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Network Effect

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PPGPortal > Home > Concept Dictionary > N, O > Network Effect
 

Network Effect 

The effect that one user of a good or service has on the value of that product to other users (also called network externality).

(Ian Clark drawing on Wikipedia)

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Network effects become significant after a certain participation percentage has been achieved, called critical mass. At the critical mass point, the value obtained from the service is greater than or equal to the price paid for (or effort required to participate in) the service. As the value of the service is determined by the user base, this implies that after a certain number of people have joined the network, additional people will join due to the positive utility: effort ratio. A key design concern must then be how to attract users prior to reaching critical mass. One way is to rely on extrinsic motivation, such as a payment, or a request for friends to sign up. A more natural strategy is to build a system that has enough value without network effects, at least to early adopters. Then, as the number of users increases, the system becomes even more valuable and is able to attract a wider user base. Joshua Schachter has explained that he built Del.icio.us along these lines – he built an online system where he could keep bookmarks for himself, such that even if no other user joined, it would still be valuable to him. It was relatively easy to build up a user base from zero because early adopters found enough value in the system outside of the network aspects. The same could be said for many other successful websites which derive value from network effects, e.g. Flickr, MySpace. Beyond critical mass, the increasing number of participants generally cannot continue indefinitely. After a certain point, most networks become either congested or saturated, stopping future uptake. Congestion occurs due to overuse. The applicable analogy is that of a telephone network. While the number of users is below the congestion point, each additional user adds additional value to every other customer. However, at some point the addition of an extra user exceeds the capacity of the existing system. After this point, each additional user decreases the value obtained by every other user. The network will cease to grow at this point, and the system must be enlarged. Network effects are commonly mistaken for economies of scale, which result from business size rather than interoperability. To help clarify the distinction, people speak of demand side vs. supply side economies of scale. Classical economies of scale are on the production (supply) side, while network effects arise on the demand side.

 

     

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