Identifying Network Effects Specific to Your Business Model
Identifying Network Effects Specific to Your Business Model
Part 3 of 4 in our month long series on Network Effects
Network Effects are a virtuous circle - the gift that keeps giving.
And in my opinion, Network Effects are the most valuable and most defensible competitive moat a company can develop.
Network Effects come in different flavors. And not all are created equal.
As such, there’s an art and a science in identifying which you should put your resources towards trying to harness. Some take capital, some take content, and all require users.
This week we’ll dive into the subtle differences that define these flywheels:
Physical Network Effects
Direct Network Effects
Two Sided Network Effects
Local Network Effects
Indirect Network Effects
Hub and Spoke Network Effects
Data Network Effects
Belief Network Effects
Tech Performance Network Effects
Asymptotic Network Effects
(The Pony Express was an OG Physical Network Effect. Killer advertising, BTW.)
Physical Network Effects:
The network becomes more valuable as more physical nodes join the system. The network is dependent on physical, tangible objects, and they need to be local.
Pony Express: The more riders, the faster you could get mail somewhere. Each new rider who signs his life away makes the nascent postal service more valuable.
Railroads: Another OG physical network, which replaced the Pony Express… The more railroad ties laid and stations built, the further you could transport goods and people.
Cable TV: The fact that crazy people laid physical cables across the country, hanging from telephone poles and digging under lakes and oceans, makes this one even more impressive.
Physical networks are less impressive for their technology (e.g., horses) and more impressive for their sheer scale, breadth, and capital intensity. That’s why people stick with Comcast even though their customer service sucks - the physical network they’ve built makes them the only show in town (until streaming came along).
Direct Network Effects:
The value of the network simply increases with more users. The most obvious example: the phone. I imagine Thomas Edison had a tough first sale - it was entirely useless without anyone else to call.
Facebook: As more users join, there are more people to interact with and share your crappy photos (Annual PSA - please do not share your 4th of July firework photos this year. I do not care…)
Twitter: Each new user adds value by contributing content, which in turn attracts more users seeking information and interaction (read: bullying)
WhatsApp: The utility of the messaging app increases as more people in one’s personal network join… you get the point.
Two-Sided Network Effects:
More supply attracts more buyers, and more buyers attract more suppliers. Think of a farmer’s market - more families make it a weekend activity as more local vendors hawk their jams (variety!). And more local vendors show up because they hear about the increase in foot traffic, envisioning all the money they could make. Bingo bango.
Airbnb: More listings attract more travelers, and more travelers encourage more hosts to list their properties.
LinkedIn: The platform becomes more valuable for candidates as more companies use it to recruit, and with more fish in the pond, it becomes more attractive for recruiters.
DoorDash: A growing number of restaurants on the platform attracts more customers, and more customers means more orders for restaurants, drawing in even more dining establishments who want to share in the network activity.
Local Network Effects:
Babysitters in the Chicago area are useless to parents in Boston. Speaking of that. Edwin Dorsey told a hilarious story about exposing Care.com on the Run the Numbers Podcast (Apple | Spotify | YouTube)
Grubhub: Restaurants and diners need to be located in proximity of one another for it to be useful - nachos don’t travel well.
Lyft: The availability of drivers in a specific area improves wait times and reliability, making the ride share service more attractive to people in the area.
Nextdoor: You don’t want advice on a retirement community in Florida if you live in a bustling suburb of Nevada.
Indirect Network Effects:
Remember when you were a kid and wanted to play Halo, but had a PlayStation, not a Xbox? This one was always a hard one for me to wrap my head around. I’ll try to make it simple…