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Network Externalities

Network Externalities refer to the effects on a user of others using the same or compatible products.

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What is:

Network Externalities

In simple words, imagine:

Using a messageing app because all your friends are on it.

Network Externalities explain how the value of a product or service increases as more people use it. Think about social media platforms like Facebook or WhatsApp:

  • Direct network effects:  The more people join, the more valuable the service becomes for everyone
  • Indirect network effects:  More users attract more developers to create apps or content for the platform

Network Externalities help companies understand how to build products that become more valuable as they grow in user base.

Explain it to Grandma:

Imagine you’ve just started using a new kind of fertiliser, and your whole gardening community starts using it too. The more people use it, the better it works for everyone because we can share tips and tricks. That’s what this theory is about – the more people join in on something, the more valuable it becomes for everyone.

Business Cases:

Vodafone
WhatsApp
Venmo
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Vodafone
Global Roaming Service
Telecommunications

Vodafone capitalised on Network Externalities when launching its Global Roaming service. The value of the service increased as more users adopted it, making international communication easier and more affordable.

Result
Successful
The widespread adoption of the service made Vodafone a preferred choice for international travellers.
WhatsApp
WhatsApp Messenger
Social Networking

WhatsApp harnessed Network Externalities by offering a free, cross-platform messaging service. The value of the app increased as more users joined, leading to its exponential growth.

Result
Successful
WhatsApp became one of the most popular messaging apps worldwide, with over 2 billion users.
Venmo
Peer-to-Peer Payment System
Digital Payments

Venmo utilised Network Externalities by making it easy for users to send money to friends. As more people used the service, it became more valuable, creating a network effect that spurred further adoption.

Result
Successful
Venmo quickly became a popular payment app, especially among younger users.

Academic Research:

Network Externalities

Authors:

Michael L. Katz and Carl Shapiro

Paper Link

https://doi.org/10.1007/978-1-349-74173-1_252

Year Researched

1985

Summary:

The study explored how the value of a product or service increases as more people use it, a phenomenon known as network externalities. It explains that when more people adopt a technology or product, it becomes more valuable to each user, often leading to a dominant market position for certain technologies. For example, the usefulness of a phone network or social media platform grows as more people join and use it.

Some links

  • https://www.nber.org/papers/w10276
  • https://www.degruyter.com/document/doi/10.1515/9783110414393-016/html
  • https://link.springer.com/article/10.1007/BF00131938
  • https://www.jstor.org/stable/2006920
  • https://www.ssrn.com/abstract=17246