What is the Network Effect?

WHAT IS THE NETWORK EFFECT? THE VALUE OF USERS EXPLAINED Living in a world governed by network technology, people are connecting to services-and to each other-like never before. It's effectively changing the rules for not only how products are marketed and value is created, but also how the very foundation of successful businesses are built and maintained. What is the network effect and why is it important? What is a Network Effect? How Does it Work? In reference to business, a network effect is when a service becomes more valuable as more people use it, thereby leading to The network effect was first popularized by Bob Metcalfe, a co-founder of Ethernet, who claimed that the value of a network increases in proportion to the square of nodes or users in the network. He called his theory "Metcalfe's Law." an increasing number of adopters. Say you have four computers on a network. If you added one more computer to the network, the value would + increase to 5' or 25. 4? 52 Its value would be 42, or 16. Connecting Users Facebook and Twitter have perfected this model, and their success is almost entirely attributable to the network effect. Let's take this example, as it applies to users in the modern Internet Age: Since the average user has 130 friends, this The minute the user adds just five friends to their list, his or her means that any typical user's network can be One user joins Facebook, but doesn't have a value up to 17,161 connections. network's value have any friends yet. goes up to 36. What Doesn't Achieve the Network Effect? If one more item sold or added doesn't provide value to the network of all its users, and there's no difference between one user and one million users, it's not classified as part of the network effect. Example: television set. How is Social Networking More Powerful? The assumption for devices like telephones and fax What social media sites have that these machines is that they connect only directly to each other to create a network. traditional methods don't is the ability to network simultaneously. One single tweet can reach hundreds of followers in real-time. Critical Mass There comes a point in the network For businesses, a key method in attaining this pinnacle is to effectively attract more active members. Some common ways? where critical mass is reached. O Credit This occurs when: O Fee waivers The value or benefit from the O Getting friends to sign up for a service service is > or = to the price paid for the service. O Once the critical mass threshold is passed, the network powers itself and the system becomes even more valuable. And the quicker value is derived, the more is recelved in the long run. Sources: Created y satisfaction www.getsatisfaction.com Liebowitz, S.J. "Network Externalities (Effects)" | Startup-Marketing.com I ChristophersPenn.com | FastCompany.com COLUMN FIVE Hendler, James and Jennifer Golbeck. "Metcalfe's Law, Web 2.0, and the Semantic Web." 2008.