By: Gabe Rodriguez Morrison

The internet has created network effects and enabled the winner-takes-all landscape in a way we have never seen before. Tech giants like Facebook, Amazon and Google have all used network effects to monopolize their respective industries, but the network effect has been around long before the internet. An early example of this taking place is the telephone. The first telephone sold provided little value to the user because they had no one to call and no one could call them. With every additional user added to the telephone network, incremental value was added to every user in the network.

Network effects are demonstrated when the sheer volume of users attracts more users.

This phenomenon has led to exponential growth for tech giants and has created some of the most valuable companies in the world. Facebook’s social network functions similarly to the example of telephone. As more people join the social network, more content is posted, shared and liked; more friends are added and more value is provided to the user. With every additional Facebook user added, the social network becomes incrementally more valuable. A strong network like this is difficult to compete with. This explains why Facebook among other tech giants have been accused of monopolistic behaviour and have faced anti-trust allegations. Another modern example of the network effect is the Google search engine. When a user conducts a search, Google is aware of what people are searching for. When users click on a site, they are telling Google which search results are helpful. This data is used to optimize the search results for other users. In this way, every search query provides incremental value to the search engine and its users.

The network effect works both ways; it provides value to users on the demand side, while providing value to users on the supply side. Amazon is a great example of how the network effect is bi-directional. Every additional customer provides incremental value to vendors. This is because the vendor benefits from having more customers. Subsequently, every additional vendor provides incremental value to the customer. Customers benefit from more vendors because it gives them more options to chose from. This cycle is repeated to maximize the value of the overall network and its users.

Tesla is currently developing its own network of autonomous vehicles, each car uses cameras to provide valuable data that enhances self driving capabilities for every driver. Every additional driver provides data to develop the neural network, subsequently adding value to the network. The network effect will allow Tesla to achieve full autonomy one day, it is only a matter of when. Technology has enabled the winner-takes-all environment in a remarkable way. Investors can take advantage of this by investing early in data-driven companies with strong network effects which enable exponential growth and market share dominance.

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The Investment Journal

Winner-Takes-All and the Network Effect