A network effect is defined as a phenomenon that occurs when a product/service becomes more important or valuable with the increase in the number of people utilizing it; hence promoting the number of users or adopters. One good example of a network effect is the telephone service (Gallaugher, 2018). The increase in ownership of the phones, the more valuable and essential the service or device becomes to each owner. The network effect phenomenon was ideally studied in the 70s using the context of telephony but was popularized by Metcalfe Robert, who coined the Metcalfe’s law. This law states that the network value is relative to the square of the population of users. Three primary sources account for this value of the network effect, including, complementary benefits, staying power, and exchange. The three sources are discussed below.
Information exchange is the first source of network value generation. Based on 'exchange,' it is assumed that the value of a network increases in value because of the ability of its users to communicate and interact freely with one another (Frischmann, 2013). This applies to companies that are technology intensive, including computer programs, movies, games, music, and many others.
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Staying power is the second crucial source that can create and improve network valuation (Enders, 2012). In essence, staying power influences the viability and sustainability of service or product. This implies that the more the number of subscribers or users in a network the higher its sustainability or staying power. As such, customers often tend to subscribe to or purchase services or products that are durable or high longevity (Gallaugher, 2018).
Complementary benefits are the third and last source of value generation in network effect. They refer to services or products that contribute to the value of a network. In most instances, permitting other companies to add value to an organization is beneficial since such firms invest their money and time during value addition.
References
Enders, A. (2012). Management competence: Resource-based management and plant performance. Springer Science & Science Media.
Gallaugher, J. (2018). Information systems: A manager’s guide to harnessing technology. Flat World.
Frischmann, B. M. (2013). Infrastructure: The social value of shared resources. Oxford: Oxford University Press.
