BIS301

Chapter 5:
Understanding Network Effect
 Objectives

01 02 03 04 05 06
Define network Recognize products Understand the Identify the three Recognize factors Understand how firms
effects. and services that are factors that add value primary sources of that contribute to the like Microsoft and
subject to network to products and value for network staying power and Apple each benefit
effects. services that are effects. complementary from strong network
subject to network benefits of a product effects.
effects. or service subject to
network effects..
 Objectives

01 02 03 04 05 06
Recognize and Understand same-side Understand how Understand the reasons Plot strategies for Give examples of how
distinguish between and cross-side competition in markets why it is so difficult competing in markets firms have leveraged
one-sided and two- exchange benefits. where network effects for late-moving, where network effects these strategies to
sided markets. are present differ from incompatible rivals to are present, both from compete effectively.
competition in compete in markets the perspective of the
traditional markets. where a dominant, incumbent firm and the
proprietary standard is new market entrant.
present.
What is Network Effect?
• Also known as Metcalfe’s Law, or network externalities.
• The value of a product or service increases as its number of users expands. E.g; Whatsapp, fax machine, PS,
YouTube
• When network effects are present, the value of a product or service increases as the number of users
grows. Simply, more users = more value.
• Examples of entrepreneurs that have leveraged the network effect concept.
• Microsoft’s Bill Gates; Mark Zuckerberg of Facebook; Sergey Brin and Larry Page of Google; Pierre
Omidyar of eBay; Kevin Systrom of Instagram; Jack Dorsey, Evan Williams and Biz Stone of Twitter;
Nik Zennström and Janus Friis of Skype; Steve Chen and Chad Hurley of YouTube; Jan Koum and
Brian Acton of WhatsApp; Jeff Bezos’s Kindle; Travis Kalanick of Uber; and the Airbnb trio of Brian
Chesky, Joe Gebbia, and Nathan Blecharczyk
• China’s Alibaba, Tencent (with WeChat, QQ, and Qzone), and Didi
Platform
• Products and services that allow for the development and integration of software products and other
complementary goods, effectively creating an ecosystem of value-added offerings.
• Windows, iOS, the Kindle, and the standards that allow users to create Facebook apps are all
platforms. create an ecosystem, rather than a singular product or service offering.
• World’s most valuable firms by market capitalization not only benefit from network effects, but they are
also platform firms (Apple, Alphabet, Microsoft, Amazon, Tencent, Alibaba, and Facebook).
• Platforms Are Powerful, But Where Does All That Value Come From?
• exchange, staying power, and complementary benefits.
Exchange
• Facebook for one person isn’t much fun, and the first guy in the world with a fax machine didn’t have much
more than a paperweight.
• But as each new Facebook friend or fax user comes online, a network becomes more valuable because its
users can potentially communicate with more people. These examples show the importance of exchange in
creating value.
Staying Power
• The long-term viability of a product or service
• Users don’t want to buy a product or sign up for a service that’s likely to go away, and a number of factors
can halt the availability of an effort: a firm could go bankrupt or fail to attract a critical mass of user
support, or a rival may successfully invade its market and draw away current customers. Networks with
greater numbers of users suggest a stronger staying power
• The concept of staying power (and the fear of being stranded in an unsupported product or service) is
directly related to switching costs. ) and switching costs can strengthen the value of network effects as a
strategic asset. The higher the value of the user’s overall investment, the more they’re likely to consider the
staying power of any offering before choosing to adopt it.
• Similarly, the more a user has invested in a product, the less likely he or she is to leave. Considering e-book
readers? A user aware of Barnes & Noble’s struggles might think twice about choosing the Nook over
Amazon’s thriving and dominant Kindle.
Staying Power
• “It is this switching cost that has given our customers the patience to stick with Windows through all our
mistakes, our buggy drivers, our high total cost of ownership (TCO)  , our lack of a sexy vision at
times, and many other difficulties [...] Customers constantly evaluate other desktop platforms, [but] it
would be so much work to move over that they hope we just improve Windows rather than force them to
move. [...] In short, without this exclusive franchise [meaning Windows] we would have been dead a long
time ago.”
• —Comments from a Microsoft General Manager in a memo to Bill Gates
Complementary Benefits
• Products or services that add additional value to the primary product or service that makes up a network. 
• These products might include “how-to” books, software, and feature add-ons, even labor.
• You’ll find more books about auctioning that focus on eBay, more cameras that upload video to YouTube,
and more accountants who know Excel than other rival software. Why? Book authors, camera
manufacturers, and accountants invest their time and resources where they’re likely to reach the biggest
market and get the greatest benefit.
• Products and services that encourage others to offer complementary goods are sometimes
called platforms. Many firms do this by providing APIs.
• For example, Amazon provides application programming interfaces (APIs) to let developers write their
own applications and websites that can send the firm orders.
• Allowing other firms to contribute to your platform can be a brilliant strategy because those firms will
spend their time and money to enhance your offerings.
 Complementary Benefits
• Apple has begun to extend iOS into all sorts of products.
• CarPlay puts Siri on your steering wheel and allows auto manufacturers to integrate phone, maps, messaging,
music, and other apps into automobile dashboards. Eighteen auto manufacturers, from Ford to Ferrari, committed
to CarPlay at launch, and many more have been added since then.
• HealthKit allows Apple to use iOS as a platform for exercise and personal health measurement (products and
services that measure fitness and health are sometimes referred to by the term “quantified self”). HomeKit and the
Home app allow iOS to control home products including locks, lighting, security cameras, and thermostats. Today,
every major maker of home accessories supports the HomeKit platform.
• Apple Message has also become a platform, allowing developers to build apps to share cash via a text or jointly order
food with friends.
• Apple’s CloudKit allows developers to plug into Apple’s storage, hopefully creating greater bonds with iOS at the
center instead of choosing rival storage platforms from Dropbox, Google, Microsoft, or others.
• AirPlay links Macs, iOS devices, and AppleTV.
• Apple Watch is designed as a tool that integrates and extends the iPhone.
• And Apple Pay and Siri make iOS platforms all the more valuable by allowing developers to integrate payments and
voice into their apps.
One-Sided or Two-Sided Markets?
• One-sided market - A market that derives most of its value from a single class of users (e.g., instant
messaging).  An example of this kind of network is messaging.
• same-side exchange benefits - Benefits derived by interaction among members of a single class of
participant (e.g., the exchange value when increasing numbers of IM users gain the ability to message
each other). 
• Two-sided market - Network market that comprises two distinct categories of participant, both of which
are needed to deliver value for the network to work (e.g., video game console owners and developers of
video games).
• cross-side exchange benefit - When an increase in the number of users on one side of the market
(console owners, for example) creates a rise in the other side (software developers).
• In the case of mobile payments, the more people who use a given payment platform, the more
attractive that platform will be to storefronts and other businesses, and if more businesses accept these
forms of mobile payment, then this in turn should attract more end consumers (and so on).
• However, the Xbox Live network that allows users to play against each other has same-side benefits. If your
buddies use Xbox Live and you want to play against them, you’re more likely to buy an Xbox.
One-Sided or Two-Sided Markets?
• Finally, it’s important to note that the best product or service doesn’t always win.
• PlayStation 2 dominated the original Xbox in a prior generation’s game console war, despite the fact that
nearly every review claimed the Xbox was hands-down a technically superior machine.
• Why were users willing to choose an inferior product (PS2) over a superior one (Xbox)? The power of
network effects! PS2 had more users, which attracted more developers offering more games.
How Are These Markets Different?
• First, network markets experience early, fierce competition. The positive-feedback loop inherent in
network effects—where the biggest networks become even bigger—causes this. Firms are very aggressive in
the early stages of these industries because once a leader becomes clear, bandwagons form, and new
adopters begin to overwhelmingly favor the leading product over rivals, tipping the market in favor of one
dominant firm or standard. This tipping can be remarkably swift.
• These markets are also often winner-take-all or winner-take-most, exhibiting monopolistic
tendencies where one firm dominates all rivals.
• Look at all of the examples listed so far—in nearly every case the dominant player has a market share well
ahead of all competitors.
How Are These Markets Different?
• Since bigger networks offer more value, they can charge customers more.
• Firms with a commanding network effects advantage may also enjoy substantial bargaining power over
partners.
• For example, Apple, which controls over 75 percent of digital music sales, for years was able to dictate
song pricing despite the tremendous protests of the record labels. In fact, Apple’s stranglehold was so
strong that it leveraged bargaining power even though the “Big Four” record labels (Universal, Sony,
EMI, and Warner) were themselves an oligopoly .
Battling a Leader with Network Effects

• A new rival facing a strong, incompatible incumbent can't just offer a superior product—the upstart must
have an overwhelming additional value that exceeds the benefit of exchange, switching costs, and
complementary products, as well.
Technological Leapfrogging
• Any product that is incompatible with the dominant network has
to exceed the value of the technical features of the leading player,
plus (since the newcomer likely starts without any users or third-
party product complements) the value of the incumbent’s
exchange, switching cost, and complementary product benefit.
• And the incumbent must not be able to easily copy any of the
newcomer’s valuable new innovations; otherwise, the dominant
firm will quickly match any valuable improvements made by
rivals. As such, 
Is This Good for Innovation?
• Critics of firms that leverage proprietary standards for market dominance often complain that network effects
are bad for innovation
• But this statement isn’t entirely true.
• While network effects limit competition against the dominant standard, innovation within a standard may
actually blossom.
• Consider Windows:
• Microsoft has a huge advantage in the desktop operating system market, so few rivals try to compete with
it.
• But the dominance of Windows is a magnet for developers to innovate within the standard.
• Programmers with novel ideas are willing to make the investment in learning to write software for
Windows because they’re sure that a Windows version can be used by the overwhelming majority of
computer users.
Is This Good for Innovation?
• By contrast, look at the mess we initially had in the mobile phone market.
• With so many different handsets containing differing computing hardware, offering different screen sizes,
running different software, having different key layouts, and working on different carrier networks, writing
a game that’s accessible by the majority of users is nearly impossible.
• Glu Mobile, a maker of online games, launched fifty-six reengineered builds of Monopoly to satisfy the
diverse requirements of just one telecom carrier. 
 Is This Good for
Innovation?
• Because Android runs on so many different devices using
various versions of the OS, game developers like Hong
Kong-based Animoca test each product released on as
many as four hundred devices.
• As a result, entrepreneurs with great software ideas for the
mobile market were deterred because writing, marketing,
and maintaining multiple product versions is both costly
and risky.
• It wasn’t until Apple’s iPhone arrived, offering developers
both a huge market and a consistent set of development
standards, that third-party software development for
mobile phones really took off.
Strategies for Competing in Markets with
Network Effects
 Move early (Yahoo! auctions in Japan).
 Subsidize product adoption (PayPal).
 Leverage viral promotion (Skype, WhatsApp, Uber, Airbnb, Blue Apron).
 Expand by redefining the market to bring in new categories of users (Nintendo Wii) or through convergence
(iPhone).
 Form alliances and partnerships (NYCE vs. Citibank, Didi/Ola/GrabTaxi/Lyft global ride-sharing alliance vs. Uber).
 Establish distribution channels (Java with Netscape; Microsoft bundling Media Player with Windows; Apple
embedding Apple Music in all Macs and iOS devices).
 Seed the market with complements (Blu-ray, Nintendo, thredUP).
 Encourage the development of complementary goods—this can include offering resources, subsidies, reduced fees,
market research, development kits, and training (Oculus and Amazon Echo developer funds, Apple Swift
Playgrounds).
 Maintain backward compatibility (Apple’s Mac OS X Rosetta translation software for PowerPC to Intel, Samsung
Pay using existing mag-stripe standards).
 For rivals, be compatible with larger networks (Apple’s move to Intel; Samsung Pay’s compatibility with magstripe
credit card standards).
 For incumbents, constantly innovate to create a moving target and block rival efforts to access your network
(Apple’s efforts to block access to its own systems).
 For large firms with well-known followers, make preannouncements (Microsoft, Apple).
Move Early
• In Japan, worldwide auction leader eBay showed up just five months after Yahoo! launched its Japanese
auction service.
• But eBay was never able to mount a credible threat and ended up pulling out of the market. Being just five
months late cost eBay billions in lost sales, and the firm eventually retreated, acknowledging it could never
unseat Yahoo!’s network effects lead.
• Timing is often critical in the video game console wars, too.
• Sony’s PlayStation 2 enjoyed an eighteen-month lead over the technically superior Xbox (as well as
Nintendo’s GameCube). That time lead helped to create what for years was the single most profitable
division at Sony.
• By contrast, the technically superior PS3 showed up months after Xbox 360 and at roughly the same time
as the Nintendo Wii, and has struggled in its early years, racking up multibillion-dollar losses for Sony.
What If Microsoft Threw a Party and No One Showed
Up?
• Microsoft launched the Zune media player with features that should be subject to network effects—the ability to share
photos and music by wirelessly “squirting” content to other Zune users.. 
• Microsoft’s Zune was first launched in November 2006. Zune HD was launched in 2009. However, by 2011, Zune
players were discontinued. There is little evidence that the Zune was of low quality. In fact, its users enjoyed the
interface and audio quality just as much as, if not more than the iPod. Why was it so short-lived?
• Bad timing
• launched five years after the release of its competitor, Apple’s iPod. The Zune came much too late, as the iPod had already
rapidly become the go-to source for portable entertainment. Even when Zune HD was released, it had come two years
after the iPod Touch.
• When Zune debuted, Apple had already taken over almost the entire mp3 market. It was an uphill battle from the
beginning.
• Lack of Innovation
• Bad timing can sometimes be overlooked if a product has features that make it unique and innovative compared to what’s
already out in the market. However, the Zune didn’t have this. With the iPod’s already wide popularity, there was no real
incentive for consumers to choose a Zune over an iPod when it was launched, especially with the insufficient marketing.
• A cool idea does not automatically make a network effect happen.
Subsidize Adoption

• Firms may offer to subsidize initial adoption in hopes that network effects might kick in shortly after.
• Subsidies to adopters might include a price reduction, rebate, or other giveaways.
• PayPal, a service that allows users to pay one another using credit cards, gave users a modest rebate as a
sign-up incentive to encourage adoption of its new effort (in one early promotion, users got back $15 when
spending their first $30).
• This brief subsidy paid to early adopters paid off handsomely. eBay later tried to enter the market with a
rival effort, but as a late mover its effort was never able to overcome PayPal’s momentum.
• PayPal was eventually purchased by eBay for $1.5 billion, and spun out of eBay at a $45 billion valuation.
When Even Free Isn’t Good Enough
• When Yahoo! introduced a US auction service to compete with eBay, it initially didn’t charge sellers at all
(sellers typically pay eBay a small percentage of each completed auction). The hope was that with the
elimination of seller fees, enough sellers would jump from eBay to Yahoo! and help the late-mover catch up
in the network effect game.

• But eBay sellers were reluctant to leave for two reasons:

• First, there weren’t enough buyers on Yahoo! to match the high bids they earned on much-larger eBay.
Some savvy sellers played an arbitrage game where they’d buy items on Yahoo!’s auction service at
lower prices and resell them on eBay, where more users bid prices higher.

• Second, any established seller leaving eBay would give up their valuable “seller ratings,” and would
need to build their Yahoo! reputation from scratch. Seller ratings represent a critical switching cost, as
many users view a high rating as a method for reducing the risk of getting scammed or receiving lower-
quality goods.
Leverage Viral Promotion
• Internet calling service Skype (now owned by Microsoft) has over 600 million registered
users yet has spent almost nothing on advertising.
• Neither has WhatsApp (now part of Facebook) with over a billion monthly active users. 
• Most Skype and WhatsApp users were recruited by others who shared the word on free
and low-cost Internet calls and text messaging. And rise of social media has made viral
promotion a tool that many firms can exploit. Facebook, Twitter, and mobile app
integration with a phone’s address book all act as a catalyst for friends to share deals,
spread a good word, sign up for services, and load applications.
• Viral promotions are also often linked to subsidies (e.g., recruit a new customer and you
both get money to spend), but they can also provide the additional benefit of leveraging a
trusted friend to overcome adoption inertia.
• Sharing economy firms Uber and Airbnb have both used these kinds of incentives as trust
proxies, or what is sometimes referred to as social proof - The positive influence created
when someone finds out that others are doing something.. When a friend sends an invite
to a service where users may otherwise have trust concerns (e.g., Uber and stepping into a
car driven by a stranger, staying in someone’s home through Airbnb), an endorsement by
a friend can ease concerns. Airbnb saw bookings increase as much as 25 percent in
markets after offering friend referral incentives, and the firm says patrons referred by
friends are more likely to revisit the site and book future trips, and they are much more
likely to send referrals themselves.
Expand by Redefining the Market
• If a big market attracts more users (and in two-sided markets, more complements), why not redefine the
space to bring in more users?
• Nintendo did this when launching the Wii. While Sony and Microsoft focused on the graphics and raw
processing power favored by hard-core male gamers, Nintendo chose to develop a machine to appeal to
families, women, and age groups that normally shunned alien shoot-’em-ups. By going after a bigger,
redefined market, Nintendo was able to rack up sales that exceeded the Xbox 360, even though it followed
the system by twelve months.
• Wii Strategy as a blue ocean effort. The concept of blue ocean strategy An approach where firms seek to
create and compete in uncontested “blue ocean” market spaces, rather than competing in spaces and ways
that have attracted many, similar rivals. 
• The idea—instead of competing in blood-red waters where the sharks of highly competitive firms vie for
every available market scrap, firms should seek the blue waters of uncontested, new market spaces.
Expand by Redefining the Market
• Market expansion sometimes puts rivals who previously did not compete on a collision course as markets
undergo convergence - When two or more markets, once considered distinctly separate, begin to offer features
and capabilities. As an example: the markets for mobile phones and media players are converging. 
• Apple leveraged a strategy known as envelopment - When one market attempts to conquer a new market by
making it a subset, component, or feature of its primary offering.
• Apple deftly morphed the iPod into the iPhone, a device that captures all of these product categories in one device.
• But the firm went further; the iPhone is Wi-Fi capable and offers browsing, e-mail, and an application platform in
iOS that was initially based on a scaled-down version of the same OS X operating system used in Macintosh
computers.
• As a “Pocket Mac,” the appeal of the device broadened beyond just the phone or music player markets, and within
two quarters of launch, iPhone became the second-leading smartphone in North America—outpacing Palm,
Microsoft, Motorola and every other rival, except RIM’s BlackBerry, and it was only a matter of time before that rival
was vanquished, as well.
Alliances and Partnerships
• In a classic example, consider ATM networks. Citibank was the first major bank in New York City to offer a
large ATM network.
• But the Citi network was initially proprietary, meaning customers of other banks couldn’t take advantage of
Citi ATMs. Citi’s innovation was wildly popular and being a pioneer in rolling out cash machines helped the
firm grow deposits fourfold in just a few years.
• Competitors responded with a partnership.
• Instead of each rival bank offering another incompatible network destined to trail Citi’s lead, competing
banks agreed to share their ATM operations through NYCE (New York Cash Exchange). While Citi’s
network was initially the biggest, after the NYCE launch a Chase bank customer could use ATMs at a host of
other banks that covered a geography far greater than Citi offered alone. Network effects in ATMs shifted to
the rival bank alliance, Citi eventually joined NYCE and today, nearly every ATM in the United States
carries a NYCE sticker.
Leverage Distribution Channels
• Sun faced a challenge when launching the Java programming language—no computers could run it. In
order for Java to work, computers need a little interpreter program called the Java Virtual Machine (JVM).
• Most users weren’t willing to download the JVM if there were no applications written in Java, and no
developers were willing to write in Java if no one could run their code.
• Sun broke the logjam when it bundled the JVM with Netscape’s browser. When millions of users
downloaded Netscape, Sun’s software snuck in, almost instantly creating a platform of millions for would-
be Java developers.
• Today, even though Netscape has failed, Sun’s Java remains one of the world’s most popular programming
languages. Indeed, Java was cited as one of the main reasons for Oracle’s 2009 acquisition of Sun, with
Oracle’s CEO saying the language represented “the single most important software asset we have ever
acquired.”
Leverage Distribution Channels
• When you don’t have distribution channels, create them.
• That’s what Apple did when it launched the Apple retail stores a little over a decade ago.
• At the time of launch, nearly every pundit expected the effort to fail. But it turns out, the attractive, high-
service storefronts were the perfect platform to promote the uniqueness of Apple products.
• Apple’s more than four hundred stores worldwide now bring in over $21 billion in revenue and are among
the world’s most successful retail outlets on a sales-per-square-foot basis.
Seed the Market
• When Sony launched the PS3, it subsidized each console by selling at a price estimated at three hundred
dollars below unit cost. 
• Subsidizing consoles is a common practice in the video game industry—game player manufacturers usually
make most of their money through royalties paid by game developers.
• But Sony’s subsidy had an additional benefit for the firm—it helped sneak a Blu-ray player into every home
buying a PS3 (Sony was backing the Blu-ray standard over the rival HD DVD effort).
• PS3 has struggled with fierce competition, but initially seeding the market with low-cost Blu-ray players at
a time when that hardware sold at a very high price gave eventual winner Blu-ray some extra momentum.
• Since Sony is also a movie studio and manufacturer of DVD players and other consumer electronics, it had
a particularly strong set of assets to leverage to encourage the adoption of Blu-ray over rival HD DVD.
Seed the Market
• Giving away products for half of a two-sided market is an extreme example of this kind of behavior, but it’s
often used. In two-sided markets, you charge the one who will pay.
• Adobe gives away the Acrobat reader to build a market for the sale of software that creates Acrobat files.
• Firms with Yellow Page directories give away countless copies of their products, delivered straight to your
home, in order to create a market for selling advertising.
• And Google does much the same by providing free, ad-supported search.
Encourage the Development of Complementary
Goods
• A firm may charge lower royalties or offer a period of royalty-free licensing. It can also offer free software
development kits (SDKs), training programs, co-marketing dollars, or even startup capital to potential
suppliers.
• Microsoft and Apple both allow developers to sell their products online through Xbox LIVE Marketplace
and iTunes, respectively. This channel lowers developer expenses by eliminating costs associated with
selling physical inventory in brick-and-mortar stores and can provide a free way to reach millions of
potential consumers without significant promotional spending.
• Apple has taken encouraging developers a step further by offering Swift Playgrounds in the iPad, a kid-
focused learn-to-program environment featuring the created-by-Apple Swift programming language.
• Apple has since open sourced Swift so it can be used on development efforts outside its own products, and
its broad efforts to encourage Swift adoption have made Swift one of the world’s most popular and in-
demand programming languages.
Leverage Backward Compatibility
• Backward compatibility was the centerpiece of Apple’s strategy to revitalize the Macintosh through its move to the Intel
microprocessor.
• Intel chips aren’t compatible with the instruction set used by the PowerPC processor used in earlier Mac models. Think of
this as two entirely different languages—Intel speaks French, PowerPC speaks Urdu.
• To ease the transition, Apple included a free software-based adaptor A product that allows a firm to tap into the
complementary products, data, or user base of another product or service., called Rosetta, that automatically emulated the
functionality of the old chip on all new Macs (a sort of Urdu to French translator).
• By doing so, all new Intel Macs could use the base of existing software written for the old chip; owners of PowerPC Macs
were able to upgrade while preserving their investment in old software; and software firms could still sell older programs
while they rewrote applications for new Intel-based Macs. 
• Even more significant, since Intel is the same standard used by Windows, Apple developed a free software adaptor called
Boot Camp that allowed Windows to be installed on Macs. Boot Camp (and similar solutions by other vendors)
dramatically lowered the cost for Windows users to switch to Macs.
• Within two years of making the switch, Mac sales skyrocketed to record levels. Apple now boasts a commanding lead in
notebook sales to the education market, and a survey by Yankee Group found that 87 percent of corporations were using at
least some Macintosh computers, up from 48 percent at the end of the PowerPC era two years earlier.
Incumbents: Close Off Rival Access and
Constantly Innovate
• Firms that constantly innovate make it particularly difficult for competitors to become compatible.
• Again, we can look to Apple as an example of these concepts in action.
• While Macs run Windows, Windows computers can’t run Mac programs.
• Apple has embedded key software in Mac hardware, making it difficult for rivals to write a software
emulator like Boot Camp that would let Windows PCs drink from the Mac milkshake. And if any firm gets
close to cloning Mac hardware, Apple sues.
• The firm also modifies software on other products like the iPhone and iTunes each time wily hackers tap
into closed aspects of its systems. And Apple has regularly moved to block competing third-party hardware
products from plugging into iTunes. 
• Even if firms create adaptors that emulate a standard, a firm that constantly innovates creates a moving
target that’s tough for others to keep up with.
Large, Well-Known Followers:
Preannouncements
• Large firms that find new markets attractive but don’t yet have products ready for delivery
might preannounce efforts in order to cause potential adaptors to sit on the fence, delaying a purchasing decision
until the
• While Apple rarely preannounces products, it previewed Apple Watch roughly eight months before it was ready to
ship.
• Rivals from the Kickstarter darling, Pebble, to Google’s Android Wear were courting developers, but Apple’s early
product demonstration caused many customers considering wearables to hold off until Apple Watch was out.
• Developers also knew that, unlike fragmented Android Wear offerings with varying watch face shapes and
capabilities, Apple Watch would provide a uniform standard offered by the industry’s biggest player.
• While large, respected firms may be able to influence markets through preannouncements, startups often lack
credibility to delay user purchases. The tech industry acronym for the impact firms try to impart on markets
through preannouncements is FUD, for fear, uncertainty, and doubt.
The Osborne Effect
• When a firm preannounces a forthcoming product or service and experiences a sharp and detrimental drop
in sales of current offerings as users wait for the new item..”
• Sega, which exited the video game console market entirely after preannouncements of a next-generation
system killed enthusiasm for its Saturn console.
Too Much of a Good Thing?
• When network effects are present, more users attract more users. That’s a good thing as long as a firm can earn money
from this virtuous cycle.
• But sometimes a network effect attracts too many users, and a service can be so overwhelmed that it becomes unusable.
These so-called congestion effects, occur when increasing numbers of users lower the value of a product or service.
• This most often happens when a key resource becomes increasingly scarce. 
• Fortune reported how the launch of a new version of the hit EA game SimCity fell victim to congestion effects, stating
that “thanks to what the company called ‘overwhelming demand,’ players experienced a myriad of problems like
failures to load the game entirely and wait times of twenty minutes to log in.
• Gameplay became so problematic that Amazon temporarily halted sales of the game, and EA offered users the option of
downloading a free game from its online store.
• While network effects can attract positive complementary products, a dominant standard may also be the first place
where virus writers and malicious hackers choose to strike.
Summary
• Network effects are among the most powerful strategic resources that can be created by technology-based innovation. Many
category-dominating organizations and technologies, including Microsoft, Apple, NASDAQ, eBay, Facebook, and Visa, owe their
success to network effects.
• Network effects are also behind the establishment of most standards, including Blu-ray, Wi-Fi, and Bluetooth.
• Products and services subject to network effects get their value from exchange, perceived staying power, and complementary
products and services. Tech firms and services that gain the lead in these categories often dominate all rivals.
• Many firms attempt to enhance their network effects by creating a platform for the development of third-party products and
services that enhance the primary offering.
• In one-sided markets, users gain benefits from interacting with a similar category of users (think messaging apps, where
everyone can send and receive messages to and from one another).
• In two-sided markets, users gain benefits from interacting with a separate, complementary class of users (e.g., in the mobile
payment business, payment app–wielding consumers are attracted to a platform because there are more merchants offering
convenient payment, while merchants are attracted to a payment system that others will actually use and that yields clear
benefits over cash).
Summary
• Unseating a firm that dominates with network effects can be extremely difficult, especially if the newcomer is not compatible
with the established leader. Newcomers will find their technology will need to be so good that it must leapfrog not only the value
of the established firm’s tech, but also the perceived stability of the dominant firm, the exchange benefits provided by the existing
user base, and the benefits from any product complements. For evidence, just look at how difficult it’s been for rivals to unseat
the dominance of Windows.
• Because of this, network effects might limit the number of rivals that challenge a dominant firm. But the establishment of a
dominant standard may actually encourage innovation within the standard, since firms producing complements for the leader
have faith the leader will have staying power in the market.
• Moving early matters in network markets—firms that move early can often use that time to establish a lead in users, switching
costs, and complementary products that can be difficult for rivals to match.
• Additional factors that can help a firm establish a network effects lead include subsidizing adoption; leveraging viral marketing,
creating alliances to promote a product or to increase a service’s user base; redefining the market to appeal to more users;
leveraging unique distribution channels to reach new customers; seeding the market with complements; encouraging the
development of complements; and maintaining backward compatibility.
• Established firms may try to make it difficult for rivals to gain compatibility with their users, standards, or product complements.
Large firms may also create uncertainty among those considering adoption of a rival by preannouncing competing products.