Positive feedback effects are one of the most important sources of growth for businesses in many industries from new ones like social networking to old ones like telephones. It turns out that, like leverage, what’s really good on the upside is also quite bad on the downside. Malls and newspapers are two interesting recent examples.

Let’s remember how positive feedback effects—aka network effects—work. Take social networking. People value a site like Facebook more if they can connect with more of their friends. When one person joins it increases the value of other people who are therefore more likely to join. Or consider smart mobile phones. People value a mobile phone brand more if they can find more applications for it; application developers value a mobile phone brand more if there are more potential customers on it. More people lead to more applications which lead to more people and so forth. This positive feedback propels business growth and can result in very successful businesses.

Back in the dot.com days these network effects were so hyped that some misguided souls actually thought that one could build businesses just on the back of these effects. More people, would lead to more people, would lead to being king of the hill. Getting these positive feedback effects going is hard work, and many failed to get the upward spiral. Unfortunately, many of those that succeeded in generating network effects did so by giving everything away for free. They had a lot of customers but no way to make money. All that of course is old news but it is good to be reminded that positive feedback isn’t a sure road to nirvana.

Recent events also emphasize that positive feedback effects can be the path to hell. That’s because they also work in reverse. If one participant in the positive feedback loop leaves then the service will be less valuable to other participants who will be more likely to leave and less valuable to newcomers who will be less likely to join. What goes up the hill can also go down the hill.

A recent article on dying malls shows what can happen. Malls are more valuable to stores that rent space in them when they attract more shoppers, and they are more valuable to shoppers when they attract more stores these shoppers care about. The economic downturn brought on by the financial crisis has shown how quickly positive feedback effects can work in reverse. People shop less. Stores that were just marginally profitable are forced to close down. That makes the mall less interesting to shoppers. They shop even less. That leads to more stores closing down. Across the country malls are dying and some have already bitten the dust. Some of them can be found on www.deadmalls.com.

As I’ve blogged about several times now about the dying newspapers, check out, The Creative Destruction of the Newspaper Industry which is another example of positive feedback effects in reverse. Many newspaper readers can see this happening slowly every day. Newspapers have fewer readers. That means they secure less advertising revenue. They cut back on content as a result. Even the Wall Street Journal seems to be getting skinnier every day. Several newspapers have gone into a death spiral and closed down. (See, The Online Advertising Industry: Economics, Evolution, and Privacy for some data that shows the decline in circulation, revenue and market caps for newspapers.)

Death spirals can happen very quickly. They can result from an economic downtown as we have seen with malls, the appearance of a disruptive technology as is the case with traditional media, or with the arrival of a superior competitor as we’ve seen with mobile phones. Catalyst businesses that depend on positive feedback effects should consider lowering prices or increasing service to avoid losing the customers or suppliers that generate these feedback effects. That is especially true during a temporary downturn. It may be better to take a short-run hit than to lose the value of the positive feedbacks that have accumulated over time. If they can’t take that short-run hit then these businesses need to carefully manage their way to a new equilibrium through adjusting prices and service to their customers and suppliers. And finally, if the business is tumbling down the mountain from the force of positive feedback effects in reverse it is best to get a helmet and hope for the best at the bottom. The more savvy newspaper publishers are at recognizing that there are just some newspapers they can’t save such as the San Francisco Chronicle. Bringing these businesses to an orderly close beats bleeding to death.

As the economy deteriorates further more and more catalysts may find themselves tumbling down the hill propelled by positive feedback effects in reverse. So watch out!