In class, we discussed network effects and described it as a situation that arises when each user added to the network increases the value of the network to other users. Given the tremendous connectedness of the Internet, many web-based companies such as eBay, Digg, Wikipedia are able to take advantage of the phenomenon of network effects to succeed in the economy. The Business Week article talks about how companies such as these are thriving by locking in a large customer base, and also by creating barriers to entry against potential competitors.

The success of Digg, is entirely based on its users. With more users there is a greater chance that better quality articles will reach the front page. This is because more people will be submitting interesting news stories, and ‘digging’ (voting for) the specific articles. Similarly, the power of eBay as a competitive auction marketplace is strongly driven by network effects. With more users, auctions become more competitive and the bid prices are pushed up. More sellers begin to sell their items on eBay, and as the supply increases, prices decrease. In turn, the decreased prices bring more customers to the site. As users become increasingly comfortable buying and selling in the online market, they begin to see value in the service. For industry competitors, it becomes difficult to get customers to switch to a different service once they have been locked in.

In his article, What is Web 2.0? Tim O’Reilly says that “network effects from user contributions are the key to market dominance in the Web 2.0 era.” He defines web 2.0 companies as those which recognize that users add value, and can take advantage of this. Wikipedia, for example harnesses the collective intelligence of its users to generate a wide database of information. The more the number of active users of the site, the more it becomes valuable to all.

References:

http://www.businessweek.com/investor/content/feb2003/pi20030228_4861_pi044.htm

http://www.oreillynet.com/pub/a/oreilly/tim/news/2005/09/30/what-is-web-20.html?page=1