Editing Network effect (section)

{{Short description|Increasing value with increasing participation}}
{{for|the 2020 novel|Network Effect (novel)}}
[[Image:Metcalfe-Network-Effect.svg|right|thumb|Diagram illustrating the network effect in a few simple phone networks. The lines represent potential calls between phones. As the number of phones connected to the network grows, the number of potential calls available to each phone grows and increases the utility of each phone, new and existing.]]

In [[economics]], a '''network effect''' (also called '''network externality''' or '''demand-side economies of scale''') is the phenomenon by which the [[Value (economics)|value]] or [[utility]] a user derives from a [[Goods|good]] or [[Service (economics)|service]] depends on the number of users of compatible products. Network effects are typically [[positive feedback]] systems, resulting in users deriving more and more value from a product as more users join the same network. The adoption of a product by an additional user can be broken into two effects: an increase in the value to all other users (''total effect'') and also the enhancement of other non-users' motivation for using the product (''marginal effect'').<ref name=":3">{{Cite book |last1=Shapiro |first1=Carl |url=https://www.worldcat.org/oclc/39210116 |title=Information rules : a strategic guide to the network economy |date=1999 |publisher=Harvard Business School Press |last2=Varian |first2=Hal R. |isbn=0-87584-863-X |location=Boston |oclc=39210116 |access-date=2020-10-31 |archive-date=2023-02-04 |archive-url=https://web.archive.org/web/20230204151806/https://www.worldcat.org/title/39210116 |url-status=live}}</ref>

Network effects can be direct or indirect. Direct network effects arise when a given user's utility increases with the number of other users of the same product or technology, meaning that adoption of a product by different users is complementary.<ref name=":2" /> This effect is separate from effects related to price, such as a benefit to existing users resulting from price decreases as more users join. Direct network effects can be seen with [[social networking service]]s, including [[Twitter]], [[Facebook]], [[Airbnb]], [[Uber]], and [[LinkedIn]]; [[telecommunications]] devices like the [[telephone]]; and [[instant messaging]] services such as [[Windows Live Messenger|MSN]], [[AIM (software)|AIM]] or [[Tencent QQ|QQ]].<ref>{{Cite book |last=Klemperer |first=P. |title=The New Palgrave Dictionary of Economics |publisher=Macmillan Publishers Ltd |year=2018|location=London}}</ref> Indirect (or cross-group) network effects arise when there are "at least two different customer groups that are interdependent, and the utility of at least one group grows as the other group(s) grow".<ref name=":4">{{Cite book|last=Hagiui|first=Andrei|title=The Palgrave Encyclopedia of Strategic Management|publisher=Macmillan Publishers Ltd|year=2018|location=Cambridge, Mass. |pages=1104–1107}}</ref> For example, hardware may become more valuable to consumers with the growth of compatible software.

Network effects are commonly mistaken for [[economies of scale]], which describe decreasing average production costs in relation to the total volume of units produced. Economies of scale are a common phenomenon in traditional industries such as manufacturing, whereas network effects are most prevalent in [[new economy]] industries, particularly [[Information and communication technology|information and communication technologies]]. Network effects are the [[demand|demand side]] counterpart of economies of scale, as they function by increasing a customer's willingness to pay due rather than decreasing the supplier's average cost.<ref name=":0">{{Cite book|title=The new Palgrave dictionary of economics|isbn=978-1-349-95121-5|edition=Living|location=London|oclc=1111663693|last1=Blume|first1=Lawrence E.|last2=(Firm)|first2=Palgrave Macmillan|last3=Durlauf|first3=Steven N.|year=2019}}</ref>

Upon reaching critical mass, a [[bandwagon effect]] can result. As the network continues to become more valuable with each new adopter, more people are incentivised to adopt, resulting in a [[positive feedback]] loop. Multiple equilibria and a market [[monopoly]] are two key potential outcomes in markets that exhibit network effects. Consumer expectations are key in determining which outcomes will result.