twitter, LinkedIn, Facebook etc. These social networking site have grown at tremendous rate and have touched millions of user base in short span of time because of the explosive rate of growth of network effect

A product endorsed on the social media platform quite often creates buzz and hence adoption of that product/service increase at rapid pace cause the tremendous improvement in the value of the product.

Network Effect virtuous circle

A network can be defined as a common user base that is able to communicate and share with one another. For example, LinkedIn users make a network, so is the traders who trade in Sensex, NASDAQ etc.

Source of Values Creation in Network Effect

Primarily three sources accounts for the value derived from network effects: Exchange, Staying Power and Complementary Benefits

Exchange: A network become more valuable because its user can freely communicate with each other. Hence, information exchange is the vital source of value creation. For firms which are technology intensive it can be anything in the digital form like movies, music, games, computer program etc.

Staying Power: The staying power determines the long term sustainability/viability of a product or service. Higher the number of user on a network higher is its staying power. Consumers never want to buy a product or service that’s likely to go away.

The staying power concept is directly related to switching costs. Hence, the more a user has invested in a product, the less likely he is to leave. An example is the Apple ecosystem for Apple users.

Complementary Benefits: These benefits are those products/services that provides additional value to the network. Allowing other firms to contribute to your platform can be a good strategy because those firms will spend their own time and money to improve your offerings.

For example, consider the Apple’s billion-dollar hardware eco-system. Thirty- four auto manufacturers now claim their cars as being iPod-ready.

Source of Values Creation in Network Effect Contd.

Network Effect in Apple Ecosystem

Types of Network Effects

Direct Network Effects: These are simplest kind of network effects where the increase in the usage lead to the direct increase in the value. For example, telephone service

Two sided Network Effects: In the case of two-sided network effects, increases in usage by one set of users enhances the value of a complementary product to another distinct set of users, and vice versa. For example, Hardware/software platforms, reader/writer software pairs

Bandwagon Effects: It means as more people buy something another set of people also ride on the bandwagon and buys that product

Positive Network Effects: In case of positive network effect the network become more valuable as more people join in

Negative Network Effects: In case of negative network effect each additional user decreases the value of the network for other user by creating more congestion or clogging. The example can be that of a mobile network or an internet service like online shopping portal, ticket booking websites, etc.

Network Effect : More Insights

The larger your network, the greater is the difficulties for competitors to challenge your leadership position.

Firms with commanding network effects can have substantial bargaining power over the competitors. For example, Apple, which controls over 75 percent of digital music sales, is able to control and dictate song pricing

In order to win the customer away from the dominant player the newcomer will have to provide the better value .And the dominant player must not be able to easily copy the innovation of the new comer.

References:

http://www.utdallas.edu/~liebowit/palgrave/network.html

The Tipping Point: How Little Things Can Make a Big Difference(By Malcolm Gladwell)

http://oz.stern.nyu.edu/io/network.html

http://theweek.com/article/index/272152/how-network-effects-explain-the-future-of-twitter

http://www.economicshelp.org/blog/glossary/network-effects/

http://www.businessinsider.com/network-effects-2011-5#ixzz3LzwmrzQP

http://en.wikipedia.org/wiki/Network_effect

http://www.investopedia.com/terms/n/network-effect.asp

https://www.princeton.edu/~achaney/tmve/wiki100k/docs/Network_effect.html

http://www.nytimes.com/2014/06/14/upshot/ubers-real-challenge-leveraging-the-network-effect.html?_r=0&abt=0002&abg=0