Please ensure Javascript is enabled for purposes of website accessibility

No, Netflix and Peloton Do Not Have Network Effects

By Neil Patel – Aug 23, 2021 at 9:00AM

Key Points

  • Thinking that Netflix and Peloton both possess network effects is mistaken, primarily because they control their own production and services.
  • Social communities built around a company's products or services don't necessarily show that this competitive advantage exists.
  • As investors, we shouldn't assume that all internet businesses have network effects by default.

Motley Fool Issues Rare “All In” Buy Alert

You’re reading a free article with opinions that may differ from The Motley Fool’s Premium Investing Services. Become a Motley Fool member today to get instant access to our top analyst recommendations, in-depth research, investing resources, and more. Learn More

This might be an ongoing topic of debate, but seeking a deeper understanding of this competitive advantage should clear things up.

One of the strongest competitive advantages in the business world today is network effects. At a high level, this generally means that as a company gains additional users or customers, the product or service improves for everyone else. 

While easy to comprehend, investors often mistakenly believe internet companies automatically possess this trait. Two popular companies in particular, Netflix (NFLX -2.04%) and Peloton (PTON 0.30%), are widely thought of as businesses with network effects. 

But there is more to the definition I gave above. Let's dive in and understand why the misconception exists.

A drawing of a group of people standing in a group to create the shape of the continental United States.

Image source: Getty Images.

Why Netflix and Peloton don't have true network effects 

Netflix and Peloton actually own the means of production for their products and services. The streaming entertainment giant spends massive amounts of cash ($17 billion this year alone) to enhance and expand its vast content catalog. And the at-home fitness pioneer chooses which trainers to work with, what classes to offer, and what equipment to design and manufacture. The end user, whether it's someone watching TV or an exercise junkie, has no direct connection to that process for the business.

Compare this dynamic to companies like UberAirbnb, or Etsy with true network effects. All three of these companies simply facilitate a connection and transaction between users of its marketplaces. Uber doesn't own the cars that ferry passengers around the world. Airbnb doesn't own the properties that host millions of travelers every year. And Etsy doesn't own the merchandise sold on its website and mobile app. Netflix and Peloton, on the other hand, do take on the risk of producing their services and products, and this is a key distinction. 

The common misconception 

I often read or hear that if communities form around a product or service, then the company must have network effects. 

There's an official Peloton member page on Facebook that has attracted over 434,000 people. Netflix's hit series Stranger Things also has a fan page on Facebook that 223,000 people follow. This does not, however, mean network effects are present. 

Sure, these social communities can drive referrals and attract new customers. They can also increase engagement by encouraging users to take more classes or watch more content. This is no different than a restaurant or chiropractor in your hometown gaining customers by word-of-mouth advertising -- albeit on a much larger scale. The internet has simply made it easier for customers to connect with each other, which can apply to any company. 

Gathering data is the curveball 

There is something that complicates the argument for Netflix and Peloton having network effects though, and this is the large quantities of data they're able to collect. Both companies amass troves of data on their users. For example, Netflix knows what content viewers watch, when they watch it, how often they use the service, and more. Peloton is similar in that it knows what types of workouts are popular, how often connected fitness subscribers exercise, and so on.

More users equals more data. And with more data, these businesses can better direct their investments in technology and the user experience. This all creates a feedback loop. But again, I'm skeptical that this translates into a true network effect. 

We don't associate Home DepotCostco, or Starbucks with having network effects, but they also collect lots of data on their customers and their behavior -- all of which leads to better leverage with vendors and a continuous improvement in the shopping and ordering experience.

And in today's competitive landscape, if a company is not gleaning valuable insights from the data it gathers in order to improve the customer value proposition, then it will inevitably fall behind. 

The investor takeaway 

Netflix and Peloton are both outstanding businesses as they've each found tremendous success by disrupting outdated industries. Considering them as additions to your portfolio would certainly benefit long-term investors. 

Just don't assume that all internet-based businesses have network effects, regardless of how popular they may be.

Randi Zuckerberg, a former director of market development and spokeswoman for Facebook and sister to its CEO, Mark Zuckerberg, is a member of The Motley Fool's board of directors. Neil Patel owns shares of Etsy and Starbucks. The Motley Fool owns shares of and recommends Costco Wholesale, Etsy, Facebook, Home Depot, Netflix, Peloton Interactive, and Starbucks. The Motley Fool recommends Uber Technologies and recommends the following options: short October 2021 $120 calls on Starbucks. The Motley Fool has a disclosure policy.

Invest Smarter with The Motley Fool

Join Over 1 Million Premium Members Receiving…

  • New Stock Picks Each Month
  • Detailed Analysis of Companies
  • Model Portfolios
  • Live Streaming During Market Hours
  • And Much More
Get Started Now

Stocks Mentioned

Related Articles

Motley Fool Returns

Motley Fool Stock Advisor

Market-beating stocks from our award-winning analyst team.

Stock Advisor Returns
356%
 
S&P 500 Returns
118%

Calculated by average return of all stock recommendations since inception of the Stock Advisor service in February of 2002. Returns as of 11/27/2022.

Discounted offers are only available to new members. Stock Advisor list price is $199 per year.

Premium Investing Services

Invest better with The Motley Fool. Get stock recommendations, portfolio guidance, and more from The Motley Fool's premium services.