Understanding Network Effect for your Product

Once your product has an established product-market fit, we delve deeper into different types of network effects and which ones work for different kinds of markets. In this blog, we will discuss what network effect is, and types of network effect businesses can benefit from.

What is the network effect?

A network effect is simply the effect on the value of a product as its usage increases. Due to the network effect, the value of a product or service increases as per the increase in users. The ultimate example of the network effect is Facebook. When Facebook was developed,  there were multiple players in the social network market. But it managed to reach a certain threshold, leaving behind all the competitors. Facebook was successful in doing so because every addition of friends on Facebook, made it more valuable as a platform. This addition to the platform made it valuable to other users to attract them to join Facebook. It is ruling the social network market and boast the strongest network effect. 

Similarly, for LinkedIn to be valuable, the single user utility is that you can create an online resume. As many people started using it, the platform became valuable and attracted more people to build a profile on LinkedIn. The increase in users on the platform helps to make the product defensible. Interaction and using the product creates more data that makes the product more useful. 

There are numerous types of network effect, we will be discussing a few of them below:

  1. Two-sided Network Effect
    The two-sided network effect involves the demand and supply side of the market. The supply-side network can be observed in Yelp, where the data from the restaurant’s end makes the product valuable. The demand side network effect, on the other hand, is driven by data of the customers or users as Facebook.In the two-sided network effect, each new addition in the supply side adds value to the demand side who are the users. For example, eBay. Increasing suppliers in eBay will increase the variety of goods for the buyers that consequently increases the value of eBay for buyers.
  2. Global Network Effect
    The global network effect is the network effect that affects all the user irrespective of their locations. The global network effect can be observed in social media platforms where the location is not a barrier for growth.
  3. Personal or Identity Based Network Effect
    The personal network effect takes place when the user’s identification is tied with the product. More users join in the social media to connect with people who they know in real life. Here, the identity of the people plays a significant role in adding value to product users. The more people are on social media, you’ll likely have more people to engage with. This adds value to users looking to connect with people.
  4. Data Network Effect
    The data network effect uses data to make the product valuable. This network effect may not be as strong as the people based network effect. However, the collection of data can provide added features to users. For instance, the Netflix recommendation system uses data to cater personalized content to the user. This adds value to a certain level, though the real value is generated by the inventory of content.
  5. Location-Based Network Effect
    In contrast to the global network effect, the location-based network is location-centric. The location-based network effect has been utilized by services like Uber and Yelp, where they focus on targeting one specific location before heading to another.

As product owners, we need to understand what type of network effect we are targeting for and build the product accordingly. For b2b businesses, it might be challenging to identify network effect but not unattainable. For example, if company A uses Yammer- enterprise social network, no value is added to company B using the same platform. However, the value increases within the company.  If people in Company A start using the product and create knowledge repository, more value will be added for A. The network effect will be limited within the company. Hence, it will be defensible. 

Likewise, if Leapfrog uses Yammer more and more, we cannot let go Yammer, as it includes a lot of our data. We dive into a virtuous cycle and data lockin. 

When do we think about the network effect?

Start thinking about network effect from the very beginning of your product development cycle. However, the road to it is having a frictionless onboarding, single-user utility, multiple user utility, and product-led growth. Have a mindset and then devise the product accordingly. Developing a product for growth and defensibility begins from day 1. 

Not all the product owners will be aware of the concept. They aren’t aware of how a network effect can reduce acquisition cost. It is the responsibility of development partners to make clients understand about network effect and its impact on customer acquisition cost. The cost reduces as users increase. For example, we are a SAAs product. To serve 10 customers, the marginal cost will be zero as we do not need to manufacture the product for every user. You then need to think about whether you can have a user network effect. 

Some clients come with network effect in mind, but we suggest them to start from step 0, then move towards single user utility, multiple user utility, product-led growth features. Then, finally layout journey to the network effect. 

Some companies to analyze for better understanding of network effect are Facebook, Yammer, Slack, MailChimp, Hubspot, and Basecamp. Follow their model and study them. Have realistic expectations and build strategies to grow using the network effect. That will be a better way to the instrument network effect and implement in your product.

For further details on types of a network effect, we suggest you go through “The Network Effects Manual: 13 Different Network Effects” by nfx.

Done with Step 7? Learn about all the steps in Product Development from this series.


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