Network Effects are the most powerful force in business.
They produced some of the most iconic products and companies ever. Examples: WhatsApp, Airbnb, Google, Amazon, Alibaba, Uber, ebay, Facebook, Opentable, WeChat and Twitter.
According to venture capital firm, NFX, network effects are responsible for 70% of the value created by tech companies since the Internet became a thing in 1994 🤯
Here are my favorite posts on Network Effects.
Anu gives the best explanation of the differences between networks, marketplaces and platforms.
- Network = group of connected users and you’re sharing information and you’re trying to drive your product. ( fb, WhatsApp, slack )
- Marketplace = two heterogeneous sides. So you have two sites, think of Ebay as a marketplace. You have sellers and buyers. Think of Airbnb, you have hosts and guests. ( eBay, airbnb, instacart )
- Platform = you have users and developers and a platform. And so think of it where both groups, users and developers, help build the platform, it can be programmatic, customized. But each group reinforces the value of each other. ( apple, microsoft, fb )
Anu Hariharan and a16z put together an awesome slideshare deck network effects.
Bill Gurley’s “All Markets Are Not Created Equal” is a legendary post for anyone thinking about building a marketplace.
10 factors to consider when evaluating new marketplace opportunity:
- New Experience vs. the Status Quo
- Economic Advantages vs. the Status Quo
- Opportunity for Technology to Add Value
- High Fragmentation
- Friction of Supplier Sign-Up
- Size of the Market Opportunity
- Expand the Market
- Payment Flow
- Network Effects
Pete Flint outlines the building of Trulia’s network effects.
Our first big challenge, one which every online marketplace must reckon with, was the so-called “chicken-and-egg” problem. How could we attract a consumer audience (homebuyers) without any listings, and how could we attract listings without an audience?
Trent Giffin’s “A Dozen Things I’ve Learned about Multi-sided Markets” is insightful and very easy to digest.
I recommend reading everything Trent writes.
- Multi-sided markets bring together two or more interdependent groups who need each other in some way.
- A critical difference between single and multi-sided market is that the sides interact directly.
- Multi-sided markets are not linear.
- A multi-sided market is not valuable if the sides can find each other easily.
- “Demand side economies of scale” result when the value of a product or service changes in a positive way as more people use it.
- “Supply side economies of scale” exist when there are reductions in the average cost per unit associated with increasing the scale of production.
- Creating a successful multi-sided market requires that the business overcome the “chicken and egg problem.”
- The chicken and egg problem is best overcome if one side is clearly made the loss leader.
- The sides of the market should complement each other – if the sides are complements, it not only reduces the customer acquisition cost (CAC) but assembles sides that want to to enter into exchanges.
- Subsidizing the side of the multi-sided market with lower marginal cost/COGS is optimal.
- Businesses that are slow to get to critical mass can run out of cash and momentum.
- Clear profit pools should exist.
The NFX team take Network Effects to a whole new level with “The Network Effects Manual”
They list out each type of network effect with a diagram, explanation of properties and example companies.
- Why Network Effects Are Important
- How Networks Work
- Properties of Networks
- Building and Maintaining Network Effects
- Related Concepts
Last but not least, Andrew Chen gives the world a new mental model 😉
The Kardashian Network Effect - Cross promotion platform built by multiple mutually reinforcing social accounts that cross-promote each other
Network Effects aren’t just for tech companies.