A network effect is a concept rooted in the intersection of economic theory and telecommunications, but I won’t take you too far down that road here. For now, think of network effects simply as powerful, virtuous cycles that offer major benefits to companies and users alike. Still with me? When a network effect exists, the value of a product or service increases in proportion to the number of people using it.
Does the concept still seem a bit vague or theoretical? Fine, I’ll make it a bit more concrete.
Larger networks aren’t just more valuable than smaller ones; they’re exponentially more valuable. George Gilder built on the work of Internet pioneer Robert Metcalfe to coin the phrase Metcalfe’s Law: the effect of a telecommunications network is proportional to the square of the number of connected users of the system. Put simply, a network consisting of two members is worth four units, not two. A network with three members isn’t worth three; it’s worth nine. A four-member network is worth 16, and so on. Make no mistake: This law is a really big deal.
In 1994, Jeff Bezos quit working at the hedge fund D.E. Shaw, moved to Seattle, and started one of the Web’s first e-commerce companies. (Yes, I vividly remember its inception, and I’m dating myself.) These events occurred long before his grand idea became the everything store — the title of Brad Stone’s excellent book on the company. At that time, Amazon’s comparatively modest ambition was to become the world’s largest bookstore. Nothing else.
Bezos understood then — as he surely does now — the remarkable power of network effects. In his case, if Amazon could become the default destination for buying books online, then good things would happen for the company, himself, and his employees. Specifically, more publishers, vendors, and partners would sell their books on Amazon because that’s where people shopped. In turn, even more people would purchase their books on Amazon. This virtuous cycle would continue indefinitely and ultimate generate enormous economic value.
It turns out that Bezos’s 1994 intuition was spot-on. As of this writing, Amazon’s market capitalization exceeds $1 trillion. Even after Bezos’s recent and historically expensive divorce, he remains the richest person on the planet.
Think that Amazon represents the sole example of a contemporary network effect? Think again? The leaders at Facebook, Google, Apple, Uber, LinkedIn, Microsoft, Twitter, and many other tech behemoths intimately grasp the power of network effects. They have taken steps to strengthen those networks that, in part, explain current and forthcoming legislation. That has been the subject of many a powerpoint course that I've been on. Take away network effects, and those companies would be worth a fraction of their current values.
Just like Amazon and Facebook, organizations that use social apps can benefit from network effects. That is, as more employees use social apps, firms benefit more from it. This truism makes the app a more valuable tool than if only a few employees in an company dabble in it.
A social network app is not an individual tool; it is a group one. As such, the benefits that you and your organization ultimately accrue from it hinge upon its successful adoption and use. Put differently, its outputs are a direct function of its inputs. More of the latter yields more of the former.