Network effects refer to a phenomenon where the value of a product or service increases as more people use it. In other words, the value of a network increases as more people join it.
There are two types of network effects: direct and indirect. Direct network effects occur when the value of a product or service to a user increases with the number of users. For example, the value of a telephone increases as more people have telephones because it becomes more useful for making calls. Indirect network effects occur when the value of a product or service to a user increases with the number of complementary products or services. For example, the value of a computer operating system increases as more software applications are developed for it.
A classic example of a network effect is Facebook. The value of the social network increases as more people join and use it because it becomes a more useful tool for connecting with friends and sharing information. The more people that join, the more valuable it becomes, creating a virtuous cycle of growth.
Another example of a network effect is eBay. The value of eBay to buyers increases as more sellers join the platform, and the value of eBay to sellers increases as more buyers join. This creates a positive feedback loop that makes the platform more valuable to everyone, encouraging even more people to join.
In both cases, the network effect is a key driver of the platform's growth and success, making it difficult for competitors to catch up once a dominant player has established itself.
Certain industries are more favorable to Network Effects than others.
Two sided pier to pier market places, such as ebay, the more users buying and selling goods benefits the buyers by having more to pick from, and benefits the seller by having more potential buyers. Uber could also be considered a two sided market place, supply of drivers and riders becomes easier to use as more people join the platform.
Social networks and or any communication platform, the more users on the platform makes the network more valuable, as users have more people to connect with and use the platform with.
Open Source software benefits from network effects as it helps the software become more anti-fragile. The more people that use the software and find bugs in it, and then patch those bugs, the more anti-fragile the software becomes. All users of open source software benefit from the size of the network using the software.