Network Effect vs. Cost Advantage

Nugget of the week

Limits: Network effects are limited solely by eventual market saturation. Cost savings are inherently limited.

Inimitability: After reaching critical mass, network effects become nearly impossible for competitors to replicate, creating a strong barrier to entry. Many types of cost advantages can be duplicated by competitors with access to sufficient capital, often leading to a “race to the bottom” in commodity industries. Cost advantages based on economies of scale are harder to achieve and more defensible than other cost advantages.

Durability: Network effects are self-reinforcing and create a durable moat. Companies must continuously innovate in order to maintain a cost advantage.