Marketing Communication

Network Effect: A Proven Way to Create a Moat

13 May 2019

The term “economic moat” describes a company’s ability to maintain its competitive advantages and defend its long-term profitability. This moat investing education series explores the five primary sources of moat, according to Morningstar: 1) Switching Costs; 2) Intangible Assets; 3) Network Effect; 4) Cost Advantage; 5) Efficient Scale. Here we explore the concept of:

Network Effect: As more people use a company’s product or service, the value of that product or service increases for both new and existing users.

Growing Reach Puts Network Effect in Play

The “network effect" moat source has become more relevant as our world has grown more digital. It describes the phenomenon where the value of a product or service increases as the number of its users grows.

The internet is a good example. It originally had few users outside the military and research science spheres, but its expanding user base exploded its reach and impact. More recently, companies like Facebook and Google have been labeled network effect paragons. Morningstar posits that a network effect can help a company to increase its advantages over competitors, and is often an important source of a company's moat.

The term "critical mass" is often used in connection with the network effect. In game theory, this means that not all game participants need to be convinced for a strategy to succeed, just a very specific portion of them. If this participation threshold is exceeded, the strategy is likely to succeed of its own accord. The network effect works in similar fashion. If the user base for a product or service reaches a critical mass, the network is likely to expand under its own power. Ultimately, however, a company’s ability to monetize a network is also important to consider before network effect can be assigned as a moat source.

Network Effect in Action

Visa dominates the global electronic payments industry. The company controls approximately half of all credit card transactions and an even higher portion of debit card activity.¹It is a great example of how the network effect can create a powerful competitive advantage. Morningstar says of Visa: “The brand is accepted by approximately 44 million merchants worldwide, with 3.1 billion cards in circulation. Perhaps most importantly, 16,800 financial institutions worldwide make up the Visa network.”

Alphabet, with a global share of over 80%, leads the online search market. The company’s network effect is comes primarily from its Google products, which includes search, Android, Maps, Gmail, YouTube, and more. In Morningstar’s view, “Google has the world’s most widely used search engine, and such a large and growing user base has created a network difficult to replicate.”

Important Disclosure

This is a marketing communication. Please refer to the prospectus of the UCITS and to the KID before making any final investment decisions.

This information originates from VanEck (Europe) GmbH, which has been appointed as distributor of VanEck products in Europe by the Management Company VanEck Asset Management B.V., incorporated under Dutch law and registered with the Dutch Authority for the Financial Markets (AFM). VanEck (Europe) GmbH with registered address at Kreuznacher Str. 30, 60486 Frankfurt, Germany, is a financial services provider regulated by the Federal Financial Supervisory Authority in Germany (BaFin).

The information is intended only to provide general and preliminary information to investors and shall not be construed as investment, legal or tax advice VanEck (Europe) GmbH, VanEck Switzerland AG, VanEck Securities UK Limited and their associated and affiliated companies (together “VanEck”) assume no liability with regards to any investment, divestment or retention decision taken by the investor on the basis of this information. The views and opinions expressed are those of the author(s) but not necessarily those of VanEck. Opinions are current as of the publication date and are subject to change with market conditions. Certain statements contained herein may constitute projections, forecasts and other forward-looking statements, which do not reflect actual results. Information provided by third party sources is believed to be reliable and have not been independently verified for accuracy or completeness and cannot be guaranteed. Brokerage or transaction fees may apply.

VanEck Asset Management B.V., the management company of VanEck Morningstar US Sustainable Wide Moat UCITS ETF (the "ETF"), a sub-fund of VanEck UCITS ETFs plc, is a UCITS management company under Dutch law registered with the Dutch Authority for the Financial Markets (AFM). The ETF is registered with the Central Bank of Ireland, passively managed and tracks an equity index. Investing in the ETF should be interpreted as acquiring shares of the ETF and not the underlying assets. Investors must read the sales prospectus and key investor information before investing in a fund. These are available in English and the KIIDs/KIDs in certain other languages as applicable and can be obtained free of charge at www.vaneck.com, from the Management Company or from the following local information agents:
UK - Facilities Agent: Computershare Investor Services PLC
Austria - Facility Agent: Erste Bank der oesterreichischen Sparkassen AG
Germany - Facility Agent: VanEck (Europe) GmbH
Spain - Facility Agent: VanEck (Europe) GmbH
Sweden - Paying Agent: Skandinaviska Enskilda Banken AB (publ)
France - Facility Agent: VanEck (Europe) GmbH
Portugal - Paying Agent: BEST – Banco Eletrónico de Serviço Total, S.A.
Luxembourg - Facility Agent: VanEck (Europe) GmbH

Morningstar® US Sustainability Moat Focus Index is a trade mark of Morningstar Inc. and has been licensed for use for certain purposes by VanEck. VanEck Morningstar US Sustainable Wide Moat UCITS ETF is not sponsored, endorsed, sold or promoted by Morningstar and Morningstar makes no representation regarding the advisability in VanEck Morningstar US Sustainable Wide Moat UCITS ETF.
Effective December 17, 2021 the Morningstar® Wide Moat Focus IndexTM has been replaced with the Morningstar® US Sustainability Moat Focus Index.
Effective June 20, 2016, Morningstar implemented several changes to the Morningstar Wide Moat Focus Index construction rules. Among other changes, the index increased its constituent count from 20 stocks to at least 40 stocks and modified its rebalance and reconstitution methodology. These changes may result in more diversified exposure, lower turnover and longer holding periods for index constituents than under the rules in effect prior to this date.
It is not possible to invest directly in an index.

All performance information is based on historical data and does not predict future returns. Investing is subject to risk, including the possible loss of principal.

No part of this material may be reproduced in any form, or referred to in any other publication, without express written permission of VanEck.