Network externalities

A network effect (also called network externality or demand-side economies of scale) is the effect described in economics and business that one user of a good or service has on the value of that product to others. When a network effect is present, the value of a product or service is dependent on the number of others using it.

The classic example is the telephone, where a greater number of users increases the value to each. A positive externality is created when a telephone is purchased without its owner intending to create value for other users, but does so regardless. Online social networks work similarly, with sites like Twitter and Facebook increasing in value to each member as more users join.

The expression "network effect" is applied most commonly to positive network externalities as in the case of the telephone. Negative network externalities can also occur, where more users make a product less valuable, but are more commonly referred to as "congestion" (as in traffic congestion or network congestion).

Over time, positive network effects can create a bandwagon effect as the network becomes more valuable and more people join, in a positive feedback loop.

Network effects were a central theme in the arguments of Theodore Vail, the first post patent president of Bell Telephone, in gaining a monopoly on US telephone services. In 1908, when he presented the concept in Bell's annual report, there were over 4,000 local and regional telephone exchanges, most of which were eventually merged into the Bell System.

The economic theory of the network effect was advanced significantly between 1985 and 1995 by researchers Michael L. Katz, Carl Shapiro, Joseph Farrell and Garth Saloner.

...
Wikipedia