I’ve been doing a lot of research lately about network effects. Specifically I’ve been reading through a bunch of ultra-dry Harvard Business Review articles and HBS case studies. Hopefully I can provide a brief overview of the more interesting aspects of network effects and save someone the effort of reading 12 case studies.

The classic example of network effects is the fax machine. The first fax machine was worthless because it couldn’t send a fax to anyone. The second fax machine was worth something because it could communicate with the first fax machine. Every new fax machine put into use increases the value of all other fax machines. This network effect takes place in many modern business models and presents both challenges and opportunities for startups.

Successful businesses in the information economy are more likely to benefit from economies of networks than from economies of scale. Economies of scale are supply driven (cost savings due to mass production e.g. Toyota) and economies of networks are demand driven (the larger the network the higher the demand e.g. Craigslist).

One particularly interesting component of networks is the positive feedback loop. More users on one side of the network attract more users to the other side of the network which in turn attracts more users to the first side. So many of the major players in the travel industry have benefited (nay, relied on!) network effects:

• Every company listing product on Priceline provides additional value for those consumers searching Priceline for travel deals. Every additional consumer searching for travel on Priceline increases the likelihood a company will list travel products on Priceline.
• Where would Travelocity, Orbitz, Expedia etc. be without network effects?
• Emerging companies in the adventure travel space (e.g. Adventure Central, TourCMS etc) are currently in the challenging part of creating a network. Every tour operator listing on Adventure Central adds value for the affiliates, and every affiliate adds value to the tour operators.
• Economies of networks typically scale further than economies of scale. Eventually Toyota won’t be reducing cost with every additional unit of production, but the value of the Adventure Central platform will continue to rise as long as more tour operators and affiliates are signing up.

The HBS articles I read were pretty weak on actual tactics for securing early users for a network-based business model (insert joke about academia.) Here are some ideas I have been thinking about:

• Incentivize early users: this is the obvious solution. Xboxes are sold below cost to get them to users. This gets the product out and creates demand for games (the place Microsoft makes the most money from the Xbox). Epinions even PAYS community members to write reviews.

• Provide a product/service that is useful without the network: Delicious was very successful with this and I think Travelmuse (who is creating a delicious-like bookmarking tool for travel) is onto a great strategy here. Their bookmarking tool is useful without the network, and the social networking aspects become useful after many users have implemented the application.

• Free stock?: This idea reeks of dotcom bubble, but Travelzoo actually gave users 6 shares of company stock if they signed up for the company distribution list. This idea sounds completely nuts, but it seems to have worked out as Travelzoo survived the bubble.

• Convince the right people to make the leap: I’m not going to get any say in what the next DVD format will be (not that I give a damn.) The future format will be determined by some large group of influential businesses who band together to throw support behind a specific format.

• Broker a deal with a large crowd: One of the world’s busiest ski forums (← don’t click that link unless you have two hours to waste) actually got its start when a large crowd decided to abandon their existing forum.