In a negative network effect as the network grows in usage or scale, the value of the platform might shrink. In platform business modelsnetwork effects help the platform become more valuable for the next user joining. Negative network effects (congestion or pollution) reduce the value of the platform for the next user joining.
The more people using the highway system, the more traffic jams you end up in. Or the more people in a room, the less likely it is to have good decent conversation just because it gets crowded, but also because everybody is talking too loudly and so you can’t hear and you can’t meet the right person within that room.
He continues:
So we understand congestion in traditional terms because in the traditional world we have networks that were limited by scale.
When it comes to the digital world, instead, where there are fewer scale limitations. Or at least those can be initially overcome.
Thus, at least on the congestion side, it’s very hard to reach a point of negative network effects (for instance, if the platform crashes for usage).
Congestion, therefore, is primarily about the usage of the network.
In the bits world, it is possible not only to overcome congestion but also to build a more solid engineering infrastructure as usage increases. Of course, network congestions can also be bad for platforms (poor network design, over-subscription, security attach due to overused network parts).
Another form, of negative network effect, can take place for platform business models.
Network pollution
Where network congestion is primarily about the size of the platform.
As the platform scales, it gains network effects, as it becomes more valuable for an increasing number of users.
Yet, also for digital platforms scale might create situations of diseconomies.
What happens is the more users come on board, the more difficult it becomes to manage quality of the interactions.
Thus this makes the digital platform make sure to have a mechanism to manage the quality of those interactions to avoid those negative network effects picking up.
If we think of social media, or publishing platforms at scale, among the most difficult task, that requires dozens if not hundreds of engineers and humans (Google might have thousands of human quality raters) to fix spam and low-quality user-generated content.
Examples of negative network effects
As highlighted negative network effects, dilute the value of the platform. And the way they can take over will depend on the kind of platform you’ve built. For instance:
Google case study
In a platform that leverages direct side network effects after a certain number of users, it might also result in increased spam on the platform which can’t be easily managed through automated processes, or human curation, thus diluting the value of the platform.
Take the case of how Google, back in the days, was offering an index of the web with its core algorithm called PageRank. At a certain point had to figure out also how to manage the spam on its index.
Practitioners understood how to trick Google’s core algorithm into showing up spammy results on top of that. This would have jeopardized the value of the overall platform, thus resulting in a diluted value of that.
Thus Google had to start to build up a solid team dedicated to spam and update its algorithms to avoid spam in search results in order to keep its platform valuable.
Google has thousands of engineers and thousands of human quality raters focused on both preventing spam and on low-quality content.
Airbnb case study
In two-sided platforms, a kind of user joining the platform makes it more valuable for another type of user.
Take Airbnb where, for instance, more hosts improve value for users on the platform. On the two-sided, more value is created by more hosts (travelers have more selection)? On the other hand, the value of the platform is diluted on the hosts’ side of the platform.
They will find themselves competing for the same users.
Thus it becomes crucial to understand what’s the proper ratio between travelers and hosts on the platform to make sure it keeps being valuable on both sides.
Tinder case study
Take the case of a dating app that draws value from having people encounter locally. If more users join but from locations spread across the world, not much local network effects are picking up.
Quite the opposite. If a critical mass is not reached at each local hub, the platform might lose value quickly. Imagine the case of a woman looking for a date. The faster she will be able to meet the best match.
The more the platform will be valuable. However, to be very valuable, the service has to make sure those people can meet in a place nearby. And it there are no matches available locally, the dating platform would lose value quickly.
Key takeaways
Platform business models can leverage network effects to enable the core platform to become more valuable over time. However, they need to factor in negative network effects, which if picked up might not only prevent the success of the business but also destroy it.
Case Studies
Social Media Oversaturation: As social media platforms grow in popularity, they can become oversaturated with content. This leads to users feeling overwhelmed by excessive posts, notifications, and ads, diminishing the overall user experience.
Ride-Sharing Surge Pricing: Ride-sharing services like Uber and Lyft may experience negative network effects during peak hours. As more users request rides, surge pricing kicks in, resulting in higher fares. This can discourage users from using the service during busy times.
E-commerce Delivery Delays: Online marketplaces like Amazon can face delivery delays during peak shopping seasons (e.g., Black Friday). Increased demand can strain logistics, causing slower deliveries and frustrating customers.
Online Marketplace Counterfeits: Marketplaces like Alibaba have struggled with counterfeit products being sold by third-party sellers. As the platform scales, it becomes challenging to police the authenticity of all listings, potentially eroding trust among users.
Video Streaming Quality: Video streaming platforms may experience negative network effects during high-demand periods. This can lead to buffering and lower video quality, frustrating users who expect seamless streaming.
Messaging App Spam: Messaging apps can suffer from spam and unsolicited messages as their user base grows. This can result in a poorer user experience, as users receive unwanted content and may miss important messages.
Online Review Manipulation: User-generated review platforms such as Yelp or TripAdvisor can face issues with fake reviews. As the platform attracts more businesses and users, the incentive for fraudulent reviews also increases, potentially reducing the trustworthiness of reviews.
Online Learning Platform Overload: During peak educational seasons, online learning platforms can experience server overloads and slower response times due to increased user activity. This can hinder the learning experience for students.
Crowdfunding Campaign Saturation: Crowdfunding platforms like Kickstarter or Indiegogo may experience saturation, where numerous projects are seeking funding simultaneously. This can make it harder for individual campaigns to stand out and attract backers.
Online Auction Bidding Wars: Auction websites like eBay can see negative network effects when too many users bid on the same item. This can drive up prices to levels that some users find unreasonable, deterring participation.
Key Highlights about Negative Network Effects in Platform Business Models:
Introduction: Negative network effects occur when the growth or scale of a network reduces the value of the platform for new users. While positive network effects make platforms more valuable with increased usage, negative network effects can lead to congestion and pollution, diminishing the platform’s value.
Network Congestion:
Analogous to physical congestion in highways or crowded rooms.
Increased usage leads to reduced quality of interactions.
Relevant in traditional networks with scale limitations.
In the digital realm, scale limitations are fewer due to technological advances.
Solutions involve solid engineering infrastructure and avoiding overuse.
Network Pollution:
As platforms scale, managing quality interactions becomes challenging.
Diseconomies can arise as more users join.
Maintaining quality requires mechanisms to manage interactions.
Examples of Negative Network Effects:
Google Case Study: Google’s search algorithm faced spam issues that could dilute the platform’s value. Google invested in engineers and human raters to combat spam and maintain value.
Airbnb Case Study: In two-sided platforms, imbalance between user types (e.g., hosts and travelers) can dilute value. Proper balance between sides is crucial for sustained value.
Tinder Case Study: Local network effects are important in platforms like dating apps. Matching users in the same location enhances value, while widespread user locations can diminish it.
The idea of a market economy first came from classical economists, including David Ricardo, Jean-Baptiste Say, and Adam Smith. All three of these economists were advocates for a free market. They argued that the “invisible hand” of market incentives and profit motives were more efficient in guiding economic decisions to prosperity than strict government planning.
Positive economics is concerned with describing and explaining economic phenomena; it is based on facts and empirical evidence. Normative economics, on the other hand, is concerned with making judgments about what “should be” done. It contains value judgments and recommendations about how the economy should be.
When there is an increased price of goods and services over a long period, it is called inflation. In these times, currency shows less potential to buy products and services. Thus, general prices of goods and services increase. Consequently, decreases in the purchasing power of currency is called inflation.
Asymmetric information as a concept has probably existed for thousands of years, but it became mainstream in 2001 after Michael Spence, George Akerlof, and Joseph Stiglitz won the Nobel Prize in Economics for their work on information asymmetry in capital markets. Asymmetric information, otherwise known as information asymmetry, occurs when one party in a business transaction has access to more information than the other party.
Autarky comes from the Greek words autos (self)and arkein (to suffice) and in essence, describes a general state of self-sufficiency. However, the term is most commonly used to describe the economic system of a nation that can operate without support from the economic systems of other nations. Autarky, therefore, is an economic system characterized by self-sufficiency and limited trade with international partners.
Creative destruction was first described by Austrian economist Joseph Schumpeter in 1942, who suggested that capital was never stationary and constantly evolving. To describe this process, Schumpeter defined creative destruction as the “process of industrial mutation that incessantly revolutionizes the economic structure from within, incessantly destroying the old one, incessantly creating a new one.” Therefore, creative destruction is the replacing of long-standing practices or procedures with more innovative, disruptive practices in capitalist markets.
Happiness economics seeks to relate economic decisions to wider measures of individual welfare than traditional measures which focus on income and wealth. Happiness economics, therefore, is the formal study of the relationship between individual satisfaction, employment, and wealth.
An oligopsony is a market form characterized by the presence of only a small number of buyers. These buyers have market power and can lower the price of a good or service because of a lack of competition. In other words, the seller loses its bargaining power because it is unable to find a buyer outside of the oligopsony that is willing to pay a better price.
The term “animal spirits” is derived from the Latin spiritus animalis, loosely translated as “the breath that awakens the human mind”. As far back as 300 B.C., animal spirits were used to explain psychological phenomena such as hysterias and manias. Animal spirits also appeared in literature where they exemplified qualities such as exuberance, gaiety, and courage. Thus, the term “animal spirits” is used to describe how people arrive at financial decisions during periods of economic stress or uncertainty.
State capitalism is an economic system where business and commercial activity is controlled by the state through state-owned enterprises. In a state capitalist environment, the government is the principal actor. It takes an active role in the formation, regulation, and subsidization of businesses to divert capital to state-appointed bureaucrats. In effect, the government uses capital to further its political ambitions or strengthen its leverage on the international stage.
The boom and bust cycle describes the alternating periods of economic growth and decline common in many capitalist economies. The boom and bust cycle is a phrase used to describe the fluctuations in an economy in which there is persistent expansion and contraction. Expansion is associated with prosperity, while the contraction is associated with either a recession or a depression.
The paradox of thrift was popularised by British economist John Maynard Keynes and is a central component of Keynesian economics. Proponents of Keynesian economics believe the proper response to a recession is more spending, more risk-taking, and less saving. They also believe that spending, otherwise known as consumption, drives economic growth. The paradox of thrift, therefore, is an economic theory arguing that personal savings are a net drag on the economy during a recession.
In simplistic terms, the circular flow model describes the mutually beneficial exchange of money between the two most vital parts of an economy: households, firms and how money moves between them. The circular flow model describes money as it moves through various aspects of society in a cyclical process.
Trade deficits occur when a country’s imports outweigh its exports over a specific period. Experts also refer to this as a negative balance of trade. Most of the time, trade balances are calculated based on a variety of different categories.
A market type is a way a given group of consumers and producers interact, based on the context determined by the readiness of consumers to understand the product, the complexity of the product; how big is the existing market and how much it can potentially expand in the future.
Rational choice theory states that an individual uses rational calculations to make rational choices that are most in line with their personal preferences. Rational choice theory refers to a set of guidelines that explain economic and social behavior. The theory has two underlying assumptions, which are completeness (individuals have access to a set of alternatives among they can equally choose) and transitivity.
The peer-to-peer (P2P) economy is one where buyers and sellers interact directly without the need for an intermediary third party or other business. The peer-to-peer economy is a business model where two individuals buy and sell products and services directly. In a peer-to-peer company, the seller has the ability to create the product or offer the service themselves.
The term “knowledge economy” was first coined in the 1960s by Peter Drucker. The management consultant used the term to describe a shift from traditional economies, where there was a reliance on unskilled labor and primary production, to economies reliant on service industries and jobs requiring more thinking and data analysis. The knowledge economy is a system of consumption and production based on knowledge-intensive activities that contribute to scientific and technical innovation.
In a command economy, the government controls the economy through various commands, laws, and national goals which are used to coordinate complex social and economic systems. In other words, a social or political hierarchy determines what is produced, how it is produced, and how it is distributed. Therefore, the command economy is one in which the government controls all major aspects of the economy and economic production.
How do you protect your rights as a worker? Who is there to help defend you against unfair and unjust work conditions? Both of these questions have an answer, and it’s a solution that many are familiar with. The answer is a labor union. From construction to teaching, there are labor unions out there for just about any field of work.
The bottom of the pyramid is a term describing the largest and poorest global socio-economic group. Franklin D. Roosevelt first used the bottom of the pyramid (BOP) in a 1932 public address during the Great Depression. Roosevelt noted that – when talking about the ‘forgotten man:’ “these unhappy times call for the building of plans that rest upon the forgotten, the unorganized but the indispensable units of economic power.. that build from the bottom up and not from the top down, that put their faith once more in the forgotten man at the bottom of the economic pyramid.”
Glocalization is a portmanteau of the words “globalization” and “localization.” It is a concept that describes a globally developed and distributed product or service that is also adjusted to be suitable for sale in the local market. With the rise of the digital economy, brands now can go global by building a local footprint.
Market fragmentation is most commonly seen in growing markets, which fragment and break away from the parent market to become self-sustaining markets with different products and services. Market fragmentation is a concept suggesting that all markets are diverse and fragment into distinct customer groups over time.
The L-shaped recovery refers to an economy that declines steeply and then flatlines with weak or no growth. On a graph plotting GDP against time, this precipitous fall combined with a long period of stagnation looks like the letter “L”. The L-shaped recovery is sometimes called an L-shaped recession because the economy does not return to trend line growth. The L-shaped recovery, therefore, is a recession shape used by economists to describe different types of recessions and their subsequent recoveries. In an L-shaped recovery, the economy is characterized by a severe recession with high unemployment and near-zero economic growth.
Comparative advantage was first described by political economist David Ricardo in his book Principles of Political Economy and Taxation. Ricardo used his theory to argue against Great Britain’s protectionist laws which restricted the import of wheat from 1815 to 1846. Comparative advantage occurs when a country can produce a good or service for a lower opportunity cost than another country.
The Easterlin paradox was first described by then professor of economics at the University of Pennsylvania Richard Easterlin. In the 1970s, Easterlin found that despite the American economy experiencing growth over the previous few decades, the average level of happiness seen in American citizens remained the same. He called this the Easterlin paradox, where income and happiness correlate with each other until a certain point is reached after at least ten years or so. After this point, income and happiness levels are not significantly related. The Easterlin paradox states that happiness is positively correlated with income, but only to a certain extent.
In Economics, Economies of Scale is a theory for which, as companies grow, they gain cost advantages. More precisely, companies manage to benefit from these cost advantages as they grow, due to increased efficiency in production. Thus, as companies scale and increase production, a subsequent decrease in the costs associated with it will help the organizationscale further.
In Economics, a Diseconomy of Scale happens when a company has grown so large that its costs per unit will start to increase. Thus, losing the benefits of scale. That can happen due to several factors arising as a company scales. From coordination issues to management inefficiencies and lack of proper communication flows.
An economy of scope means that the production of one good reduces the cost of producing some other related good. This means the unit cost to produce a product will decline as the variety of manufactured products increases. Importantly, the manufactured products must be related in some way.
Price sensitivity can be explained using the price elasticity of demand, a concept in economics that measures the variation in product demand as the price of the product itself varies. In consumer behavior, price sensitivity describes and measures fluctuations in product demand as the price of that product changes.
Gennaro is the creator of FourWeekMBA, which reached about four million business people, comprising C-level executives, investors, analysts, product managers, and aspiring digital entrepreneurs in 2022 alone | He is also Director of Sales for a high-tech scaleup in the AI Industry | In 2012, Gennaro earned an International MBA with emphasis on Corporate Finance and Business Strategy.
