Glossary
Network effects
What are network effects?
A network effect occurs when the value of a product or service to a user depends on other users’ participation. A positive effect increases value; the relevant users are those whose participation affects that person, not necessarily every user of a brand.
Research foundation
Katz and Shapiro’s 1985 analysis distinguishes direct effects, such as being able to contact more people, from indirect effects, such as a larger compatible hardware market supporting more software. Compatibility determines which users belong to the relevant network.
Illustrative example
A messaging service can become more useful when people someone needs to contact join it. An increase among unrelated users need not provide the same benefit.
Limits
Network effects do not make monopoly inevitable or prove that the dominant product is inferior. Market structure also depends on compatibility, expectations, costs, and preferences.