Network effect
Also known as: Network externality
A product becomes more valuable to each user as more people use it.
What it means
A network effect exists when the value a person derives from a good or service rises with the number of other people using it, so demand depends on the size of the installed base. Direct network effects come from same-side users — a phone or messaging app is useful in proportion to how many others you can reach — while indirect (cross-side) effects arise in platforms, where more buyers attract more sellers and vice versa. Because value compounds with adoption, network-effect markets tend toward winner-take-most outcomes, high switching costs and lock-in, and a chicken-and-egg cold-start problem that makes the early going hard until a critical mass tips growth into self-sustaining momentum. The flip side is congestion and negative network effects, where too many users degrade the experience. It matters for understanding platform competition, standards battles, and why dominant digital incumbents are so durable.
Examples
A social network or marketplace like a telephone system is nearly worthless with ten users but indispensable with ten million, because each new user makes it more useful to everyone already there.
A ride-hailing app is useless in a new city until enough drivers sign on to make waits short, which is what brings riders, which is what keeps drivers on the road.
The fax machine, once in every office, became worthless not because it stopped working but because everyone else stopped having one.
First described in Rohlfs (1974); popularized via Katz & Shapiro (1985) and Metcalfe's law.