The network effect is a phenomenon that occurs when a product or service gains value as more people use it. In other words, it's the idea that a product becomes more useful as more people adopt it. Think about social media platforms like Facebook or LinkedIn— the more people that use these platforms, the more valuable they become to its members. This effect is not limited to technology; it can also be seen in industries like transportation (where ride sharing services like Uber and Lyft gain value as more people join), and even in basic communication tools like email.
Understanding the network effect is important for businesses and investors alike, as it can help them make strategic decisions about which products or services to invest in, and what markets to enter.
In Marketplace Best Practices, Tom McFadyen explains:
"Generally, there is a critical mass inflection point at which the network effect kicks in and helps build a defensible market position. The network effect compounds the inverted firm efficiency as the platform user count grows. Rapid user-base expansion is also often referred to as going viral."