The Billion Dollar Value of Immovability
How an inferior product can leverage its users to dominate a market
October 13, 2020
Special thanks to Dr. Steven Weber of Drexel University, for introducing me to the subject. To Dan Mall of SuperFriendly, for inviting me to give a talk on the subject and inspiring this post. To Gaby Goldberg, for her wonderful suggestions and edits. And to my good buddy Kevin Finch, for his diligent proofreading and being a great friend.
Trouble in the Neighborhood
On August 7th, it was revealed that Google banned a very specific phrase. They banned it from all internal documents, all official communications— they even discouraged employees from using this phrase in casual conversations. In fact, it's the same phrase that enabled the US government to prosecute Microsoft for anti-competitive practices in 1998. The loaded phrase is “network effects”. Sounds powerful, right? Let’s dive into what network effects are and how to create them.
What are Network Effects?
“Network effects” are a key principle in network science that describes why individuals experience benefit or detriment when aligning their behavior with the behavior of others. Situations such as a user joining a social network, where their action of joining benefits all other users on the network, would be considered a network effect.
At its core, network effects are the result of users contributing value. Let that hit home. Network effects are when users contribute back to a platform, and their presence makes the platform more valuable for other users. Leveraging network effects is “the single most predictable attribute of the highest value technology companies” and accounts for “70% of all value in tech”. Unfortunately, this doesn’t happen automatically. It’s the platform’s responsibility to foster this level of interaction and value-creation. This will be our main focus: How can we enable users to give back to the platform we’re creating? But first, let’s dive deeper.
A social network is the traditional exhibit of network effects in practice. With only one user on a platform, the network is useless. But the moment another user joins, the two users can connect, they can interact, and they can communicate, making the network valuable to join. For every new user that joins, the network becomes increasingly more valuable.
When new users start to realize how much content existing users have contributed to a platform, they won’t leave. With enough content and a growing user base, it doesn’t make sense to! In fact, they’ll start to contribute themselves, and recommend their friends to join. Think about the excitement when you first made your Facebook account ~2008. All your friends were on there, everyone was posting, and it was fun. You made your first post, got some likes, and got that dopamine flowing. Then you probably told a friend or two to join after that rush. This is what’s called a “high-inertia market”; once users start to join, growth happens, and it happens very quickly; a chain-reaction of users joining, creating content, and contributing more value. Once that growth starts, users become less and less incentivized to switch to a different network with similar functionality. Why switch to a new platform when Facebook is where you’re already connected to almost everyone you know? Staying on the network has far more benefits than leaving.
A Market Share Cheat Code
So, why did this word get banned from Google? The term 'network effects', as determined by economists, is on par with anti-competitive practices. For big companies to leverage network effects, it becomes proof that their goal is to squash competition and to become immovable in their market. Using the term, in combination with a dominant market share, is enough evidence for regulators to prosecute anti-competitive behavior.
If you turn the tables, however, and you’re a small company without a dominant market share, this “anti-competitive” practice becomes one of the most valuable parts of your business— a cheat code to gain market share. The beauty is network effects don't pick sides; the user-value chain reaction is just as powerful whether Google is facilitating it or you’re facilitating it. For startup founders, it’s crucial to understand network effects and think about how you might implement them. In fact, network effects may be the underlying driver to your business without you even realizing it. If your business is a social network, a two-sided marketplace, or any platform where users interact, you need to pay attention. This concept will allow you to overtake competitors, and once integrated successfully, will enable your business to become extremely defensible.
Defensibility is Value
Network effects are one of the four main defensibilities of a business. According to the Venture Capital firm NfX, the other defensibilities are brand, scale, and embedding. Defensibilities protect your business from being copied or overtaken by a competitor, so businesses should aim to equip at least one of these four defensibilities; without one, your business becomes vulnerable. Network effects are the most valuable defensibility because it’s the hardest defensibility to employ, and therefore hardest for a competitor to successfully duplicate.
You’ll also notice how the high-inertia of a growing platform with network effects is very difficult for a competitor to disrupt. Bill Gurley, in his essay titled “All Revenue is Not Created Equal”, backs this claim up by stating “No discussion of competitive advantages and barriers to entry is complete without a nod to perhaps the strongest economic moat of all, network effects”. That “economic moat” of network effects will serve to fuel a business’ immovability and dominance in their market.
If you consider the Facebook example, with friends and family supplying so much content, users simply have no reason or incentive to switch to another less-popular network, no matter how bad the current one is. Once the users’ behavior is aligned on a big enough scale, convincing them to switch to another network will be very difficult— nearly impossible. Because of this, the success of a network employing network effects is almost impossible to repeat within the same market. The network effects have created a defensive barrier from competitors. This is why it’s considered anti-competitive for a company like Google, but absolutely necessary for a young startup. Platforms with network effects are not going anywhere. This is defensibility at work.
Finish First, or Don't Finish At All
Now, there are six principles that describe a market influenced by network effects.
Influential economist Brian Arthur describes an industry with network effects as having these traits in common: market instability, multiple potential outcomes, unpredictability, the ability to lock in a market, the possible predominance of an inferior product, and fat profits for the winner.
Essentially, anything can happen, and whoever wins the race will win big. What I think is the most interesting is the possible predominance of an inferior product. This market symptom, as well as the others, is because network effects cannot be duplicated. I’ll say it again: the success of a network employing network effects is almost impossible to repeat within the same market. You don’t have to be the best, you just have to reach the tipping point first, then there’s very little a new competitor can do to take those users away from your high-inertia network (we’ll get more into the tipping point in part two). We discussed this with Facebook, but it’s true for all companies employing network effects, and is a symptom of the immovability.
Even with an inferior product, once tipping point is reached, your runway for implementing feature upgrades or a monetization strategy becomes longer and longer with each user you add to the platform. This is why you see unprofitable companies being fueled by investor dollars. One day it’ll pay off, and pay off big. We’ve seen it time and time again. Finishing first is more important than finishing with the best implementation.
How to Create Your Own Network Effect
There are a ton of features a product might introduce to incorporate network effects. As a matter of fact, there are at least 13 different types of network effects you can employ. We’re not going to go through them, but it’s definitely worth mentioning the variety of approaches you can take.
For this post’s purpose, we’re going to focus a little more broadly. How we implement network effects can be written differently, and make our objective more clear: How can we enable users to give back to the platform we’re creating?
The first step is to analyze what data your platform is working with. What’s your resource? What is already bringing value to your platform? Why are users coming here in the first place? What makes you unique?
The second step is to enable users to contribute their own versions of this thing back to the platform for other users to consume. As James Currier puts it, the goal is to turn your product into a multiplayer experience: “‘Multiplayer’ products, [...] let their users feel the presence and impact of the other users of the product, but have a hard time being useful without those other users. Multiplayer products let users add value to each other through their actions, even if it’s just viewing something, like on YouTube.”
For social networks, this is obvious. Allow users to interact, to create posts, and share content. Easy. You’ll see that many networks implement sociality for the network effects benefits, like Venmo. But what about a non-social network? A product that doesn’t necessarily have a social aspect?
Creating a Multiplayer Experience
Let’s talk about Unsplash and how the business introduced network effects. For those that don’t know, Unsplash is a platform where anyone can download high-quality royalty-free pictures, completely free. It began as a collection of pictures uploaded by the sites’ author Mikael Cho. It was one person uploading, and several users downloading– a unidirectional, ‘singleplayer’ experience. Cho then saw the demand, and whether he knew it or not, began to incorporate a network effect.
Cho knew other photographers had a ton of extra pictures with no use for them, so decided to turn the platform into a multiplayer experience by enabling users to upload their own pictures that they’ve taken, released under the same free-to-use license. The amount of content available on the site exploded. The platform’s relationship with users became bidirectional, as users began contributing back while simultaneously consuming. It benefits both parties, too: users benefit from a wider-variety of pictures, and photographers get a huge amount of exposure from the growing user base. By aligning their behavior on the platform, all users benefit and the network grows in size and value. Like Cho, your goal as a founder is to ‘set your platform free’, and let the users contribute back to support the growing network.
Don’t Fumble Your Opportunity
Sometimes network effects go uncaptured, as well. It’s the founder’s job to recognize how users want to use the network and facilitate that. Dan Mall shared a link with me recently where somebody created a third-party website that acted as a directory for companies’ design systems on Figma. Not capturing this network effect is a massive failure of Figma. The platform has a resource: a collection of public design system files. This resource can directly benefit other users on the platform, but Figma has failed to make a direct integration on their platform and facilitate a network effect.
This is a blown opportunity for making themselves a highly-defensible company, and leaves room for a competitor to capture that network effect first. Remember, once the first company in a market captures network effects, they will dominate and become immovable. Even though the main service of Figma isn’t its network effects, they become exposed in the market by not capturing this opportunity. The third-party product validates that users want this network effect, and Figma is currently missing the boat. In my opinion, the first design tool to successfully capture this network effect of public design will become the dominant design-tooling company, and will reap the rewards of that title. From my perspective, the race is on. Let’s see who wins.
So, whatever your platform does, whatever data your users are creating, if you enable that data to support other users in any capacity, that's a network effect. Make your platform bidirectional. Turn your consumers into producers. Aim to create a two-way relationship between your platform and your users. Allow them to contribute back and add value to your platform for you. Like we discussed, even if the product is inferior, with good network effects you can win the market share against a much larger company.
While introducing a network effect can launch your business into a path of automatic high growth, it’s also one of the most difficult challenges a new startup can face. Getting those first users and laying the foundation for your network is not easy, and is partly responsible for the high failure-rate of startups. In part two, I’m going to dive into how we can grow our network effects and drive a new business onto the path of guaranteed success. Your billion-dollar valuation awaits. Follow our Twitter to find out when part two drops.