Imagine as a business you are shown two doors. Behind door one, you have unlimited growth powered by value delivered to users and behind door two you have growth that dies out after the initial hype. Any business that needs to survive and build a lasting relationship will choose door two. Network effect powers door two before we detail out what network effect is let’s start with a story.
Sometime in 2014, Alex Zhu the founder of an education startup was traveling from Mountain View, California. The app Zhu had launched after six months of hard work was labeled a failure and had left him with 8% money from the $250,000 raised via venture capitalists. Faced with dire consequences, Zhu could have shut shop and returned money to investors.
But he chose otherwise Zhu knew the only way he could keep his company running would be to pivot away from being an educational app. It was on this train ride that Zhu found that majority of teens were listening to music while the other half took selfies or videos, covering them in stickers, and then sharing the results with their friends.
Zhu realized that using the code they had written for the educational app they could create an app which could combine music, videos, and a social network to attract the early teen demographic. Zhu along with his co-founder spent the next 30 days bringing this idea to life in the form of an app. They named the app Musical.ly and launched it in July 2014.
Today the app has over 200 million users across the world, but it wasn’t an over night success. After the first 14 months of the launch, the growth had started declining. Zhu knew for network effect to kick in they had to translate usage into retention.
Zhu and team started looking at possible areas of improvement. A lot of users on the platform were sharing the videos on Twitter and Instagram, so the team made the logo more prominent to get higher brand recall and downloads. They also realized that not all users were equal. Few users had more following and published content more frequently than others. To allow the ‘musers’ (as Zhu calls them) to interact with each other they created a Q&A platform within the platform. Both the changes enabled the app to improve usage which ultimately allowed the network effect to work in their favor.
What is Network Effect?
Zhu’s story exhibit how network effect can help you to scale your platform. So how do you define ‘network effect’?
Network effect occurs when a product or service becomes more valuable to its users as more people start using it.
Network effect is also known as demand side economies of scale. Facebook and Whatsapp are classic examples of companies that had network effect working in their favor.
That brings us to the question how would you know that your brand has Network Effect? For a brand to have to network effect it has to meet two key factors. Barriers to Entry and Barriers to Exit.
Barriers to Entry
Barriers to entry focuses on what is your product/service and what is the competitive advantage that you can offer that can’t be easily replicated. As Facebook grew in size its competitive advantage switched to having more users on the platform which became a reason for more people to sign-up on the platform.
Barriers to Exit
With Facebook, you have so many connections that it becomes ultimately difficult for any user to leave the platform. Besides the content that is valuable the user also develops sentimental value towards the platform.
How Network Effect Makes Content More Valuable?
If you are in a business that acquires new customers make those customers valuable to each other so that value compounds on top of each other. A Marketplace has multiple parties involved which allows value to be transferred to one another. For instance, as Airbnb gets more hosts the platform becomes more valuable to travelers as they get more selections. Similarly, if the platform gets more travelers, it becomes more valuable to hosts, as they can make more money on the platform. Ben Gilbert, Co-founder of Pioneer Square Labs calls this ‘cross-side network effect’.
If you forget that the platform has travelers and hosts even as more reviews are added to the platform it comes more valuable to travelers leading to network effect. This is called ‘same-side network effect’.
Then you have Flywheel effect which has been only mastered by a handful of companies in the world including Google and Amazon. For instance, Amazon with its lower cost structure has been able to lower prices which enables it to offer superior customer experience along with a larger selection from varied sellers leading to higher traffic.
Network Effect is a growth engine for companies. If you are start-up think of how will you make your product/ service more valuable to your users? If you are offering a feature, then think of how you can work with platforms like Facebook which have network effect to reach more users. As Eric Jorgenson from Zarely shares using content is the most effective way to demonstrate the value of a network to users.
The secret to creating a social product that demonstrates immediate value is to enable content before creating the network. Content created on the network is the new source of competitive advantage. The videos on YouTube, the pictures on Instagram, the answers on Quora are the primary source of value for users and the key driver of competitive advantage for these platforms.
What are your thoughts on network effect? Do you know of any non-tech brands that have created network effect for their product/service? Do share your thoughts in the comments sections below.