CAREERSLinkedin 🔴🔴🔴: NETWORK EFFECTS DEFINITION 🔴🔴🔴

WHY NETWORK EFFECTS ARE IMPORTANT?

70% of the value created in technology since 1994 has been driven by network effects. Still, too few Founders understand network effects well, nor know how to design them into products.

NETWORK EFFECTS DEFENSIBILITIES

Scale,
Embedding,
Brand,
Network Effects.

Of these four, network effects are the most powerful!

NETWORKS ARE ANY SET OF NODES AND LINKS

Nodes are network participants. Not all nodes are equal in function and importance. Central nodes have a high relative number of links, and marginal nodes have fewer links.
Network size can be measured by the total number of nodes in a network, and degree is a measure of the number of links each node has.
Links are the connections between nodes in a network. Links vary in terms of directionality, the strength of the connection, and the frequency of activity.
Network density is the proportion of links to nodes within a network.

NETWORK DENSITY

Network density is the ratio of its links to nodes. The higher the ratio, the greater the density of the network. Typically, the higher the density of the network, the more powerful its network effects are.
Founders should build products to promote higher network density. Within a network, density is usually distributed unevenly. At the beginning, Founders should typically focus on the “white-hot center” of your network, where the density and activity are highest, and let the network grow from there.

DIRECTIONALITY

A link between nodes can be either directed or undirected.
Directed links denote one-way relationships. When the interaction between one node and another isn’t reciprocated, it’s a directed link.
Undirected links are two-way, reciprocal relationships. The interaction between two nodes on a network with undirected links flows both ways.

ONE-TO-ONE vs. ONE-TO-MANY

Relationships between nodes in a network can be one-to-one, or they can be one-to-many.
YouTube is an example of a network with one-to-many links (accounts with large followings that they don’t follow back).
Facebook has one-to-one connections at its foundation.

NETWORK CRITICAL MASS

The critical mass of a network refers to the point at which the value produced by the network exceeds the value of the product itself and of competing products.
Most products with network effects must ultimately reach critical mass in order to fully take advantage of the defensibility provided by their network effects.
Before the size of the network reaches critical mass, the product remains quite vulnerable and may not have much value to users.

THE NETWORK “LAWS"

These laws describe the rate at which network value increases as they scale.
Sarnoff’s Law describes broadcast networks, which increase in value in proportion to N (with N being the number of nodes).
Metcalfe’s Law describes networks without clustering, which grow in value at a geometric rate (N^2).
Reed’s Law applies to networks with clusters, which increase in value at an exponential rate (2^N)

REAL IDENTITY, PSEUDONYMITY, & ANONYMITY

Many network effect businesses require users to create a profile that’s visible to other nodes in the network. Networks with profiles tied to a node’s real identity, like your real personal name or real company name, are typically more effective at building network effects than networks with pseudonymous profiles (e.g. user-generated handles like “Tiger123”) or completely anonymous networks.

ASYMMETRY

This term relates mostly to marketplaces, whether that marketplace is 1, 2, 3, or N-sided.
In nearly every marketplace, one side - or one type of node - is harder to acquire than the other. In a “demand-side marketplace,” the demand side (buyers) are harder to acquire. In a “supply-side marketplace,” the sellers are harder.
Look for these various asymmetries in a marketplace and prioritize which types of demand or supply will be the best to attract first, second, and third. Then focus on developing tactics to crack the highest-value target first.

HOMOGENEOUS VS HETEROGENEOUS NETWORKS

Homogeneous networks are networks where all the nodes have the same function in the network. One user is interchangeable with the next in the basic function they perform. In a landline telephone network, for example, each node (telephone) performs basically the same function as any other.
Heterogeneous networks are networks where there are two or more classes of nodes categorized by both function and utility. Buyer nodes on eBay, for example, are on the network for fundamentally different reasons from seller nodes.

SAME-SIDE NETWORK EFFECTS

Same-side network effects are direct network effects that occur on the same side of a multi-sided (2-sided or N-sided) network. A platform like Microsoft’s OS, for instance, has a same-side network effect because Microsoft users directly benefit from an increase in other same-side users (on the demand side of the platform) since they can interchange Word, Excel, and other files with a greater number of people. This makes both the platform itself and applications developed on the platform more valuable for users.

CROSS-SIDE NETWORK EFFECTS

Cross-side network effects are direct network effects that arise from complementary goods or services in a network with more than one side. As opposed to indirect network effects, cross-side network effects refers specifically to the direct increase in value to users on one side of a network by the addition of users to another side. More supply is better for the demand. More demand is better for the Supply.

INDIRECT NETWORK EFFECTS

Indirect network effects occur when the value of a network increases as a result of one type of node benefitting another type of node directly, but not directly benefiting the other nodes of its same type.
Same-side nodes indirectly benefit each other because they create an increased incentive for complementary users on the other side of the network to use the network, which in turn benefits all the nodes on the same side.

MULTIPLAYER VS SINGLE-PLAYER MODE

“Multiplayer mode” and “single-player mode” are terms that came from the gaming industry, but are useful for discussing network effects.
With single-player mode products, you get the full value of the product no matter who else is using it. For example, filing taxes via TurboTax. With multiplayer mode products, some of the value of using a product (and often the majority of it) comes from other users. A multi-player product lets you feel and benefit from the activity of other users.
Products can have both single-player and multiplayer value. Watching YouTube videos is a single-player experience. YouTube, with view count and comments, is also a multiplayer experience.

SWITCHING COSTS

Switching costs refer to the costs in time, effort, or money that arise when you switch from using one product to another incompatible product. When switching costs are high, it tends to create customer lock-in because the customer has more of an incentive to stick with the same supplier throughout their life cycle. Any product that has a lot of defensibility will have high switching costs

MULTITENANTING

Multi-tenanting occurs when there are low costs or no costs to simultaneously participating in competing networks at the same time. When the two sides of a marketplace switch between services to get to the other side of the marketplace at no cost, that’s multi-tenanting. For example, both riders and passengers frequently switch between Uber and Lyft to find rides/passengers.

DISINTERMEDIATION

Disintermediation is a vulnerability that mostly applies to Marketplaces and Market Networks. It happens when, after initially connecting through a marketplace or market network product, users take future transactions off the product and transact directly, without paying a fee to the marketplace.
For example, you might hire someone to build IKEA furniture using Taskrabbit, and then exchange numbers so that you can hire them for future jobs directly.
This is a significant problem for marketplaces and market networks because repeat purchase is critical to most transactional networks.
To help prevent disintermediation, you can provide tools, reputation, insurance, compliance, leads and other incentives.

RETENTION

Retention is about how often your users return to use your product. This can make a big difference in how powerful the network effects of a product are.
Recall that network effects happen when increased usage of a network leads to greater value. Usage can increase in one of two ways: either new users join the network, or existing users increase their usage.
Any drop off in usage from existing users will weigh against the growth of the network from new users. That’s why retention is so important for building network effects.

VIRAL EFFECTS AND VIRALITY

Viral effects are different than network effects, but many people confuse the two because they are both positive feedback loops, and because they were experienced together in famous companies like Facebook, Twitter, and WhatsApp over the last 15 years.
Viral effects are about growth -- when existing users bring you more new users for free. Network effects are about defensibility: a product gets more valuable when more people use it. A product or service with viral effects has a “viral coefficient”, which is the number of new users that join as a result of each user.

BRAND

Brand defensibility is different from network effects. Like scale, the strength of your brand is correlated with the growth and usage of your product, so it’s easy to confuse brand with network effects. However, they work very differently.
Brand arises when people know who you are and what you do. A well-established brand identity comes with psychological switching costs. People are less likely to switch to an unknown or lesser-known brand from yours because psychologically they will default toward what’s familiar

EMBEDDING

Embedding is an effective defensibility strategy that involves integrating your product directly into a customer’s operations so the customer can’t rip you out and replace you with a competitor without incurring significant cost in terms of time, energy, or both.
Embedding can work with network effects to make your business more defensible, but they are separate concepts. Business models based on embedding include Oracle and WorkDay

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NETWORK EFFECTS DEFINITION 🔴🔴🔴