Introduction
Discover how the strength of network effects may help a business succeed.
The wild Silicon Valley cats like their catchphrases and taglines. The term “network impact” is now outranking all others. It’s been used so often, by aspiring business owners and seasoned CEOs alike, that it’s started to sound funny.
Startups often utilise the term “network impact” as a blanket response when making their case to potential investors. They are questioned on how they plan to handle rivals. Their response? Networking impact. They can ask: How will you grow in international markets? The response is Network. Impact.
Yet, what exactly is network effect and why is it a hot topic?
Let’s examine Uber to better understand network impact. Uber evolved from state to state and city to city in the US until it was the enormous international corporation it is today. And the network effect helped it expand.
According to how it worked, the more users who downloaded the Uber app, the more probable it was for them to discover other people with whom to share a trip. Unsurprisingly, this also made it simpler for drivers to find passengers who needed rides. The network expanded more rapidly as more users engaged with the technology. And Uber’s profits increased. It’s called the network effect.
Let’s look at an older device, the telephone, to further our understanding of the situation.
Less than 5 million telephones were in use in the US at the start of the 20th century. Almost 90 million people needed to be reached by these 5 million phones. Yet, one phone company, the American Telephone and Telegraph Company, or AT&T as it is now known, was expanding quickly.
Theodore Vail, the firm president, was instrumental in that expansion. At the time, he was the one who understood network effect the best. In 1900 he said that one of the most pointless things in the world is a telephone that doesn’t have a connection. How on earth can you call someone if they don’t have a phone? For a phone to be useful, other people must also have one.
According to Vail, the value of a telephone relies on the connections it has to other telephones and rises as the number of connections rises.
And that, in a nutshell, is the network effect. The product is only as useful as the network utilising it, whether we’re talking about transportation services like Uber and Lyft or applications like Instagram and Snapchat.
When the network is gone, the product just vanishes.
Key idea 1
In the twenty-first century, it is exceedingly challenging to introduce new technology.
Well, so now that we are aware of what the network effect is, we could be tempted to believe that it would be simple to profit from. People are glued to their smartphones, staring into them wherever they go, from the subway to the sidewalk.
Thus, it stands to reason that now would be the best time to introduce new technologies. The conditions appear ideal for developing a tenacious tiny start-up into the next Tinder or Zoom. Network impact refers to the ease with which new items may gain customers via word-of-mouth and organic expansion. A small start-up may outperform larger organisations. Right?
Wrong. It is quite difficult to use network effect.
In actuality, it’s incredibly challenging since only the most beneficial or interesting applications and technology will flourish in this era of constrained attention spans.
Rewind for a minute to 2008. In that year, iPhone applications were widely available for phones and other devices. A new app just needed to be more engaging than commuting or waiting for a bus back when there wasn’t much on the market to thrive. It was simple.
A decade later, the situation has changed. Several millions of applications are available in the App Store now, all vying for users’ attention. Every new app has to stand out from the crowd of highly addictive ones, many of which have become more user-friendly over time, in order to flourish. The top charts of the Apple App Store and Google Play Store have had the same design for a long time.
Even for large, established giants trying to enter a new market where a smaller competitor dominates, success is challenging. A bigger firm won’t be able to overtake a smaller rival even if they both provide the same product if the latter has already cornered the market and is expanding due to the network effect.
Consider the conflict between Instagram and Snapchat. Instagram sought to imitate Snapchat’s features, such as its Stories and picture messaging, but it was unable to surpass its competitor. The cause? Instagram just couldn’t compete with the network that Snapchat had, which was robust and expanding.
Key idea 2
We can learn a lot about the network effect from meerkats.
We ought to be able to understand the network effect at this point. So, let’s go a bit further and take a more novel approach to the idea.
Time to discuss meerkats.
You’ve probably seen a row of meerkats standing to attention, just like miniature humans, if you’ve seen a lot of nature films on the African savanna.
Meerkats are highly sociable animals, much like humans. They can also teach us a lot about network impact since they are so gregarious and interact so regularly.
Meerkats band together to protect each other from predators. The likelihood is that a monitor lizard, leopard, or python will ambush them if they don’t take their turn on “meerkat watch.” As you would expect, their population size is greatly influenced by how closely they stay together.
It will be considerably simpler for people to be devoured if a meerkat mob is too small to maintain an effective watch. Soon enough, as predators steal one meerkat after another, the number will dwindle to nothing.
In contrast, if there is a large, healthy group of meerkats, they will be able to continue to develop and split into other mobs. They will then hit the so-called tipping point and start to grow exponentially at this time. Nevertheless, if they multiply too much, there won’t be enough food for everyone. The statistics will then start to level and slightly decline at this stage.
In the 1930s, Warder Clyde Allee, a professor at the University of Chicago, provided a detailed account of the whole procedure. The Allee threshold is the term for the point at which a population starts to increase rapidly.
We can learn a lot about the network effect in IT businesses from meerkat dynamics. Think about Myspace, for instance. In the middle of the 2000s, the social network achieved the Allee threshold, or the tipping point, and expanded quickly, much like a healthy meerkat population.
Yet soon after its massive, epoch-defining expansion, Facebook, a formidable rival, appeared on the scene. Myspace quickly failed as a result of Facebook quickly stealing a large portion of its network. There was nothing but quiet and tumbleweeds on Myspace when devoted users checked in.
They also disappeared since no one was left to “friend” them or read their postings.
Key idea 3
The term “escape velocity” refers to the moment at which a network starts to grow quickly.
Let’s review what was said earlier: when a meerkat population reaches a particular level, it crosses a threshold and starts to grow rapidly.
A network may experience exactly the same thing. A network reaches what is known as escape velocity and when it surpasses that limit it develops very quickly.
A corporation will start to recruit hundreds of new employees, undertake ambitious new initiatives, and try to expand abroad once it reaches escape velocity. Its objective is to continue to expand the network effects that contributed to its early success.
You must dissect escape velocity in order to fully comprehend how it operates. You can see that there are three separate forces at play if you look a little closer.
The acquisition impact is the first of them. This is the time when consumers start inviting other people into the network as a result of their good first experiences. That is evident in PayPal’s early history as a major player in payments. When PayPal first started out, it gave new customers cash rewards for referring friends to open accounts. Unsurprisingly, a lot of people accepted the offer, and the network blew out.
The engagement effect is the name given to the second of these forces. By exposing users to new use cases and enhancing their existing experience as the network expands, it is feasible to boost user engagement with the product. So, let’s return to Uber. Uber began “leveling-up” users who were going to the airport and going out to eat. This inspired a portion of Uber’s network to see the service as capable of more than simply getting people from point A to point B.
The economic impact is the third and final factor at play in escape velocity. At this point, a product’s economic success starts to catch up to the network’s quick growth. For instance, if a player’s friends join up to play together, a multiplayer game like Fortnite, which offers personalised goods and weaponry, will start to monetise more successfully. Or use Slack as another example. An organisation is more likely to become a paying client when more teams inside the company sign up for the service.
Each of these elements plays a role in the process that will ignite a network’s development rocket.
Key idea 4
The first challenge faced by organisations is the “cold start probleme”.
I believe you now have a clear understanding of what a network effect is and how it works. I imagine that you’re also getting a little tired of hearing me repeat it.
Therefore, let’s move on to our next topic of discussion. That is the cold start dilemma, which is also the subject of the book.
Imagine attempting to start a vehicle on a chilly morning and having trouble getting the engine to start. This is an example of a cold start issue. You may attempt the ignition many times, but nothing seems to happen. In the bitter cold, your breath is misting. You eventually give up and request assistance from a mechanic.
Businesses may be affected in the same way that old automobiles are. It might be challenging for a company concept to take off. And this is the issue with cold starts.
What then is the cause of the issue? The issue basically comes down to networks of people either not connecting with a concept or them embracing it for a little while then finding it unsatisfying. The tiniest startup or the largest corporation may both experience it.
As an example, consider a movie streaming service from a well-known company. Picture it taking off with plenty of fanfare. At initially, customers swarm to the service. Yet, it doesn’t initially provide a large variety of material. The library just has a limited amount of materials. Users leave as a result. They eventually float off and disappear forever. The end of it is at hand. The issue with cold starts is that.
The initial network a product protects, holds the key to the cold start issue. The most crucial characters in a company’s tale are its first customers; if you don’t win them, you don’t win anybody.
A corporation should attempt to construct what is referred to as a “atomic network” if it hopes to prosper at this early stage with these early consumers. A secure, compact network that may expand on its own is called an atomic network. It’s the antithesis of just disseminating an untested product into the public domain and hoping for the best.
Consider the Slack corporate messaging service’s history. Tiny Speck was the original name of the start-up that preceded Slack. Glitch, a multiplayer game, was its debut release. Glitch wasn’t as successful as Tiny Speck had hoped. It received negative reviews and was quickly dropped.
Unfazed, the Tiny Speck team instead went to the little communication tool they had been using while creating the game. Several names, including “Frankentool”, “Honeycomb” and “Chatly.io” had been given to it. It eventually acquired the name Slack.
Slack was first tested with Tiny Speck’s buddies. Other start-ups including Rdio, Wantful, and Cozy were among them. In the end, 45 businesses agreed to employ the product. This was the first micro atomic network, which is crucial for overcoming the cold start issue.
These startups adored Slack because it met all of their requirements. They informed their pals of the news as a result. The rest is history, as we all know.
Key idea 5
A huge network may be very challenging to maintain.
Imagine your software product has overcome the cold start issue and become a success, such as a new app that helps people locate pet sitters in their neighbourhood. As a result of network effects, you are now in charge of a big international corporation that enables pet owners to take vacations knowing that their kitten or labradoodle would be cared for.
Nothing more has to be done except to relax and enjoy the benefits, right? Wrong. It’s never that simple; it’s never that difficult. The network itself may become quite problematic as it expands.
The first kind of issue involves rapid expansion. Soon after the business reaches escape velocity, its expansion will probably reach a limit. There are several potential causes for this. It could result from a market for a certain product or service getting saturated. Or maybe it’s because consumers are tuning out of old marketing mediums.
When the network expands, the appearance of bad actors becomes another issue. In social networks, it is particularly severe. Usenet, a discussion board from the early days of the internet, is a prime example. Usenet was once a forum where users could discuss whatever they wanted, from brewing wine to philosophy, and it was free of spammers and trolls for years.
However, when the internet began to take off in September 1993, spammers and trolls began to appear. Usenet ceased to function. Its initial function as a forum for in-depth debate amongst users collapsed.
Large networks naturally have these issues, and it is necessary to handle them. A corporation may discover remedies for the first issue, which is declining growth, by attempting to restart its growth cycle. They will quickly reach escape velocity a second, third, or possibly fourth time by creating new networks.
Look to contemporary messaging apps like WhatsApp and iMessage for a solution to the second issue, which is the collapse of context in a network. It is feasible to create smaller, self-contained bubbles where a chosen group of individuals may engage however, they see fit rather than enabling networks to grow so huge that the original context is lost.
Key idea 6
The strongest defense against fledgling rivals for a seasoned business is to create a moat.
Do you have any memory of life before Airbnb? It is now the largest rental service in the world. Networks are the key to its success in every manner, from how rapidly it expanded to how it continues to hold the top rank in its industry.
Yet, it wasn’t always that safe. It had to contend with Wimdu in Europe, a formidable rival. With a large amount of cash, hundreds of devoted staff, and greater traction than Airbnb in the areas it served, Wimdu arose in Berlin, Germany.
How then did Airbnb succeed?
Airbnb prevailed because it expanded the moat. And any successful, established business today must follow this path.
So just what does it mean to construct a moat?
Naturally, when a business grows, it will encounter competition. The problem is that smaller rivals may often use the same network effects that gave it initial success for very little cost. things like organic growth, viral spread, and rising revenue as more people sign up.
Hence, in order to remain competitive, a corporation must create a vast, impenetrable network, or moat, around itself in addition to having the finest brand, product, and alliances. Above all else, it must compete at the network level.
In its conflict with Wimdu, Airbnb acted precisely as described. Instead of competing immediately by lowering its prices, Airbnb concentrated on the calibre of the networks it was establishing in Europe.
Wimdu was not picky about the kind of houses it advertised, but Airbnb was. Beyond their original expectations, Airbnb made sure that its consumers had the most amazing rental experiences. Wimdu customers can end up in overflowing youth hostels, but Airbnb made sure its customers received what they wanted.
Together with a focused marketing effort, Airbnb used this to establish devoted networks throughout the continent. This was the moat that gave it the advantage.
Every established business will always be challenged by lesser rivals. Like those meerkats on alert against snakes and jackals, it must continually monitor its network in order to thrive in today’s world. Its network will be gradually stolen away by a competitor if it relaxes and believes the war is won. Until there is nothing left one day.
Final Overview
Below is a summary of the primary idea:
The network effect is what occurs when a company or product gains value the more people use it. A good example of this is the telephone at the start of the 20th century, which was useless without humans on the other end. Yet as more people placed phones, the network expanded and proved to be quite strong. However, it might be quite difficult to start the network effect. The term “cold start problem” refers to this. Before scaling up, firms must first create small, viable networks to address the issue. Companies will then face issues with the network effect itself as they develop, such as reaching a growth cap and attracting undesirable actors. Ultimately, established businesses need to create a moat, or a big, reliable network, to succeed over the long haul.
