Network Effect - Types of Network Effects

Types of Network Effects

There are many ways to classify networks effects. One popular segmentation views network effects as being of four kinds:

• Two-sided network effects: An increase in usage by one set of users increases the value to and participation of a complementary and distinct set of users, and vice versa. An example is developers choosing to code for an operating system with many users, with users choosing to adopt an operating system with many developers. This is a special case of a two-sided market.

• Direct network effects: An increase in usage leads to a direct increase in value for other users. For example, telephone systems, fax machines, and social networks all imply direct contact among users. In two-sided networks, a direct network effect is called a same-side network effect. An example is online gamers who benefit from participation of other gamers as distinct from how they benefit from game developers.

• Indirect network effects: Increases in usage of one product or network spawn increases in the value of a complementary product or network, which can in turn increase the value of the original. Examples of complementary goods include software (such as an Office suite for operating systems) and DVDs (for DVD players). This is why Windows and Linux might compete not just for users, but for software developers. This is more accurately called a cross-side network effect in order to distinguish network benefits that cross distinct markets.

• Local network effects: The structure of an underlying social network affects who benefits from whom. For example, a good displays local network effects when rather than being influenced by an increase in the size of a product's user base in general, each consumer is influenced directly by the decisions of only a typically small subset of other consumers, for instance those he or she is "connected" to via an underlying social or business network. Instant messaging is an example of a product that displays local network effects.

Additionally, there are two sources of economic value that are relevant when analyzing products that display network effects:

• Inherent value: I derive value from my use of the product
• Network value: I derive value from other people's use of the product