Network Effects Explained
How Products Leverage Their User Base To Drive Growth And Adoption
Certain products are valuable because of how many people use them, rather than their specific features and functionality. As more people use these products, their value increases, creating a self-reinforcing cycle that drives product adoption and growth. This is called a network effect. Many of the world’s most recognizable products have used these powerful mechanisms to dominate markets and build massively successful companies. When product teams understand how to effectively leverage network effects, they can build great products and great businesses.
What Are Network Effects
Network effects happen when a product becomes more valuable as more people use it.
Network effects occur when the value of a product, service, or platform depends on the size of its user base. Its usefulness increases as its user base grows, making it more valuable over time, which attracts more users. This creates a self-reinforcing cycle of growth. It also helps retain users and makes the product harder to replace. For example, when a marketplace (like Amazon, eBay, etc.) gets bigger, buyers get more options and better pricing, and sellers get access to a bigger market. Products can achieve enduring long-term success by taking advantage of network effects.
Network effects can benefit products across many industries and applications:
Rideshare: Uber, Lyft, Bolt
E-Commerce: eBay, Etsy, Amazon
Travel: Airbnb, Booking.com, Expedia
Delivery: Grubhub, DoorDash, Uber Eats
Messaging: WhatsApp, Telegram, WeChat
Social Media: Facebook, Twitter, Instagram
P2P Payments: PayPal, Cash App, Google Pay
Types of Network Effects
Direct Network Effects
Direct network effects occur when the product’s value is influenced by the size of the user base (the network). Every additional user makes the product better for all the existing users. For example, social media platforms (like Instagram, Facebook, etc.) get more appealing to users as their active user base grows. More users mean more content. This gives users more chances to consume (view, read, etc.) and engage (like, share, comment, etc.) with content. Therefore, as these platforms grow, they must continuously expand their user base to ensure they remain valuable to users.
Multi-Sided Network Effects
Multi-sided network effects occur when the product’s value is influenced by the size of two or more user groups (such as buyers and sellers). Every additional user on one side of the network makes it more valuable for all the types of users on the other side of the network and vice-versa. For example, ride-sharing platforms (like, Uber, Lyft, etc.) get more appealing to riders based on the number of drivers, and, conversely, get more appealing to drivers based on the number of riders. Therefore, as these platforms grow, they must continuously match their platform's supply and demand sides to ensure they remain valuable to all user groups.
Data Network Effects
Data network effects occur when the product’s value is influenced by the amount and quality of information available in the network. Every additional user increases the amount of data available. This data is used to optimize the product and improve the user experience, which attracts more users. For example, navigation applications (like Google Maps, Apple Maps, etc.) perform better as the richness of navigation data improves, resulting in better directions, traffic predictions, etc. Therefore, as these platforms grow, they must continue to use data to refine the user experience to ensure they remain valuable to users.
Why Network Effects Matter
Network effects are a powerful driver of customer acquisition and market dominance.
Network effects create a powerful competitive advantage. Once a product successfully leverages network effects, it establishes itself as a market leader. It can be challenging for competitors with smaller networks to draw users away because the product’s value proposition is tied to the size of the network. It can be challenging for disruptors to offer unique value that the established giants don’t because they can’t just replicate the product’s functionality, they must replicate the network’s size. This makes them a great form of defensibility.
As the network grows, the product’s value proposition, trustworthiness, and competitive advantage increase. In competitive markets where network effects apply, the challenge for product teams is not necessarily building a better product than the competition but growing the user base faster than them. Often, the winning strategy is maximizing market share rather than maximizing profits. Once a significant market share has been achieved, they can always raise prices or monetize the user base in different ways.
Companies that can leverage or exploit network effects often experience rapid rates of growth…Not just that: Once you’re ahead, you tend to stay ahead. Your demand keeps growing even faster as you get bigger.
— Bharat Anand, Harvard Business School Professor & Economist
Leveraging Network Effects
Optimize The Core Interaction
Every product has a core interaction that triggers an “aha” moment. They realize how and why it’s valuable, which gives them a compelling reason to use it. For network effects to take hold, this moment needs to be immediately apparent and users must repeatedly realize value. People now have high expectations and short attention spans, making it critical to demonstrate value to users within seconds of using an app. They will leave if they don’t see how the product makes things easier, faster, or better for them. Product teams must design their core interaction to establish clear, tangible value, even when the network is small. When they can satisfy early users, these users stick around long enough for the network effects to kick in.
Solve The Cold Start Problem
You need to have a certain number of users for the network effects to really kick in. However, while it’s easy to attract users when the network is big, it’s much harder to attract users when the network is small. This is called the cold start problem. You need users to create value, but without value, you can’t get users. For product teams, figuring out this paradox is one of the most important early-stage challenges. Established competitors already benefit from network effects, so drawing users away from them is difficult. The best strategy to deal with this problem depends on the users, the product, and the business model. For example, many marketplace products (like Airbnb, Uber, etc.) focused on growing their supply side by first incentivizing sellers to join by offering them strong incentives (better pricing, better access to buyers, better experiences, etc.).
Continuously Evaluate The Network
While a network effect is a self-propelling mechanism, the networks can still stagnate, decay, or even collapse. The product needs to continue delivering a great experience, even as it scales. Therefore, the product team must continuously monitor the quality of users to weed out bad users and the quality of user interactions to identify points of friction. For example, ridesharing platforms (like Uber) must constantly evaluate the rider and driver user experience, no matter how big the network gets. The user experience can quickly deteriorate if riders and drivers keep having bad rides — encountering issues like long wait times, inaccurate trip duration estimates, frequent cancellations, etc. Over time this can negatively impact retention and user acquisition, causing riders and drivers to leave the platform and disincentivize new riders and drivers from joining.
Conclusion
Understand How Your Product Can Drive Its Own Growth
Many successful companies have been built around products with network effects. Network effects occur when a product achieves a certain critical mass of users. However, triggering these effects is not just about relentlessly pursuing user acquisition. Product teams must deeply understand how users think, feel, and act, and design thoughtful, meaningful solutions that give them a reason to stick around. When value truly compounds with each new user, the product creates the momentum needed for growth, all on its own.