- October 23, 2019
- Posted by: Ramkumar
- Category: Strategy
Network effects in ecosystems
Companies who are leaders in their respective industries leverage network effects to their advantage.In simple terms, Network effects refer to the increased value a firm captures when it has more users or customers than other firms.
Platform companies leverage Network effects as a strategy to generate profits by combining different sides of both ends of the market.For instance, Uber intermediates between drivers and passengers who want a ride, benefitting both the sides and thus making a profit in exchange.
The network effects and the emergence of platform economies leads us to rethink what monopoly means in this digital age?In the traditional businesses, high entry barriers often raises regulatory oversight because the incumbents can raise prices to their convenience.This makes an industry with high entry barrier as a seller market.
Today market domination is gained by firms like Amazon, Google and Facebook because of their extensive networks, desirable platforms and ability to deliver enormous value to customers without traditional barriers to entry. These companies are able to create a high entry barrier by reducing their prices so much that a new entrant will not find it economical to operate.This entry barrier is created by the Network effects.
While it might seem that customers are the beneficiaries in this market, it is not right as they suffer in other ways.Customers need to give up significant information about themselves to avail the benefits offered by tech ecosystems.Due to the breach of privacy that customers are vulnerable to, regulatory authorities are slowly figuring out how to regulate companies with network effects in the face of new barriers to entry.
Barries to entry in traditional strategy
Porter’s five forces is one of the fundamental strategic frameworks used to evaluate the attractiveness of an industry.Strategic frameworks rewards companies which have a repeatable and reliable business model that is not easy to be replicated by other companies especially companies that want to enter that business.In other words when a barrier to entry is high for a new company to enter into a specific industry, then the attractiveness of the industry tends to be very high.This is because it prevents the new entrants from simply matching or copying their incumbents.
The entry barriers can take many forms including regulatory hurdles, high invesments in assets, patents and strong brand names.In today’s business environment, traditional entry barriers have weakened and it is possible for new entrants to disrupt any industry.At the same time, there are new entry barriers that have emerged which are very powerful and at the same time, companies are struggling to figure out.
Network effects in digital strategy
Let us take an entry barrier like high costs required to enter into a sector.In a conventional setup, if a startup wants to enter into that sector, then it would have needed to raise funds to buy computer servers, hire resources, get office space and might also be required to invest in equipments or machinery in order to set up a functioning company.
The current digital economy has shifted from ownership of assets to access of assets, hence startups today need not buy anything.Computing power can be purchased on demand as needed.The company need not hire full time resources as freelancers are available.Office space again need not be bought.The office space can be used as when required from real estate service providers like Wework. Digitally intermediated marketplaces match supply and demand with great efficiency.Hence the necessity to invest in any assets reduces dramatically.
In the current market environment, strategic advantage is often determined by complementary relationships rather than by an individual product or service benefits. A product on it’s own does not add any value to the customer.For instance, a music player with no music or a streaming service with no content does not add any value.
Inspite of the criticality of complementary relationships, we do not give it any importance in conventional strategy frameworks.In this digital era, companies do not compete with companies, it is one ecosystems that compete with other ecosystems.This clearly shows that in digital economy, interdependency is vital.
Network effects will be the future
In the current digital economy, Companies dominate because of their extensive networks, attractive platforms and ability to deliver enormous value to their customers.
These companies do not raise their prices, rather reduce their prices because of their strategic advantage in leveraging network effects that act as a barrier to entry preventing new entrants to operate economically.