Network effects occur when a network's value increases for users as more people begin using it.
The adoption of a product by an additional can create two effects:
- Total effect: increase the value to all other users;
- Marginal effect: enhances other non-users' motivation for using the product.
- Upon reaching critical mass, a bandwagon effect can result.
As the network becomes more valuable with each new adopter, more people tend to use the network, resulting in a positive feedback loop.
- Airbnb, for example, increases its value as more people use it. The network effect happens because if more people use it, more people want to offer their places, attracting more people.
The network effect is an entrance barrier because it's difficult for competitors to enter the market and compete with a company that already has a good network. This advantage is also known as the first-scaler advantage.
Social networks, as Facebook or Twitter, are good examples of the network effect.