Tuesday, November 30, 2010

Web 2.0: The Network Effect

When I was younger, I made a deal with a youth-leader and friend, the terms were: I would delete my Myspace account if he would quit drinking caffeine. I am certain that he thought that his end of the bargain was certainly much more difficult. He might have thought that giving up Myspace would be a bit hard because I spent a good deal on it but what I am fairly certain that he didn't consider was that giving up Myspace was significantly more difficult than merely giving up a service, it was giving up a network and community--one in which I had become locked-in.

Sure enough, though it was very difficult (note: these were pre-Facebook days and luckily, Facebook was there to save me a few short months later), after much hesitation and trepidation, I reluctantly deleted my Myspace account. This short anecdote illustrates an interesting concept that is integral to understanding Web 2.0, called the Network Effect.

As an economics student, I like to think of the network effect in terms of economic theory. In economics, there is something called an externality. An externality is a situation in which a transaction has an effect--positive or negative--on others outside the immediate influence of that transaction. Examples of negative externality is: secondhand smoke i.e. you didn't buy the cigarette but your breathing in the dangerous smoke. An example of a positive externality is: instant hand sanitizer i.e. your friend with a cold bought and used instant hand sanitizer so you don't get the cold.

The network effect, is simply the idea of a positive externality on a group that results from an individual joining a network i.e. the benefits of an individual joining a group extend beyond the individual but to the group itself. Some examples of this are: cellphone networks, social networks e.g. Facebook and Twitter, various types of software e.g. Microsoft Word, et al. I am certain that we can all relate personally to the Network effect...

I would argue that overall, the network effect is certainly a very good thing. However, a negative side-effect is that it often leads to people being "locked-in" to certain products and services. For example, how many times have you been frustrated with a recent change on Facebook, felt the sudden urge to quit it, and then realized that there is nowhere else to go because all of your friends are there? I have. This is an example of being "locked in."

Here is perhaps an even better example: How many times have you been so irritated with Microsoft Word but realized that your frustration was in vain because there was really no better alternative? Once again, I have--I even once started typing a paper using Word Perfect on a friend's computer...it was a nightmare trying to get it off his computer.

The interesting/unfortunate thing about the lock-in effect is that it can sometimes cause inferior products, because of early adoption, to gain predominance in the market and then crowd out potential competitors. It is because of this, that we frequently see heavy competition in the early stages of innovation of new products.

With this in mind, one can conclude that the value of many companies is not necessarily in their products and services but rather in the communities and networks that they facilitate. It is an interesting thing to consider. It is also interesting that with many companies like Twitter, the network effect is both at the root of their success and greatest challenges (read here and here)

In closing, I ask: So how many products are you "locked-in to?" How many products and/or services do you use simply because your friend uses them?