Understanding the network effect

The ‘Network Effect’ concept is essentially this: the more people who use your service or product, the more valuable it becomes, especially if these users have some sort of connection (think social media platforms). There are three types of network effects that can increase the value of your product or service, and we’ve explored these along with some popular examples below.

Direct Network Effect

Direct Network Effect is the most common of the three and is where an increase in users or customers leads to a direct increase in the value of the service or product for others.

A prime example of this is Facebook. In the beginning, there were only a handful of users, but as their user base grew, so did the value of the network as more people were able to communicate with friends and family. No one could have predicted its success, but today Facebook is used by 1.79 billion people daily. That’s just under a quarter of the world’s population.

Local Network Effect

Online communities and networking platforms such as Facebook, LinkedIn, Instagram or even Discord are made up of smaller local networks (you and your peers or colleagues). In essence, the stronger the local network, the more valuable the social network is as a platform, as more users will want to join due to the more personal engagement they can find within these smaller or more niche communities.

Two-Sided Network Effect

The Two-Sided Network Effect is where, as the network expands, the related goods or services increase in value. For example, in an online marketplace, an increase in buyers leads to an increase in the number of vendors using the platform to sell and vice versa. Therefore, the more buyers and sellers that use the marketplace, the more valuable it is as a network. Think about Amazon; if no one used the platform, why would you sell your products through it? But equally, if there were no sellers, you wouldn’t buy from them either.