The Network Effect
One of the largest contributors to the Digital Transformation Revolution.
Because of the network effect, products, or services become more valuable when more people use them. The telephone at the dawn of the twentieth century is a good example of this, which was completely useless without someone on the other end of the line. Due to the growth in cell phone users, the network’s power increased drastically. However, starting the network effect can be a challenging task. Before expanding to a larger scale, businesses must build a modest, sustainable network. As their networks grow, companies will eventually have to deal with network effect’s own challenges, such as reaching a growth cap and attracting unwanted players. To succeed in the long run, established enterprises must build a moat — a big, stable network.
Silicon Valley’s players have a thing for jargon and phrases. However, the term “network effect” is now dominating the conversation. Since its widespread usage by both aspiring entrepreneurs and seasoned CEOs, the phrase has become a joke.
The term “network impact” is often used by start-ups when pitching to investors. Asked: How are you going to deal with your rivals? What did they say? The power of the web. They can ask: How do you plan to scale in other countries? Invariably, the simple answer is: With the power of Network Effects.
Consider Uber as an example of the network effect in action. Throughout the United States, Uber developed from neighborhood to neighborhood, city to city. The network effect helped it to grow as well.
To put it another way, the more people who downloaded the Uber app, the more probable it was that they would be able to locate a ride-share partner with whom to split the cost. This, of course, made it simpler for drivers to find those who needed a ride. The network expanded tremendously as more and more individuals engaged with the technology. Uber’s profits increased as a result.
The telephone as an example of an older technology.
There were less than 5 million telephones in the United States at the beginning of the twentieth century. Nearly 90 million Americans needed to be served by these 5 million phones. AT&T, the American Telephone and Telegraph Business (now AT&T), was the fastest-growing phone company.
Theodore Vail was the driving force behind the company’s rapid expansion. At the time, he had a greater understanding of the network effect than anybody else. According to him, an unconnected telephone is one of the most pointless objects in existence. The only way to get in touch with them is if they have a phone of their own. To be useful, a phone must be shared with others.
The value of a phone relies on the number of connections it has with other phones. In a nutshell, this is the network effect. Apps like Instagram and Snapchat, or ride-sharing services like Uber and Lyft, are only as important as the networks that use them.
If you take away the network, the product vanishes.
In the 21st century, bringing innovative technology to market is very challenging.
Now that we are familiar with the concept of the network effect, it is simple to see how it may be used. From the subway to the sidewalk, you will observe individuals peering at their smartphones, glued to their screens.
Wouldn’t you agree that now is the perfect time to introduce new technologies? In this setting, a small, intrepid start-up could easily become the next Tinder or Zoom. By spreading word-of-mouth and expanding organically with new items that have the network effect, users may quickly spread the word. Even modest start-ups can beat the big boys. Right?
Wrong. It is not at all simple to make use of the network effect.
We live in an era when attention spans are so short that only the most helpful and engaging applications and technology will flourish.
Let us rewind to the year 2008. Those were the days when the iPhone applications platform was first introduced to smartphones and other mobile devices. A new app just needed to be more entertaining than commuting or waiting for a bus in the early days when the platform was sparsely populated for it to flourish. This was a cinch.
A decade later, the picture is much different. As of this writing, the App Store has more than a million applications. To be a success, each new app has to capture users’ attention from the plethora of already popular and highly addicting applications. Both the Google Play Store and the Apple App Store’s top rankings have had the same design for a long time.
Even for the world’s most powerful corporations, moving into a new market dominated by a smaller firm may be tough. Because of the power of the network effect, a bigger firm cannot compete with a smaller firm that has already established itself and is gaining market share via word-of-mouth advertising.
As an example, consider Snapchat and Instagram’s struggle for market dominance. Like its Stories and picture messaging, Instagram could not outdo Snapchat when it attempted to mimic its services. Why is this so? Instagram was unable to compete with Snapchat’s steadfast and expanding user base.
The Cold Start Problem — By Andrew Chen
At this point, you understand what the network effect is and how it works. You may also be tired of hearing it from me over and over again.
An example of a cold start difficulty is when you attempt to start up your automobile on a frosty morning, and it is difficult. The ignition does not work, no matter how hard you try. In the frigid air, your breath feels like snot. After a while, you decide to phone a mechanic for aid.
Businesses, like old automobiles, may benefit from a similar strategy. It may be challenging to get a new company off the ground. And then there is the cold-start issue.
Where do we begin to look for an answer? It all comes down to networks of individuals either not connecting with an idea or jumping on the concept for a brief period of time, but finding it unsatisfying. It does not matter whether you are a tiny start-up or a large corporation.
Imagine a movie-streaming app from a well-known company. Think of it as a huge success. At initially, the service attracts a lot of attention. However, it does not have a lot of substance to begin with. The library lacks a lot of material. As a result, visitors leave quickly. Because of their ebb and flow, they never return. That is all there is to it. So, there you have it.
The initial network a product secures is the key to solving the cold start issue. If you do not gain those first customers, you will not win anybody else eventually.
An atomic network is the best way for a startup to get off the ground with these early adopters. Networks that may expand on their own are known as “atomic networks.” You do not simply throw something out there and hope people would flock to it; you really test it first.
Slack, a corporate messaging service, has a fascinating history. Tiny Speck, the original name of Slack’s predecessor, was a start-up. Glitch, the company’s initial offering, was a multiplayer game. When Tiny Speck set out to create Glitch, he had high aspirations for it. It had a scathing critical reception and was quickly shelved.
To overcome this setback, the Tiny Speck development team resorted to the little communication tool they would be utilizing throughout the game’s first development phase. Frankentool, Honeycomb, and Chatly.io are just a few of the monikers given to it. Slack was the name given to it through time.
Slack was first tested with Tiny Speck’s buddies. Rdio, Wantful, and Cozy were among the other start-ups on the list. 45 businesses eventually signed up to utilize the software. For the cold start challenge, this was the first small, atomic network that was crucial.
Slack was a favorite among these fledgling businesses since it met all of their communication requirements to an exacting degree. As a result, they informed their contacts. As we all know, the rest is history.
It may be incredibly difficult to maintain a vast network.
Suppose you have developed a new app that helps people locate pet-sitters in their region, and it has gotten off to a good start. A big worldwide corporation that enables pet owners to go on vacation, comfortable in the knowledge that their kitten or labradoodle would be in good hands, has taken hold of the market, making you CEO.
Nothing more has to be done except sit back and enjoy the fruits of your labor, right? Wrong. In reality, it is seldom as simple as that. The network itself might pose a severe challenge as it expands.
The first kind of issue is one of rapid expansion. The company’s growth will likely reach a plateau not long after it reaches escape velocity. For a number of reasons, this may be the case. In certain cases, it may be due to a saturated market for a specific product or service. Or, it might be that people have become tired of seeing the same old ads.
Bad actors are also an issue as the network expands. In social media, the problem is particularly serious. Usenet, an early internet forum, serves as an excellent case study. People were able to discuss everything from wine-making to philosophy on Usenet for years before it was deluged with trolls and spam.
As the internet took off in September 1993, spammers and trolls appeared. The use of Usenet was rendered impossible. It lost its initial function as a forum for in-depth debate.
To deal with these issues, huge networks need to be organized. You can solve the first issue of decreasing growth simply by pushing for more growth. Their second, third, and even fourth escape velocity will be achieved via the creation of new networks.
For the second issue, which is that context is lost in a network, you may turn to new communication platforms like WhatsApp and iMessage. Smaller, self-contained bubbles may be created instead of enabling networks to grow so vast that the original context is lost, allowing individuals to communicate in the manner they like.
Building a moat is the strongest defense for an established firm against new competition.
When was the last time you heard of Airbnb? It is now the world’s most popular rental service. Networks are at the heart of its success, from how swiftly it grew to its current position at the top of the industry.
However, things were not always that safe. Wimdu was a formidable rival in Europe. Wimdu, a German start-up founded in Berlin, has raised more money, hired more people, and gained momentum in more markets than Airbnb.
How, however, did Airbnb triumph?
Because Airbnb created a larger moat, it won the competition. As a result, every successful, mature organization must do this now.
Building a moat, however, is a very other matter.
As a business grows, it will inevitably come up against competition. Because of these network effects, smaller rivals may frequently easily and cheaply utilize a company’s initial success to their advantage. Viral, organic growth and a rise in revenue as a result of new users.
If you want to remain on top, you must maintain a huge and impenetrable moat surrounding your brand, product and alliances. It is essential that it compete at the same level as the network.
In its struggle with Wimdu, Airbnb used this strategy. Instead than cutting prices to compete immediately, Airbnb concentrated on improving the quality of the European networks it was creating.
Airbnb, on the other hand, was far more discriminating in the houses it posted. Airbnb went above and above to make sure its guests had a fantastic time while renting from them. Airbnb ensured that its customers received exactly what they were searching for, while Wimdu’s customers can find themselves in overcrowded student hostels.
Along with a well-targeted advertising effort, Airbnb was able to build a loyal following throughout Europe. Its victory was made possible by this moat.
Smaller rivals will always be a threat to any well-established business. With today’s threats, it must continually monitor its network. An adversary will take its network piece by piece if it feels the war is over. Until one day, nothing is left.
