Understanding Network Effects

A Network Effect occurs when the power of a system grows faster than its size. For example, we say that there exists a network effect when a company’s products or services become more valuable as the number of people using them increases. Some examples include Facebook, Uber, Bitcoin, eBay, etc.

A phone is another good example of network effect – if only one person has a phone, it’s useless. If two people have a phone, it’s valuable to both as they can communicate with each other – we say there is one unique connection in the system now. As the number of people with a phone grows, the number of unique connections in the system grows to (n(n-1)) / 2 and the system becomes a lot more valuable as more people can communicate with each other easily now.

Companies can grow exponentially when they leverage network effects.