Network Effect: “The effect that one user of a good or service has on the value of that product or service to any and all other users

House of Lords European Union Select Committee

Network effects are not a new phenomenon, nor are they exclusive to mankind. The social and economic benefits of the network are afforded to bees in the hive, fish in the school, and birds in the flock in much the same way as to violin-makers in 17th century Cremona or to fraught festival-goers desperately hunting for a Glastonbury ticket on eBay today.

In the last two decades, substantial improvements in communication technology (primarily through information digitisation and the Internet) have fuelled an exponential increase in achievable network quality and size. Cloud services now provide computing power and data storage on-demand, which takes the marginal cost of rolling out a digital network to new participants to practically zero.

“From social engagement, transport, and DIY, to Christmas shopping, dating, and private investing, the world is taking advantage of the economies of scale that a digital network can provide.”

As a result, networks are burgeoning and proliferating across all aspects of our lives. From social engagement, transport, and DIY, to Christmas shopping, dating, and private investing, the world is taking advantage of the economies of scale that a digital network can provide. In a single month, almost 2.3 billion users interact on Facebook, nearly 200 million users transact on Amazon, and around 450 million taxi rides are booked through Uber.

Exponential Growth in Connections

Connections grow exponentially with each new node in the network. With each new connection, for all members, there is a new opportunity to buy or to sell, to teach or to learn, to swipe left or to swipe right. As larger networks benefit from enhanced network effects, more users are attracted, growing the network in turn. In this way, networks benefit from a virtuous cycle of growth.

Clearly, size is an important factor in determining the value of your network. However, it is the quality of the network, and of the connections themselves, that determine the valence of the network effect.

If a network grows too broad too quickly, the size of the network may have negative impacts on the value of your service. Consider the consternation caused by the increase of other road-users as you’re driving home for Christmas, or, perhaps more relevantly in the digital economy, bandwidth bottlenecks causing 15,000 Netflix viewers to miss a long-awaited episode of Game of Thrones, the luxury problem of “choice overload” from a digital marketplace, or even criminal activity − “fake news” is all the more damaging due to the extended reach granted by digital networks:

Fake News: Abuse of the Network Effect

Four key elements determine the existence of a positive network effect: relevance of membership, diversity of membership, navigability of network, and propriety of network use.

  1. Relevance leads to more meaningful connections. Take, for example, the 100 Women in Finance network. Members find support from other women who are working within the Finance sector by gaining accessing to a pool of available business and social connections. The relevance of each member is paramount to the power of the network.
  2. Diversity: following on from the example above, our aspiring female financier will not be well served by 15 members exclusively from the Credit Suisse equity department. A broad spread of experiences and backgrounds will more likely provide her with the specific insight she requires to propel her career.
  3. Navigability: what is the use in having 2.3 billion active users if they cannot be found? A network must be navigable to be functional. In our increasingly digital environment, vast networks are filled with reams of information. This can be distracting. As a result, powerful search algorithms, powered by artificial intelligence, and advanced filtering mechanisms are required to present information to the user simply and quickly.
  4. Propriety: as a network grows, so does the propensity for abuse of its members. Network abuses are reputationally destructive. In the wake of the Cambridge Analytica scandal in March, Facebook lost 1M monthly active users in Europe over 3 months. Firm compliance rules and appropriate governance are essential to the positive impact of networks for all parties.

Whilst the size of the network amplifies the network effect, a keen eye must always be kept on its quality. Platform and service providers looking to swell their networks must first ensure that their membership is relevant and diverse, their structure is navigable, and their usage appropriate.