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February 1, 2023

Network Effects: How Can It Influence Your Startup?

Key Points

The Network Effects Phenomenon: What is it?

Imagine a domino row falling: that’s a practical way of picturing this.
In economics, a Network Effect is a phenomenon that takes place when the value of a product or service is determined depending on how many users, buyers and sellers it has. As more people interact with it, additional value is added. This is simply because as the product or service grows, interaction between users follows creating tangible probabilities of revenue increase.

Business Models: Exploring Possibilities

To sum up, what happens is that the addition of users over time makes the product or service more valuable. Network effect-based business models come in four broad categories:

1. Data networks: Businesses following this model collect users’ data with the aim of improving the value of their own experience while interacting with the digital product. In this model there’s only one type of user that interacts with a software: it’s one-sided. For example: Google.

2. Interaction networks: In this model, businesses connect users to each other, enabling direct interactions. This category includes networks that rely on the establishment of the users’ identity (e.g. Instagram) and those where identity is not so relevant (e.g. Twitter or Discord).

3. Marketplaces: Here, connections between two or more different user types take place, usually with the purpose of buying and selling products or services (e.g. Mercado Libre).

4. Platforms: This model enables software developers to integrate new applications on top of an existing software product, while connecting them to its users. (e.g. Android).

Direct & Indirect Network Effects

Network Effects can happen in a direct or indirect way. Below, we will point out and briefly explain the main characteristics of each one:

●  Direct Network Effects refer to when the value of a product or service increases as its number of users  also does, and it’s usually reserved for physical goods (e.g. Computers) and experiences (e.g. A ticket for a concert venue).

  Indirect Network Effects happen in data network, marketplaces, interaction network and platform businesses because the user audience is typically divided into two groups: producers and consumers. These two are interacting with one another via the platform and need the other to make it both useful and profitable. More consumers joining the network mean more business opportunities for the producers and, in reverse, more producers joining the network means more chances of getting the consumers’ needs met in a faster and customized way.

Acknowledging The Tool

Either way, it’s important to note that Network Effects refer to a competitive advantage thattakes place when a product’s value rises, both reputation and marketwise. Like a tidal wave,it affects both new and preexistent users changing the game for everyone involved. In thisway, it’s a powerful tool to have on your toolkit as a digital startup builder, since cases thatdevelop on the Internet are the most visible and trackable to study later on.

Building Community: Define A Growth Plan

Now that we've laid the foundations for what the Network Effects phenomenon is, it’s important for Startups to build a strategy to capitalize it. It can be a powerful tool to propel business growth, so here we will point out some important keys to unlock its potential and incentivize early usage and consumption of its product or service.
Marketing strategies such as social media advertising, subsidizing initial user acquisition, and implementing a referral fee can help. But let’s start from the beginning.
First and foremost, having a defined user person and deeply understanding its digitalbehavior is key to target your audience correctly. Ensuring that the product you are buildingor service you are providing solves their pain points is what ties all of this together, payingspecial attention to its UX, as well as having a strong Customer Success strategy set intoplace. These are keys to accomplish high user retention rates and build a community aroundwhat you are selling. You can reach out to our team at Rather Labs to help you build thetechnical side of your business, finally setting solid foundations for sustained growth.

If you pay close attention to all these points and implement social listening and accountability to iterate what needs to be re-worked, recommendations both on social media and in person will abound. When all this is set into place, you will be witnessing Network Effects in action.

Macarena López Morillo
Head of People
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