Did you ever wonder why people use WhatsApp when they have so many messaging apps like Viber, Telegram,
Signal Line and many others?
And this is not just about WhatsApp.
If you look at their e commerce preference.
Majority of people use Amazon instead of using other e commerce marketplace like Vish or eBay or Etsy
and many others.
So what's the reason behind people using WhatsApp for messaging and Amazon for e commerce?
And the reason behind that is network effect.
These two companies are able to defeat all other companies because they have a very strong network effect.
So in this video, we'll discuss what exactly is a network effect, how these brands are able to win
or maybe lose the market because of network effect and how you can implement this network effect in
your own startup.
So to understand network effect, just take a second and think about few large US companies that are
booming right now.
So you may think about companies like Apple, Google, Microsoft and many others.
All these companies are successful because of this network effect.
Now, a network effect is a phenomenon whereby a product or a service gains the additional value as
more people use it.
Now, to help you understand network effect, let me ask a very simple question.
Why do you use WhatsApp or Instagram?
Well, your answer would be because all your friends and family member use these app.
Let's say if you have ten members in your family, majority of them are using WhatsApp and that's why
you also have to use the same messaging app.
And similarly, if majority of your friends are using Instagram, well in that case, you also have
to use the same social media app.
But Network Effect is not just about messaging app or social media, telecom software or blockchain.
Almost all these companies from different sector use network effect.
In fact, 70% of value in tech is driven by network effect.
And that's why in this video we will understand about network effect.
And one of the simplest way you can understand this network effect is with the help of this simple diagram.
Now, some people call this diagram as the flywheel of Amazon, and this flywheel is driven by network
effect.
So if you fundamentally look at any business, majority of the business are winning the market because
of lower cost structure.
Now, to maintain this lower cost structure, you have to maintain the lower prices on the platform
so that more and more people can purchase the product.
Now, imagine if Amazon have the lowest price of product on their platform and many people are buying
this product on that specific platform.
The customer experience will be great.
And if you're providing a great customer experience to all these customer, then they will attract other
people as well.
So lower prices will lead to customer experience, and better customer experience will attract more
number of customer.
And if you have more number of customer on an e commerce platform, that will automatically attract
more number of seller.
And if you have more number of sellers on the platform, they will end up listing more number of product.
And now you have more product on your platform, it will automatically attract more number of people
because people like variety of product.
Now Network Effect is more prominent in case of social media, app or messaging app.
If you look into e commerce, you may find some other companies as well, like eBay, Etsy, or maybe
Walmart apart from Amazon.
But if you look into messaging, then you will find that majority of people are using WhatsApp.
Maybe 90% or 95% of people are using WhatsApp.
So some business will have more prominent network effect than other business.
Now let's understand what value does this network effect bring to the business?
And the number one value is cost reduction in the customer acquisition.
Now imagine there are ten members in your family, and let's say out of those ten members, eight members
are using WhatsApp as their messaging app.
And let's say your dad is giving a new smartphone to your grandma.
So now everyone in your family will advise your grandma to use WhatsApp because every single one of
you is using the exact same messaging app.
So now MITA or Facebook have a new customer without spending a single penny, and that is possible because
of network effect.
And the same concept goes with Instagram.
If she wanted to use a social media app, there is a very high chance that she will install Instagram
because each one of you is using the exact same platform.
The second value a network effect bring to the business is the higher liquidity.
And this is more prominent in a marketplace.
So if you have more number of sellers on the platform, they end up listing more number of product and
that will attract more number of customer and those people will end up buying all of their product.
And that's why these marketplace have higher liquidity if they have a strong network effect.
Now, the third value these businesses get out of network effect is deeper relationships.
So if you have used apps like Instagram, if you open the app, Instagram will normally suggest you
to upload a picture or maybe a video or a story so that other people will also get to know about you.
What exactly are you doing in life?
And that's how.
You end up building relationship with your colleague or with your friend?
And the app is also strengthening your relationship in your own network.
Now, these network effect are super difficult to break.
So let's say if you uninstall Instagram, you will lose all your connection and it is super difficult
for you to find the exact same people on some other platform and that's why you are stuck on Instagram.
Similarly, you don't really have any other replacement for Amazon because you cannot really find a
large variety of product that will reach to your doorstep at the most affordable price.
And that's why you are locked into the ecosystem of Amazon and Meta and all the credit goes to the network
effect.
So now let's understand how these network effects are built.
And to oversimplify this, let me give you a simple example where people are talking to each other on
a cell phone or on a mobile phone.
So let's say if two user talk to each other, that's a single interaction.
And let's say if you're giving a cell phone or a mobile phone to these five different user, they can
have ten different ways of interaction.
So let's say this person can talk to all these four people.
And similarly, this guy can talk to all these four different people.
So with five user, you will have ten different interaction.
And let's say if you increase the user count from five user to, let's say 12 user, in that case you
will have 6 to 6 different interaction.
So if you increase the user, you will have more number of interaction.
Now these users are also called as nodes and the interaction between them is connected with the link.
So in simple term, all networks are formed by nodes and links.
Now these nodes participate in the network and if the central node has the higher number of links,
then it will have a higher value when compared with marginal nodes.
So if you look at this diagram, you will see that the central node have lesser number of links when
compared with this one, and that's why it's a strong network effect when compared with this one.
So the strength of a network can be measured by two different parameters The total number of links in
the central node that is this one and the value of these links in the network.
So we understand the first part.
If we have higher number of links in the central node, the network effect will be stronger.
But what about the second part value of the network?
How will you decide the value of the network?
So let's say you have two different scenario.
In scenario one, you have 100 connections on LinkedIn and let's say out of these 100 connections,
ten of them are CEOs of some company.
In other scenario, you have the same connection, but you are connected with normal people.
So the value of your network in first case is higher than the value of network in the second case.
So the strength in your network will be decided by the total number of links in the central node and
the value of those links.
So that's all about the basics of network effect.
In the next video, we will understand how these different companies are using the different forms of
network effect.
So in the next video, we'll talk about the different types of network effect.