How Tech Firms Use Networks to Beat Rivals

Network effects as a source of competitive advantage, also known as an economic moat

Brian Colello, CPA 10 November, 2017 | 15:02
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The network effects is when the value of a good or service increases for both new and existing users as more customers use it; the more existing users there are on a network, the more attractive it becomes for newcomers.

Networks can be direct, such as Facebook where users lead to more users, or indirect, for example Google where user searches create more data, which leads to better algorithms and better future results for all users. Marketplace and platform companies such as eBay and Microsoft have also built powerful networks over the years. Amazon has a powerful network effect in online retail.

The network effects as a source of competitive advantage, also known as an economic moat, can only be present if the firm is able to properly monetise the network, which is not a given for many services and industries. Not only must new users see a rise in value from the network, but existing users as well.

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Brian Colello, CPA  Brian Colello, CPA is a senior stock analyst with Morningstar.

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