Startup Advocate: Build better business models with network effects
Network effects are fundamental to many business models, and virality can be crucial for certain aspects of growth of some businesses.
So, what are network effects?
At its most basic, network effects happen when the product or service that a company offers increases in value as more people use it.
Why are they beneficial?
Network effects—and there are many different types of them—are a primary way to create a competitive advantage. They’re also the best option when it comes to seeing long-term exponential growth.
What about virality?
Virality, on the other hand, occurs when your existing users get you new users for free. This usually happens when information about a company’s service or product spreads rapidly via word of mouth.
Why isn’t virality as helpful to growth as network effects?
Virality is exciting for obvious reasons. It feels good to see more people using – and talking about – your product/service. And it can be very effective and cost efficient for generating rapid awareness and adoption – important aspects of growth.
The downsides, however, are that for many business models it’s generally not great for increasing the value of the core customer proposition, it isn’t effective when it comes to overall defensibility, and the numbers often times aren’t great in terms of customer retention.
Types of network effects:
Broadly, there are four different types of network effects: marketplaces, interaction networks, data networks, and platforms. However, these can be broken down even further into 16 different types of network effects driven business models:
- Physical (direct)
- Protocol (direct)
- Personal utility (direct)
- Personal (direct)
- Market network (direct)
- Marketplace (2-sided)
- Platform (2-sided)
- Asymptotic marketplaces (2-sided)
- Tech performance
- Bandwagon (social)
- Belief (social)
- Tribal (social)
Success with network effects and the cold start problem
Many of the most famous tech companies and startups owe some of their success to network effects, including Twitter, Apple, Uber, Lyft, and Waze. For example, in the case of ridesharing like Uber and Lyft, the value of the marketplace improves and is interdependent as both sides of the market grow, whereas with Waze – the more quality real-time data points you get from a larger user base, the quicker and better the reliability of the user experience becomes, which builds trust in the brand. From these examples, you can see how scaling with network effects has improved the value of the user experience for these kinds of companies over time, but early stage startups who want to leverage network effects can find it challenging. We call this the “cold start” problem.
The cold start problem
The cold start problem is an issue that nearly every founder runs into. At the very beginning, how can you have network effects when you don’t yet have customers? Different companies have tackled it in different ways, but with the right plan, it is possible to start with zero customers and scale to billions using network effects. Andrew Chen of a16z talks about how different companies have done this successfully (and analyzes why others have failed) in his book The Cold Start Problem: How to start and scale network effects.
Virality and network effects at Gameplay
In 1999, I was on the founding team of Gameplay, Europe’s biggest online ecommerce store for games, gamers, and online multiplayer gaming. I was working for the founding CEO developing new online multiplayer gaming experiences and partnerships to accelerate growth. In order to gain attention and grow brand awareness amongst casual gamers, we created a “celebrity death match” between Robbie Williams and Liam Gallagher, who were publicly feuding at the time. It garnered so much press and web traffic that all of our servers immediately crashed.
While this was a great example of virality, it wasn’t necessarily the answer for Gameplay’s long-term growth. However, when it came to massive multiplayer games, many of the community features we developed at the time became intrinsic to the gaming experience, including tips and cheats and digital assets and league tables and enabling the developer community to build new patches and creatives to develop downloadable content/digital assets/skills in the marketplace we developed. This approach made gameplay as a company and gameplay as a gaming experience for hardcore gamers pivotal to our growth and expansion. For us, the viral games were a top-of-funnel way to lure a wide range of gamers to the site, and the network effects built into and around the games hooked them into spending hours with us, retuning repeatedly throughout the day, and becoming creators in the marketplace, which gave us a low-cost way to continually innovate and offer value to our users. Now, those were the heady days of the internet and I’m proud to say that although the business is different today, Gameplay survived through it all. We were too early in the market, but we did learn some early insights that highlighted the difference between the power of network effects and the useful but fleeting impact of virality.
At Gameplay, when we focused on what we now call network effects, as many game companies do now, we were winning. When we used virality to get people to the site and convert to our call to action (CTA) with a low customer acquisition content (CAC) and then layered different combinations and types of network effects, we yielded the greatest results. And if we had had access to Amazon Web Services (AWS)—and all of the infrastructure, resources, and expertise—at that stage, we would have been able to ensure that our entire network didn’t crash that day!
With virality, you have to constantly come up with new forms of viral engineering and content to stay ahead. This leads to geometric growth, which is great to see, especially at early stages and can impact the perceived value of your business—but it doesn’t necessarily lead to growth in value of your offer to customers. Determining how you can leverage network effects, so that the awareness and engagement you’re getting from viral growth can also contribute to increasing the value of your product or service, can quickly become a winning formula if you get it right.