Evergreen is a collection of links to the best learning resources in business, collected by a group of managers, founders, and investors. We contribute resources about one topic each week, which are synthesized and shared in this Weekly Edition. The aim is to learn more efficiently through increased context and focus. Join here to receive the next Edition of Evergreen Business. Show
Remember, these are designed to feel like short books, you’re meant to meander and spend ~3 hours on this topic this week. Save some of these links and read them throughout the week. Immerse yourself in this topic and leave the week smarter than you started it! Some of the most powerful and fastest-growing companies are based upon Network Effects. That makes this an exciting topic—to find out what’s behind Apple’s app ecosystem, Facebook’s social content, and Airbnb’s community. Here’s what’s coming up in this Edition of Evergreen:
What Exactly are Network Effects?Network Effects were not really ‘a thing’ until we started to build a layer of technology for communication around our planet. It was coined in the early 1970's as academics began to study the growth of the telephone network. Here is the best definition I could find of Network Effects:
This is a more precise definition than many others floating around because of a few key concepts:
Types of Network EffectsThere are different ways that Network Effects can exist, and their dynamics change depending on the application. These concepts are often mistakenly conflated into ‘Network Effects’. Work to understand the differences, because they are not conceived the same way, and they don’t create the same results. This short breakdown from the Stern School of Business (NYU) defines the types of Network Effects: Direct Network Effects:
Indirect Network Effects:
Two-sided Network Effects:
This is the type of Network Effect that defines Marketplaces such as Airbnb, Uber, and Zaarly. More riders does not necessarily improve my Uber experience but it does attract more drivers, which will improve Uber for me. [If you happen to be working on a Marketplace or interested in them, this is an important core concept to understand. Here are two more great resources on this topic, specifically: Strategies for two-sided markets, and Jean Tirole on Platform Competition. Both valuable contributions by Karthik Rajeshwaran] Local Network Effects:
Zaarly is also a good example of this: A new Homeowner who joins in Denver contributes to the Denver Network Effect, and does not influence the quality of the experience for Homeowners in Austin. Instant messaging is another great example of a product that displays ‘local’ network effects which are social rather than geographical. What Network Effects are NotIn addition to being conflated amongst themselves, Network Effects are also conflated with other adjacent concepts in business. To understand any concept well, it’s helpful to understand what it is Not. Network Effects are Not ViralityA viral product is one whose rate of adoption increases with each additional user. The more people join, the faster it grows — until a certain point. They’re often confused because both Network Effects and Virality increase growth of a business and it’s value as new users join. However, they are completely independent concepts, as we see here:
Here’s a graphic that shows some examples of each of these concepts independently, as well as companies that have both: Thanks to Karan Khandpur for suggesting the great post with these ideas! Network Effects are Not Economies of ScaleEconomies of Scale arise (and there’s a whole separate Edition to come on this) when there’s sufficient volume of production to massively reduce the costs, so the largest player can maintain the best margin of profitability. Network Effects are distinct from Economies of scale because they produce greater value for the marginal increase in cost. As Networks grow larger, the cost increases, but the value of the product increases faster. The fact that Apple sells a lot of iPhones does not mean that it has Network Effects, just Economies of Scale. The fact that people want to buy it so that they can use iMessage with their friends — that’s the Network Effect. Why Network Effects are PowerfulTo the fun part — how to create Network Effects, and benefit from their incredible power to extract value. Let’s start with the Endgame. Why Networks create so much valueThere is one graphic that conveys the full concept of Network Effects. It was contributed by Ray Stern, who created it when he was training employees as CMO of Intuit. Take it all in… This visual showed me the value of Network Effects more clearly than all of the other posts and papers out there. The heart of the power of Network effects is right here: Value Increases Exponentially — Costs increase Linearly. The cost of maintaining the network does not grow as fast as the value of the network. The value increases as the size of the network increases. The implication is a principle that anyone operating in an industry influenced by Network Effects should understand: in the long run, there will tend to be fewer players, and they will continue to grow larger. “You can suck at everything and still make money”Another reason that Network Effects are so valuable is that they don’t require a ton of maintenance. Once they’re built, they tend to perpetuate themselves. Even if they’re managed completely incompetently. To paraphrase Warren Buffett: “It’s great to own a business that a monkey could run — because sooner or later, one will.” Here’s what James Currier learned from his time working at Monster.com:
That sounds like a good business to run — lots of margin for error, which is a great asset. We should all aspire to start businesses where we can suck at everything and still make money. (Then if we don’t — it’s all upside!) How to create Network EffectsNot all businesses can create Network Effects, and not all businesses should. There are a lot of approaches to this strategy, and it’ll look very different depending on your company and your industry. Come for the Tool, stay for the NetworkIt seems like in many cases, strategic openings to create Network Effects only become available after certain levels of success with simpler products. Chris Dixon has a very short post about this on his blog, which was suggested by Itamar Goldminz, Karan Khandpur, and David Barnes :
For example:
You can’t attract your first user with a network effect (because there is no network, and therefore no value.) Unless… Dominating Extremely Tiny MarketsAnother option is to create Network Effects in minuscule markets. We saw this as Facebook got started at Harvard. They had to start with a tight social group, like a class or group of friends — and grow quickly within a small and well-defined group, until they had a meaningful network to that demographic. This is a concept that Sean Ellis calls “Minimum Viable Critical Mass”. Product/Market Fit in Network Effect ProductsIf you’re relying on a Network Effect as your competitive advantage, it’s not as easy to test your value proposition and get early feedback from customers. Sean Ellis has some great slides about how different it is to find Product/Market Fit for a Network Effect Product: This last slide, Priming the pump is code for ‘Fake it till you make it’. If your product relies on Network Effects — you may have to create the illusion of a network for early users. Do what it takes to test your concept and get validation and early traction. Content Networks vs. Connection NetworksSo far we’ve only talked about Networks of people. The Network Effect Playbook, by Sangeet Choudary (which was suggested by Eric Wilson and Itamar Goldminz) proposes that there are two ways to solve the problem of creating a Network — connection and content.
Content platforms create Network Effects not through interaction, but through hosting videos, posts, etc. This lets them reach the point where they’re providing more value to new users much more quickly than the connection model, which relies on existing users in a social circle.
This stored value has a long tail, and will be an asset to the platform for potentially years to come. There are some very good thoughts in the Network Effect Playbook, and lots of inspiration for new ways to build content platforms, which could build Network Effects. If you enjoyed this, you’ll get more like it by joining Evergreen: My Other ProjectsUpcoming Book: The Almanack of Naval Ravikant Mini-book: Career Advice for Uniquely Ambitious People Personal Site: EJorgenson.com Evergreen Lives on DonationsEvergreen requires time and money. If you find this project helpful, please consider buying me a coffee, or sending some Bitcoin. BTC Wallet: 3KiLX3bjnpmb3a4YiBhm3vSNiV2Erxk1fX (If you’ve never used Crypto before, Coinbase is the easiest way to start.) Thank you very much! ❤ ☺ Thank youMassive appreciation for who suggested pieces of content (or wrote something new) for this Edition of Evergreen: David Duckworth, Itamar Goldminz, Aaron Wolfson, Karthik Rajeshwaran, Eric Wilson, David Barnes, Karan Khandpur and Ray Stern. Many thanks for being a part of this project! Not every suggestion is able to make it to the final edit, but every single suggestion is read and appreciated. Never EnoughAs my Father always says: “There’s always room for the best.” There’s always a better resource out there. These collections can always get better, and I hope that they do. If you can think of anything that was missed, I welcome you to share it. To share your thoughts, improvements or additions: Email or Twitter. If you liked this, check out other Editions of Evergreen:Building and Managing a Team:How to Find and Recruit the Team you Need What is staying power in network effects?The concept of staying power (and the fear of being stranded in an unsupported product or service) is directly related to switching costs (the cost a consumer incurs when moving from one product to another) and switching costs can strengthen the value of network effects as a strategic asset.
Are benefits provided by products or services that add additional value to the primary product or service that makes up a network?Complementary Benefits. Complementary benefits. are those products or services that add additional value to the network.
Which other terms are sometimes used to describe the phenomenon of switching costs?Switching costs also go by other names. You might hear the business press refer to products as being "sticky" or creating "friction." Others may refer to the concept of "lock-in." The concept of staying power is directly related to switching costs.
What are the three primary sources of value for network effects give a brief description of how each of these factors provides value for network effects?Three primary sources of value for network effects are exchange, staying power, and complementary benefits.
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