1. Home
  2. Knowledge Base
  3. Network Effect – Definition

Network Effect – Definition

Network Effect Definition

The network effect is a theory that posits that the more people use a product or service, the better the product or service. This means when there are additional users of a product, the value of the product will also improve. The network effect maintains that when there is an increase in the number of people that use a product or service, there will also be an increase in the value of the product. The most popular example used in describing the network effect is the internet. When more people began to interface with the internet, more websites, smartphone applications, and online spaces were developed, unlike when the internet first came. The internet is the most commonly used example to explain the concept of the network effect.

A Little More on What is a Network Effect

In the present day, the internet has become important for every business or organization to the extent that the success or failure of a business is connected to how well they leverage the internet. With a rise in the number of people that use the internet, many businesses have moved to the internet, where they created a website for their business, market their products and get their clients. Also, with an influx of internet users, many engaging apps and social media platforms have been created, thereby improving the value of the internet. No corporation wants to be left out in accessing larger market and wider audience through the internet as a result of the network effect.

Here are the key points about the network effect;

  • The network effect is a principle that states that when more people use a product, good or service, the value of the product will be improved. The network effect is often used in economics and business.
  • The internet is a popular example of the network effect which shows the improvement of the internet given that more people gained access to its use.
  • The network effect is also important to corporations and businesses, it shows how additional users or customers lead to an improved service.
  • A major dark side of the network effect is congestion which is a situation that arises when there are too many users on a network.

What the Network Effect Means to Businesses

The network effect impacts the success or failure of a business. Organizations, firms, and businesses that leverage the internet benefit from the network effect in a positive way, in the sense that they are able to reach a wider target market, make more sales and acquire more customers. Businesses or companies that have specialized apps or websites that users can access on their smartphones benefit from the network effect. As more people access their businesses or websites, the more popular they become in the marketplace.

Challenges for the Network Effect

For a network effect to be impactful or significant, a critical mass must be obtained, this refers to the number of users that should use a service or product to achieve the network effect. There are some challenges of the network effect, the major ones include the following;

  • Businesses that use the network effect may find it difficult to establish a good customer base before the network effect takes place.
  • Congestion: Congestion leads to poor service or slow network, it happens when there are too many people trying to access a particular website or webpage.
  • A service provider or business supplying goods may find the number of users overwhelming if the number of users becomes too much.

References for “Network Effect



https://corporatefinanceinstitute.com › Resources › Knowledge › Economics



Was this article helpful?