Network effects

(1) Upfront capital costs have dropped so that there are lower barriers to entry and frictionless scalability in online networks compared with physical networks. As a result, customer acquisition costs are reduced, and free basic services (rather than only promotional or trial usage) are relatively low-cost and sustainable in the long term.

(2) Online networks have strong demand-side scale economies where users bring other users. Social and/or late users can increase the overall global value of the network for all members and create a bandwagon or "tippy" effect, whereby the market tips in favor of one company or another. This is rarely seen in physical networks—which tend to be dominated by economies of scale in production—where higher volume leads to lower unit costs and commoditization, rather than higher or premium prices and increased market attractiveness.

(3) Online networks form faster, more frequently, and more interactively than before. Active one-percenters and uploaders can rapidly trigger a critical mass of online adoption and formation of communities. Many-to-many network effects become more commonplace.

(4) Online networks and services can expand rapidly and often virally across borders, geographies, market segments, media types, and channels.

(5) Barriers to entry are low, but barriers to success are high because of timing sensitivity and customer volatility, as expressed in winner-take-most competitive races, tippy markets, path dependency, standards, and compatibility battles.

There are different kinds of network effects:

(1) Direct network effects - The value of a good or service increases as more people use it. Each new customer boosts the value of the network and often increases the willingness of all participants to pay for network services. The fax machine is a classic example of direct network effects because the first buyer of a fax machine finds it useless with no one to fax, but as his network of users expands, so does the value of having a machine.

(2) Indirect network effects - More usage of the product spawns the production of increasingly valuable complementary goods, resulting in added value to the original product or service. For example, although some direct network effects are associated with Windows and file compatibility, the indirect network effects that arise from the increased quality and availability of complementary applications software are more significant.

(3) Cross-network effects (sometimes referred to as two-sided network effects) - A rise in usage by one group of users can increase the value of a complementary product or service to another distinct group of users. Hardware and software platforms, reader/writer software pairs, marketplaces, and matching services display this kind of network effect.

(4) Social network effects (sometimes referred to as local network effects) - Instant messaging shows local network effects. A user is influenced directly by the decisions of a typically small subset of other consumers; for instance, those she is connected to via an underlying social or business network. The extent and density of clustering in the network, as well as information access, becomes strategic in technology adoption and pricing choices.