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Business strategy, Marketing

Network effect

Network effect means that the size and frequency of use of a user affects the utility value of the product or service .
For example, if you ask “Why are you using Facebook or Twitter?”, You will answer “because people around you are using it” and “because you can’t interact with people without it.” In such cases, it can be considered that the utility value is determined not by the function or quality of the product or service, but by the number of users or terminals. The number of users and terminals is called “ network scale “.
The network effect generally works for products and services that require communication with an unspecified number of others. On the other hand, for example, when purchasing groceries and cosmetics, most people consider purchasing based on the function, quality, and price of the product. From this, it can be considered that network externalities do not work for products and services with these characteristics.
Network externalities are common in products and services that gain extremely high market share, and many of the so-called “de facto standards” products and services are influenced by the effects of network effects.

 

 

Types of network effects

There are two types of network effects: “direct network effect” and “indirect network effect”.

Direct network effect

The direct network effect is the property that the scale of the network directly affects the utility value for users , for example, Facebook and Twitter, which become more convenient as the number of users increases. SNS is applicable. Also, for example, when buying a mobile phone, the benefits a consumer gets are clearly dependent on the number of other people using the mobile phone’s network. It is believed that the more people participate in the network, the greater the utility of a single consumer, and the more “positive feedback” is generated.
Direct network effects are typically found on social networks mentioned above, as well as interconnect devices and communication services such as telephone, fax, email, chat, and instant messaging.
 

Indirect network effect

The indirect network effect is the property that the quantity and quality of complementary goods related to a certain product or service are determined according to the size of the network, and the result affects the utility value for the user . It means strong>.
For example, as Blue-ray recorders become more widespread, the number of complementary Blue-ray compatible software will increase, and as a result, the value of choosing a Blue-ray recorder will increase.
It is said that indirect network externalities work for the spread of payment services and transportation IC cards, and in this case, the complementary goods are the terminals (stores where the payment service cards are installed).
Products and services that have indirect effects include computers, videos, CDs, home video game consoles (devices and software), credit cards / electronic money (payment methods and usage scenarios), etc., in addition to the Blue-ray recorders mentioned above. there is. Similar to the direct network effect, the more popular the product, the more complementary goods will be provided and the more “positive feedback” will occur.
 

How to create a network effect

The following two points are the conditions for the network effect to work.

Secure enough users to break through the “Critical Mass”

The concept of “critical mass” is the key to the social dissemination model of new ideas and technologies proposed by American sociologist Everett Rogers.
For products and services that have a network effect, the value of the products and services increases as the number of users increases, and as a result, the value of the products and services increases.
Positive feedback ” works to increase the number of users and increase the value.
In addition, it is said that such products and services have a “ critical mass “, which is a turning point where the penetration rate jumps at a stretch. In order to secure this “critical mass”, there are strategies such as surely acquiring initial users and strategic pricing even if profits are ignored in the initial stage.
In particular, regarding this “securing of users”, it is considered to be one of the effective means to temporarily provide products and services free of charge and actively attract users.
 

Secure the number of complementary goods (when aiming for indirect network effect)

The indirect network effect is the existence of such complementary goods, such as PC hardware and software, in which the quantity and quality of complementary goods that are directly related to the value in use of the product are determined according to the scale of the network. Is the effect that affects the value of the product to consumers. Therefore, the more popular the product, the more complementary goods will be provided, and the more popular it will be, the more “positive feedback” will occur. Therefore, it is necessary to create a complementary good or build a mechanism to have it created .

 

 

Company example of network effect

Windows

When Microsoft’s Windows once dominated the market, the network effect was used to explain the principle of its growth. First, as the number of OC users who use Windows as the OS increases, the “direct network effect” that makes it more convenient to use a Windows PC for data exchange etc. works. Next, the “indirect network effect” that Windows-compatible software (complementary goods) such as document creation software and virus software increases as Windows becomes more widespread also works. As a result, a wider variety of software will be offered for Windows, and users will have more software choices, which will increase the benefits of choosing Windows. By working with both of these network effects, Windows has gained an overwhelming share .
 

Facebook

SNS such as Facebook is also one of the typical examples where network externalities work. For example, Facebook has both “direct network effect” and “indirect network effect”. As the number of users increases, the convenience and attractiveness of communication between users increases due to the “direct network effect”, and as the number of games (complementary goods) developed on Facebook increases, Facebook’s Increasing value can be said to be the function of the “indirect network effect.”
On the contrary, if the service provided is not suitable for the times and the number of users decreases, the number of active users will decrease at once, and the direct effect may be a double-edged sword.
 

Mobile phone

Mobile phones are also getting the effect of the network effect.
Even if you have only one mobile phone in the world by yourself, it is not convenient, but if the person you want to call also has a mobile phone, it will be convenient.
Recently, the number of communication methods other than the call function is increasing, so smartphones that can use them comprehensively are the mainstream. As the number of people using the same smartphone increases, the value of the smartphone itself will increase.
In addition, there are services such as free calls between mobile phones of the same mobile phone company, so the more people using the same carrier, the more people can make free calls, so the network effect here as well. Is demonstrated.
 

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