Network effects occur when a product or service becomes more valuable as more people use it. In these markets, value does not come only from features or price. Instead, value grows because users benefit from joining the same network as other users.
Example: Instagram becomes more useful when more of your friends, creators, and businesses are already on it. A social network with very few users offers much less value, even if the app itself works well.
The textbook explains that the value created by network effects comes from three major sources: exchange, staying power, and complementary benefits. Together, these help explain why some platforms become dominant while others fade out.
Example: Apple benefits from exchange when users communicate through its ecosystem, from staying power when people trust the platform will continue to be supported, and from complementary benefits through apps, accessories, and services that make the platform more useful.
Exchange means that users gain value from interacting with other users on the same network. In one-sided networks like messaging apps, this is often the most obvious source of value because every added user increases the number of possible connections.
Example: A fax machine with only one user is useless, but a fax network becomes valuable once enough people can send messages to one another.
Staying power refers to the long-term viability of a product or service. Users do not want to invest time, learning, money, and data into a platform that may disappear, lose support, or become obsolete.
Example: Someone choosing an operating system may avoid a smaller alternative if they worry it will lose app support or become incompatible with future software.
Complementary benefits are extra products or services that increase the value of a platform. These can include apps, accessories, add-ons, services, developers, books, or trained workers who support the main product.
Example: Apple’s iPhone is more valuable because it connects to millions of apps, Apple Pay, CarPlay, AirPods, watches, and other hardware and software that expand the usefulness of the platform.
A one-sided market gets most of its value from a single group of users interacting with one another. A two-sided market has two distinct groups of users who depend on each other for the network to create value. In two-sided markets, growth on one side helps attract growth on the other side.
Example: Messaging apps are one-sided because users mainly want access to other users. Video game consoles are two-sided because players want games, and game developers want access to players.
Competition in markets with strong network effects is often more intense early on and more concentrated later. Firms fight aggressively in the beginning because once one platform gains enough momentum, the market may tip toward a single dominant standard or a winner-take-most outcome.
Example: Once Blu-ray gained enough support from studios and retailers, HD DVD collapsed quickly because the market tipped toward one standard.
A platform is a product or service that allows other firms or developers to build complementary products on top of it. Platforms do not just offer one standalone product; they create ecosystems that become more valuable as complements and users grow together.
Example: iOS is a platform because app developers, hardware makers, payment systems, and accessory companies all add value to Apple’s ecosystem.
The textbook outlines several major strategies for competing in network markets: move early, subsidize adoption, leverage viral promotion, redefine the market, form alliances, seed complements, establish distribution channels, encourage complementary goods, maintain backward compatibility, and use compatibility or incompatibility strategically.
Example: Zoom used a freemium model and easy adoption to grow quickly, while Apple often uses a controlled ecosystem to strengthen its own proprietary platform.
An open standard allows many firms to adopt, contribute to, or build on a shared system. A closed or proprietary standard is controlled by one firm, which decides how the standard develops and who can access it.
Example: A firm may choose an open standard to encourage broad compatibility, but may keep a proprietary standard when it wants tighter control over the platform and its complementary products.
Backward compatibility means a new product or version can still work with older systems, files, standards, or complements. (Source)
Example: A new operating system that still runs older software gives customers less reason to delay adoption.
Blue ocean strategy refers to creating value in a new or less-contested market space instead of fighting rivals directly in an overcrowded market. (Source)
Example: Nintendo Wii expanded beyond hardcore gamers and attracted families and casual users.
Bundling is the practice of packaging multiple products or services together as one offering, often at a price that encourages customers to choose the combined package. (Source)
Example: Microsoft bundled products together in ways that increased the value of its broader software ecosystem.
Complementary benefits are the additional products, services, or resources that increase the value of a core platform or network.
Example: Apps, accessories, and integrations make smartphones much more useful than the hardware alone.
Complements are products or services that become more valuable when used with a primary product or platform. (Source)
Example: More games make a game console more valuable, which attracts more players and developers.
Congestion effects occur when too many users reduce the value of a network because performance, access, or usability gets worse.
Example: A rideshare app may become frustrating if too many users request rides at once and wait times increase sharply.
Cross-side exchange benefits occur in a two-sided market when growth on one side of the platform attracts growth on the other side.
Example: More game-console users attract more developers, and more games attract more console buyers.
Customer acquisition cost is the amount a firm spends to gain a new customer. (Source)
Example: A payment app may offer signup bonuses because gaining users early can help trigger network effects.
Freemium is a strategy where a basic product is offered for free while advanced features, capacity, or usage require payment. (Source)
Example: Zoom’s free tier helped users adopt the service before many later upgraded to paid plans.
An incumbent is an established firm already operating in a market. (Source)
Example: Microsoft was the incumbent operating system leader during much of the PC era.
Lock-in occurs when users become tied to a platform because leaving it would require losing time, money, data, skills, or compatibility.
Example: A user deeply invested in one cloud ecosystem may avoid switching because moving files, settings, and workflows would take too much effort.
A monopoly is a market with many buyers but only one dominant seller. (Source)
Example: A dominant platform standard may become so strong that rivals struggle to remain relevant.
Network effects occur when the value of a product or service increases as more people use it. (Source)
Example: A social network becomes more useful as more friends, creators, and communities join.
An oligopoly is a market dominated by a small number of powerful sellers. (Source)
Example: Smartphone operating systems have largely been dominated by iOS and Android.
A one-sided market is a network market that derives most of its value from a single class of users interacting with each other.
Example: Messaging apps gain value mainly from users being able to reach more users.
A platform is a product or service that allows other firms or developers to build complementary goods or services on top of it. (Source)
Example: iOS is a platform because developers create apps and accessory makers create products that extend its value.
A positive feedback loop in a network market occurs when growth makes a network more valuable, which then attracts even more growth.
Example: More buyers attract more sellers to an online marketplace, and more sellers attract more buyers.
Same-side exchange benefits are the benefits users gain from interaction with other users in the same group of a network.
Example: In a messaging app, each new user makes the service more useful to other users on the same side.
A standard is a common design, format, or rule that allows compatibility across products, services, or participants in a network. (Source)
Example: Competing charging standards for electric vehicles affect where drivers can recharge and which cars become more attractive.
Staying power is the perceived long-term viability of a product or service.
Example: Buyers may choose a dominant e-reader platform because they trust it will continue to receive books and software support.
Subsidizing adoption means reducing the cost of joining a network, or temporarily offering benefits for free, to encourage early growth.
Example: PayPal offered signup incentives, and Zoom used free access to help grow adoption.
Switching costs are the time, effort, money, or data loss involved in moving from one product or platform to another. (Source)
Example: A user who has bought apps, stored files, and learned workflows in one ecosystem may hesitate to move to another.
A two-sided market is a network market with two distinct user groups that create value for each other.
Example: Video game consoles need both players and developers for the network to be valuable.
Viral promotion occurs when existing users help spread awareness and adoption of a product or service to new users.
Example: Social media platforms often grow when users invite friends directly from their contact lists.
A winner-take-most market is one where a dominant platform captures most of the value, users, or profits, even if smaller rivals still exist.
Example: One dominant operating system may keep most of the market while smaller alternatives survive only in niche segments.