The External Network Effect occurs when the value of the product or service to the user is determined by the number of consumers using the product / service, one of the effects of this effect is that each additional user of the network benefits its current participants. In other words, the network effect means that the value of the product or service is created by the users, not by the producer.
The network effect becomes important after reaching the so-called Critical mass - when the number of users reaches the right value. At the point of critical mass, the usability of the product / service is greater than or equal to the price paid for it. If the number of people using the network is greater than the critical mass, more and more people will be interested in joining it, because the relation of utility to price will be beneficial.
Thus, the external effects of the network justify marketing strategies based on price subsidies in the early stages of product life (including free distribution), because at this stage the supplier invests in network development.
A common form of product dissemination is to encourage customers to encourage friends to use it. These effects also explain the gregarious behavior of users - when at the beginning everyone with a reserve refers to a new product, and later at the same time to convince him.
- Katz, M. L., & Shapiro, C. (1994). Systems competition and network effects. Journal of economic perspectives, 8(2), 93-115.
- Parker, G. G., & Van Alstyne, M. W. (2005). Two-sided network effects: A theory of information product design. Management science, 51(10), 1494-1504.