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The value of network effects

Metcalfe’s Law asserts that the power of a network is proportional to the square of the number of users connected to that network. It was originally calculated in the 1980s by George Gilder regarding telecommunications networks and later attributed to Robert Metcalfe.6 It was referenced extensively for social networking sites during the Web 2.0 movement of the early 2000s.

It is considered to be a heuristic or metaphor, not a technically accurate model, but it does illustrate the significance of community adoption in the value of user adoption and what is otherwise called “networking effects.”

When developing a business model with a dependence on social interaction, it’s important to consider this dynamic carefully. If you are an early provider of a product or service, networking effects can have a profoundly positive effect on your business. Conversely, if you are a late entrant, this will be an exponentially negative effect and will cause significant difficulty in trying to penetrate your target market, particularly once the network has reached critical mass, which is when a sufficient amount of adopters of an innovation in a social system exist such that the rate of adoption becomes self-sustaining and creates further growth.

There were a couple lessons learned here. First, if you’re a bootstrap company and are not first to market, avoid a business model that depends on networking effects; it is truly a tough paradox to overcome without resources. Second, if you’re in such a market or have reasonable resources to overcome this initial challenge, look at how you can divide and conquer by appealing to specific segments one at a time.

Like every dynamic, network effects can be a powerful force if channeled properly. Look for opportunities to leverage networking effects if you have a relatively new or viral idea that people might want to identify with socially. The litmus test when applying networking effects to your business model is to ask yourself if there is something inherently viral about your product. You can validate your chances early by doing simple tests such as posting content and doing a few social experiments via Twitter and StumbleUpon.

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