The network effect occurs when the value of a product or service increases according to the number of others using it. The classic example is the telephone - the more people who own phones, the more valuable the system is for each user. Network effects were first studied in the context of long-distance telephony and were popularized by Metcalfe's law, which states that the value of a network is proportional to the square of the number of users. Examples of products and services that exhibit strong network effects include social networks like Facebook and LinkedIn, as well as platforms like the Apple ecosystem.

1. THE NETWORK EFFECT
Presented by:
Chandan Kumar Jha
Saptadip Saha
Kumar Aniket
Deepti Tripathi
Amruth Pavan Davuluri
Neha Kasana
GROUP - 4

2. 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

3. 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

4. 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.

5. 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.

6. 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.

7.  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.

8. Network Effect in Apple Ecosystem

9. 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.

10. 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.

11. 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