How Network Effect can drive insane growth in your Startup Business? (with examples)

Navdeep Yadav

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4 min readNov 5, 2022

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We will understand how the network effect allows brands like Amazon builds entry barrier from the competition.

A business Moat is a durable competitive advantage that enables a company to be profitable in long term.

You can read a detailed post I wrote on Business Moat.

Back to the main topic of the Network effect.

Take a second and think of three large companies that are booming right now 🤔

Maybe…. Amazon, Google, and Facebook.

They all use network effects as a moat to build long-term sustainable businesses.

What is the network effect?

Network effects are phenomena by which the value of a product or service increases when the number of people who use that product or service increases.

Example: We use WhatsApp because the majority of the people in our network use it and vice versa

As value for each member increases as more members joins.

The same goes with other social media apps like Instagram, Snapchat etc

Let’s understand the network effect in the case of e-commerce(Amazon)

So success in the e-commerce is driven by these three factors: Low prices, faster delivery, and variety in products.

Low prices: Low prices attract more customers to buy products from amazon. More customers propel more sellers to join the marketplace and start selling their products which increases product variety on the platform.

More Customers = More Sellers
More Seller = More Variety
More Seller = Low Prices(Due to Competition)

This Amazon Flywheel continues to gain momentum and further reduce product prices.

How are these Network Effects built?

All networks are made up of Nodes and links.

These nodes participate and the central node has a high number of links and tends to have a high value than marginal nodes.

Low-density and High-density network effects

Network density or power is determined by the ratio of links and nodes.

There are different types of network effects seen across industries

Marketplace Effect — It’s an indirect network effect where both sides i.e Supplier and Customer effect, complement each other.

2. Data Network Effects- When the value of your products increases because of more data provided to you.

Example Google, Open AI, and Netflix

“The more data you have the better you can train your machine-learning models” Sam Altman — Founder of Open AI

3. Platform Network Effect — Quite similar to the marketplace business model where both are benefited from each other.

These Network effects grow exponentially (not linearly) every time a new user comes on the Platform.

Example: Economies of scale in Amazon

This builds a strong moat-like economy of scale which is tough to beat in the short run.

What are the Laws of the network effect?

But not all network effects are equal and they are strong or weak depending on the type of business.

There are three laws that can help you understand that

Sarnoff’s law states that the value of a network is proportional to the number of viewers.

Metcalfe’s law the value of a network is proportional to the square of the number of connected users of the system (n2)

Reed’s law particularly social networks can scale exponentially with the size of the network

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