Network Effects

A telephone is useless if you’re the only one who has one. Each additional user makes the network more valuable to everyone already on it. That’s the network effect.

It explains a lot about technology markets that otherwise seem strange. Why does one platform dominate when several alternatives exist? Why is being second often worthless? Why do tech companies grow so fast and get so big?

The math is unintuitive. Metcalfe’s Law says value grows roughly with the square of users — n users create n² potential connections. This means the gap between first and second place compounds. Once you’re ahead, each new user widens your lead. The race isn’t to be better. It’s to get ahead early.

Facebook wasn’t better than MySpace. It got ahead and stayed ahead. The standard isn’t optimal; it’s entrenched. Network effects lock in the winner regardless of merit.

Not all network effects are the same.

Direct effects: more users means more people to call, more people to trade with, more people to play against. The users benefit from each other directly.

Indirect effects: more iPhone users attract more app developers, which attract more users. The benefit flows through a complement.

Two-sided markets: Uber needs both drivers and riders. Each side’s growth benefits the other. Getting one side is useless without the other.

The strategic implications are strange if you come from traditional business. Growth matters more than profit. Subsidize early users. Lose money to reach critical mass. Sacrifice margins to prevent competitors from gaining traction.

Once you’re past the tipping point, the network builds itself. Before the tipping point, nothing works. The difference between winning and losing can be a few months of faster growth.

Network effects also create fragility. The same feedback loops that drive growth can drive collapse. If enough users leave simultaneously, the network unravels. MySpace’s decline was sudden — each departure made leaving more attractive for those remaining.

I think this is why tech platforms work so hard to increase switching costs. The lock-in isn’t just greed. It’s survival. A network that can be abandoned can be killed.