Saturday, January 28, 2012

The Effect of Network Effects

A key principle behind network economics is network effects: “for some kinds of decisions, you incur an explicit benefit when you align your behavior with the behavior of others.” (E&K, p. 449)

I always thought these network effects were of the utmost importance; for example, we see Facebook, which people use because everyone is using it and thus it becomes an outstanding way to stay in contact with friends. We also see LinkedIn, “The World's Largest Professional Network” where as more people become connected via LinkedIn the more important it is for others to also join as they can be connected to other professionals (currently the number of LinkedIn users is 135 million (Wiki) which I think is rather amazing for professional networking online) (By the way, I am not on LinkedIn or Facebook!) . However, I came across an interesting article by Pascal-Emmanuel Gobry, which got me thinking, “How Strong are Network Effects Online, Really?”

In his article “How Strong are Network Effects Online, Really?” Gobry states that “one way that network effects can be defeated is through … "verticalization."” By the term “verticalization” Gobry means that services will build “niches” in specific verticals. Take for example Facebook, which perhaps reaps most the benefits of network effects. Although no one has supplanted Facebook via a new full-blown social networking service, “plenty of apps are taking specific use-cases of Facebook and turning them into full-blown services.” Gobry gives the examples of Twitter, which made the “status-update” feature of Facebook into its own service and Instagram, which is a way to instantly upload photos (it is based of the photo-uploading feature of Facebook). Although Facebook is still going strong, it is undeniable that more people are using Twitter and Instragram and this could potentially detract from the amount of users in Facebook (according to Gobry). From my personal experience, I have seen many people beginning to use Twitter and Instagram (it is true that the market for these services are growing) but however they are still on Facebook as well … I just cannot believe that these services will supplant Facebook! In his defense, Gobry does not believe “that Facebook is going to crash tomorrow or that Twitter will "kill Facebook" or any of that crap. The point is to say that online network effects are probably overhyped.”

Gobry also argues thatonline network effects are strong barriers to entry to FRONTAL competition but not to LATERAL competition.” By this he means, using Facebook as an example, that if Facebook in its early development had focused its attention toward MySpace users (Frontal attack) it would have never have taken off. “Instead Facebook targeted a population that was less into MySpace, attacking laterally--and won.” The point of this analysis is that “Facebook won through superior execution and lateral attack at least as much as network effects.”

Personally, I do not believe network effects will be defeated by “verticalization.” Gobry does not say this will happen but he does believe this is a possibility. In fact, I believe services reliant on network effects and services reliant on “verticalization” will co-exist, i.e., Facebook will not suffer as a result of Twitter/Instagram and vice versa; people will use Twitter and Instagram for specific functionalities but they will still need Facebook to stay in touch with all their old friends; I believe that Twitter and Instagram are not in competition with Facebook but they are essentially “separate markets.”

However, I do agree that “superior execution” is just as important as network effects. Had Facebook directed their attention toward music group (apparently guitar players and band members were huge fans of MySpace) I do not think they would become as big as they are today whereas by initially marketing to people who were not ardent users of MySpace, they really “took off.”

Anyways, what do you guys think?

“How Strong Are Network Effects Online, REALLY?” by Pascal-Emmanuel Gobry

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