It’s a phenomenon called “network effects.”
The main premise of it: a product or service, also known as the network, becomes increasingly valuable as more users join.
A great and early example is the internet in its premature stages: The first developers on the web created sites that users could visit, which prompted users to explore the early internet, causing more developers to create more sites, inviting more users to browse the web, and the cycle continued.
This is how marketplaces and platforms, children under the term “network”, like Uber, Facebook, Amazon, and LinkedIn function as self-inducing engines of growth. We’ll examine how this phenomenon works for both marketplaces and platforms.
Marketplaces have two key customers: demand-side and supply-side customers. For Uber (ride-hailing), Amazon (e-commerce), Airbnb (short-term rentals), and Upwork (freelancing), demand-side customers are passengers, shoppers, guests, and hirers, respectively. Supply-side customers are drivers, sellers, hosts, and freelancers, respectively.
The key linkage between these parties is that they create explicit value for one another. Typically, demand-side customers provide monetary value for supply-side customers, whereas supply-side customers typically perform a service or provide a physical asset for demand-side customers. For example, a guest pays $300 a night to stay in an Airbnb host’s home for one weekend; both parties create explicit value for each other.
The near-magical part of this is when the business begins emphasizing growth on one side — either supply-side or demand-side. Uber post-critical-mass (the size that a company needs to grow to in order for network effects to take place), for example, emphasized demand-side growth by giving complimentary $30 credit for all new users. The result: Uber has grown past the taxi market size in San Francisco.
Travis Kalanick, at the 2015 DLD Conference, presented the startling statistic that Uber’s $500 million in San Francisco Uber revenue surpassed San Francisco’s $140 million taxi market size. Through network effects, Uber has grown San Francisco’s (and likely other cities’) taxi market sizes. As Sangeet Paul Choudary, Marshall Van Alstyne, and Geoffrey G. Parker break down in Platform Revolution, the volume of riders on Uber attracted drivers to build a career off of Uber, increasing the volume of Uber “taxis” present in the city. As a result, more riders joined the network, perpetuating the cycle: the “network effects.” The same key actions of dual value creation are seen in marketplaces like Amazon, Airbnb, and Upwork.
A plethora of products encourage consumers to buy from Amazon’s marketplace, which allows running an Amazon business an attractive career. Homes near hot destinations make renting on Airbnb a great alternative to hotels, which makes neighbors see Airbnb as a viable way of making money from spare rooms. A variety of skilled freelancers on Upwork make companies more inclined to outsource to freelancers, which encourages the freelancer community to grow. The common ground is money for these services or products, but value creation isn’t always specific to money…
For platform companies that don’t have a transactional occurrence between two parties, the amalgamation of users provide implicit value for one another instead. Instead of money being a value unit, users create non-monetary mutual value when they post, ask, or tweet on a platform.
On Quora, users that answer questions get value in the form of upvotes or comments — ways that other users can interact with responses to questions. It’s a form of approval that that the human brain has an infatuation for. Users that ask questions, quite simply, gain value by getting their questions answered. These two value units, approval and answers, are key to the flourishing Q&A ecosystem that Quora is.
These two value units also serve to perpetuate the network effects on Quora’s platform. One of the key differentiators between platforms and marketplaces is the fluidity with which users on platforms can change roles. This means that a person that asks questions likely answers questions as well. In Quora and other platforms’ cases, it’s not one side driving the other to grow, but rather the community growing itself as one large party. When a user answers a question and other users upvote and give feedback, that user is encouraged to stay on Quora’s platform — they can continue asking, answering, upvoting, and responding to questions and answers. This, like marketplaces, is a self-inducing engine of growth. More answers from more users provide more value for more users.
On Facebook, posts from users create a valuable news feed. More tweets create a denser Twitter feed. More photos on Instagram create an entertaining gallery of photos. More posts on Reddit make it a more entertaining gathering of internet memes and trends.
For these companies, both marketplaces and platforms, future growth is reliant on the broad umbrella of network effects. It has proved to be a market saturate — and even grower of markets in Uber’s case. If network effects continue to expand into more verticals, one must be optimistic about technology’s role in furthering the global economy. In some cases, limitless.