Ever notice how some people become successful because they’re really good at knowing people? The bigger his or her network grows, the more popular and valuable that social butterfly becomes.

The ‘network effect’ in business works in the same way. It is one of the five or so types of economic moat - a structural competitive advantage - you might hope to find in a company. With the network effect the value of the product or service increases as the number of users goes up, attracting more users, which further boosts value.

It’s a virtuous circle. In fact, research from Morningstar analysts indicates that this is both the rarest and most lucrative type of moat to be found… Not only that, but the best networks are very defendable for wide-moat industry leaders such as Google and Facebook.

You’ll find that quite a lot of companies with this network effect are digital or online. That’s because it is most often found in businesses based on sharing information or connecting users together.

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Very few businesses actually have this characteristic. It’s not the straight line growth of, say, selling more barrels of oil per day. This is an exponential increase in value; a curved line arching ever upwards as the nodes and connections proliferate until, ultimately, there is no other network worth visiting.

Towards the end of this post I’ve identified some online platform companies - they all typically generate high returns, but whether they benefit from network effects is another matter. And even if they do have network effects, that does not mean they are safe from competition...

I’d welcome a discussion on the subject - both in terms of the stocks listed in this article and those that might have been missed out.

The networks that do succeed tend to consolidate - the economies of scale seen in networks are just too compelling. These businesses create natural monopolies and oligopolies. As the economist and academic, Brian Arthur, once put it: ‘Of networks, there will be few.

As if to illustrate this consolidation point, one of the UK-listed companies with a valuable network finds itself at the centre of a bidding war, after years of hoovering up similar, smaller platforms…

Just Eat snapped up?

Just Eat (LON:JE.) is the online food delivery platform that has revolutionised the way we drunkenly eat…

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