Types of network effects
There are two main types of network effects – direct and indirect network effects.
Direct network effects are what we’ve just discussed with the telephone. Increased usage adds value for all other users.
A project with a strong network effect may draw in many skilled developers to audit the code since so much value is at stake (including their own). This added value comes from there being so much value in the network in the first place. This effect starts compounding, and we arrive at dominant leaders that build up significant network effects over their competitors.
Network effect examples
Modern-day examples of network effects are present in a number of different product categories. One obvious one is social media, where users tend to join services that their pre-existing social networks are using. This incentivizes people to join the same platforms, and a few services get into monopolistic positions.
If new companies want to start a new social network platform, they’re going to have a hard time gaining critical mass. Why? The network effects the market leaders have built up give them a significant competitive advantage.
Another good example of network effects is ridesharing. The network effects that Uber or Lyft have built up over the years are difficult to compete with for newer services with a smaller user base.
The same applies to Ebay and Amazon with online sales, Google with internet search, AirBNB with online renting, Microsoft in enterprise operating systems, and Apple with the iPhone. Even so, can only for-profit companies with well-defined business models achieve a network effect? No. Wikipedia is a good example of an open-source project that has built up a significant network effect.