When we teach strategy to MBA students, they want magic bullets, things they can do to make their companies thrive forever. For a long time we emphasized “network effects” as a potential secret sauce for business models. Economists use “network effects” to describe contexts where a good or service offers increasing benefits the more users it has. Network effects can be direct: for example, Slack becomes more useful as other people also use Slack. Network effects can also be indirect, meaning that one set of users benefits as more of another type of users joins a platform. For example, AirBnB would not be useful for travelers if there were no apartment-owners using the platform. Similarly, home-owners would not want to use AirBnB if travelers weren’t using it to find a place to stay.
Why Network Effects Matter Less Than They Used To
Strategy professors have long taught that network effects can provide market power and sustained or even self-reinforcing competitive advantage (the best kind). The more users you got, the larger your user base was, and the more compelling your proposition became for attracting new users. But it now seems they are not the panacea that economists first thought them to be. Today, network effects are not tied to a particular piece of hardware, like a desktop computer. Since 2000 and the desktop era, we have seen the evolution of multiple different devices, such as smartphones, tablets, and digital assistants such as Alexa. This means that network effects are no longer intertwined with a particular piece of hardware, as was the case with the desktop computer in the 1990s. Instead, any notions of scale for technology companies depend on user profiles that can be ported to multiple different hardware platforms. Social networks, ridesharing apps, or digital marketplaces do not depend on any one type of hardware, and as a consequence it costs very little for users to try new ones out. The effect on competition is clear: scale will not bring future competitive advantage through network effects if your customers can all leave tomorrow.