In this video we're going to talk about the benefits of the network effect.
When a business has the built in ability to both grow and improve as it gains more customers it is said
to benefit from the network effect.
In these cases the more people who use a certain business the bigger its market share gets but more
importantly the more exclusive it's hold on that share becomes.
This is simply because having more users translates into a more valuable product or service for all
and inherently leads to a never ending cycle of continuous growth.
The network effect is an extremely powerful type of competitive advantage and its most often found in
businesses based on sharing information or connecting users together.
You dont see it much in businesses that deal in physical goods.
Examples of this can be seen in companies such as eBay visa and Facebook.
The more people who use these particular services the better the experience becomes.
Which leads to more people using the services the network effect gives a company a lot of advantages
over its competitors.
Looking at Facebook for example Facebook becomes more and more profitable when more people use it.
You know what Facebook has access to a database of billions of people around the world.
So this means they can easily make billions of dollars just by utilizing their customer base.
You see the network effect makes it hard for other companies to compete with Facebook because if they
want to enter a competition they must spend a lot more money on advertising and a lot more effort on
reaching more people and showing their products.
In the case of Facebook they can reach billions of people without any hassles.
You can guess who will win in this game.
This competitive advantage can be difficult to dislodge once it gains momentum and so it offers a potentially
enormous economic moat to the lucky company or two that managed to establish the first successful networks
in a particular industry.
So make sure that you look for companies with a strong network effect.
They are always winners in their industry.
In the next video we'll talk about how a company can create an economic moat by commanding high switching
costs.
OK see you in the next video.