The concept of ‘network effects’ could hardly be more central to understanding why certain things work in the internet world. Simply put, ‘network effects’ means that the value of a network is a function of how many people are using it (rather than a function of, say, the strength of the underlying technology).

Insight into network effects led to the original business model of the old AT&T telephone system: keep basic rates low so that everyone can have a phone, because having a phone is only useful if lots of people have one. It also explains the incredible power of eBay and Craigslist: buyers go there because that's where the sellers are, and sellers go there because that's where the buyers are. The big social networks, namely Facebook and MySpace, keep attracting more people because they are the place to find other people.

The dream of every web entrepreneur is to use networks effects and one of its key manifestations – viral growth – to build a company. Once people get involved in a network that depends on other people being involved, it's in their interest to recruit others into the network. Goodbye, marketing costs!

Of course, this is much easier said than done; how exactly some of the aforementioned companies established themselves in the first place remains something of a mystery. And it's easy to confuse network effects with other kinds of barriers to entry in a particular business.

Consider, for example, the case of Google. While Google's position in the search business looks impregnable, what makes it so is not network effects. The value of using Google does not depend on lots of other people using Google, except perhaps at the margin. (Google can learn a lot about search habits from having so many searchers, and many websites now optimise for Google, which makes Google more effective and therefore makes people more inclined to use Google.)

In the main, though, Google's market position depends on other things: great technology, brand power, and habit. Google got to where it is by building a better mousetrap; all indicators are that it continues to build its technological lead, but in principle one of the many new search companies now under development could come up with something that delivers better results, and that would be an immediate challenge to the incumbent.

Google also benefits immensely from the fact that its name is now synonymous with search. (When your name becomes a verb, as in "to Google" or "to Xerox," you're in pretty good shape in this regard.) To overcome this, any newcomer will likely have to spend a ton on marketing. Viral growth – friends telling friends – will be important too, but it probably won't be a substitute for boatloads of advertising cash.

Then there is the simple power of habit. People like what they are accustomed to, and they won't change unless given a very compelling reason. In all aspects of the media game habit is a very powerful force. But the fact that people do not bother to switch is not the same thing as switching being essentially impossible (because the alternative doesn't offer anything close to the same kind of value).

I got to thinking about all this in reading the recent cover story in Fast Company magazine about Ning, the social networking start-up led by Netscape founder Marc Andreessen. Oddly, the story practically argues that Ning invented network effects, and paints a lovely portrait of the company's future by positing a sort of double network effect. Since Ning is a platform building a social network, it's actually a network of social networks and therefore enjoys a compounding effect.

But this doesn't really hold: the fact that I am a member of a given social network that uses Ning doesn't make a different network more compelling by definition. Or, to put it another way, the benefits of building your social network on Ning don't depend on lots of other people building their social networks on Ning (except, again, at the margins). This is not to say that Ning doesn't have a good future, or that network effects aren't critical to the development of social networks, but there is no double-bonus to be had.

There is a very simple test as to whether a given business's primacy is built on network effects or something else. If no one else were there, would it still be useful? If the answer is yes, and a lot of people are already there, you can count on a long and profitable ride.

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Jonathan Weber is the founder and editor in chief of NewWest.Net, a regional news service focused on the Rocky Mountain West in the United States. He was previously the co-founder and editor in chief of the Industry Standard

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