Ever notice how some people become successful because they’re really good at knowing people? The bigger his or her network grows, the more popular and valuable that social butterfly becomes.
The ‘network effect’ in business works in the same way. It is one of the five or so types of economic moat – a structural competitive advantage – you might hope to find in a company. With the network effect the value of the product or service increases as the number of users goes up, attracting more users, which further boosts value.
It’s a virtuous circle. In fact, research from Morningstar analysts indicates that this is both the rarest and most lucrative type of moat to be found… Not only that, but the best networks are very defendable for wide-moat industry leaders such as Google and Facebook.
You’ll find that quite a lot of companies with this network effect are digital or online. That’s because it is most often found in businesses based on sharing information or connecting users together.
Very few businesses actually have this characteristic. It’s not the straight line growth of, say, selling more barrels of oil per day. This is an exponential…
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