Economies of scale are a common phenomenon in traditional industries such as manufacturing, whereas network effects are most prevalent in new economy industries, particularly information and communication technologies. Network effects are commonly mistaken for economies of scale, which describe decreasing average production costs in relation to the total volume of units produced. For example, hardware may become more valuable to consumers with the growth of compatible software. Indirect (or cross-group) network effects arise when there are "at least two different customer groups that are interdependent, and the utility of at least one group grows as the other group(s) grow".
Direct network effects can be seen with social networking services, including Twitter, Facebook, Airbnb, Uber, and LinkedIn telecommunications devices like the telephone and instant messaging services such as MSN, AIM or QQ. This effect is separate from effects related to price, such as a benefit to existing users resulting from price decreases as more users join. Direct network effects arise when a given user's utility increases with the number of other users of the same product or technology, meaning that adoption of a product by different users is complementary. Network effects can be direct or indirect. The adoption of a product by an additional user can be broken into two effects: an increase in the value to all other users ( total effect) and also the enhancement of other non-users' motivation for using the product ( marginal effect). Network effects are typically positive feedback systems, resulting in users deriving more and more value from a product as more users join the same network. In economics, a network effect (also called network externality or demand-side economies of scale) is the phenomenon by which the value or utility a user derives from a good or service depends on the number of users of compatible products. As the number of phones connected to the network grows, the number of potential calls available to each phone grows and increases the utility of each phone, new and existing. The lines represent potential calls between phones. Diagram illustrating the network effect in a few simple phone networks. For the 2020 novel, see Network Effect (novel).
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