Network Effects are the most powerful force in business.
They produced some of the most iconic products and companies. Examples include 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 some of 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 way to think about network effects…
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 ;)