A Primer on Network Effects

The concept of “network effects” refers to the phenomenon wherein the value of a product or service increases as more people use it. While it can be difficult to quantify network effects, it is useful to have a basic understanding of the mechanisms involved. Strong network effects can rapidly grow a product's user base, creating substantial barriers to entry for potential competitors. 

To gain a deeper understanding of network effects, consider a simple example involving a communication network with n users. In this scenario, each user has the potential to establish n-1 connections with the other users currently active in the network. As the user base n increases, the number of connections that an individual user can make also grows. Now, if we consider that the value, denoted as v, derived by an individual user from this communication network is directly proportional to the number of potential connections they can establish, we find that individual value scales linearly with the number of users, v ~ n.