Network effect

Definition

A network effect or network externality is the effect that the use of a good or service by one user affects the value of the good or service to another user. The term is typically used for positive network effects, i.e., where the more the users of a network, the more beneficial it is to each user.

Examples

Communication networks

Networks that are used for user-to-user communication as well as user-to-network communication (such as phone networks and the Internet) may exhibit strong positive network effects. As more and more people get telephones, the value of getting a telephone increases because there are more people whom one can connect with via the telephone. Similarly, as more and more people get Internet access and consequently write and read material on the World Wide Web, it becomes increasingly valuable to get Internet access.

Goods that are indirectly useful for networks

Some goods are not themselves part of networks but are useful for connecting to networks, and thus, exhibit network effects indirectly. For instance, a computer is a useful way of connecting to the Internet, and people with computers are more likely to have Internet access, so as computer usage rises, Internet usage may also rise, which increases the value of Internet access and hence of computers.