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A Summary of

The Dynamics of Network Effects

by
D'Arcy Coolican, Li Jin
a16z
View original

All of the most successful technology companies have relied on network effects. As platforms with network effects get bigger, they get better. Recently, network effects companies have been splitting markets despite big moats. Network effects are as dynamic as ever. 

Not all products are created equal

  1. Ridesharing 
    1. Driver supply and passenger demand reinforce each other 
      1. More drivers means lower wait times 
      2. More passenger demand means more drivers want to drive 
    2. Once there are enough drivers to satisfy less than 5 minute wait times, passengers are indifferent to increasing network effects
  2. Social lending 
    1. Changes in network effects can be driven by absolute liquidity 
    2. If Frank was lending his money to friends, more friends meant more demand 
    3. Once a group had more than 7 friends, they became less likely to lend or borrow since people only have approximately 7 friends they trust
  3. Social networks 
    1. Adding more people to Facebook turned it from social network into social media 
    2. Adding additional nodes in context of media discovery was less valuable as more people joined the app 

Users and inventory

  1. Type of incremental user 
    1. Not all members of a given network are equal 
      1. Popular restaurants add more value to OpenTable than a restaurant nobody wants to go to 
    2. Making sure you incentivize the users you want is key 
  2. Commoditized vs differentiated supply 
    1. Platforms with more differentiated inventory have stronger network effects 
    2. The more differentiated inventory, the more the platform needs to a good job of curation and matching

Competition

  1. Network overlap 
    1. Think about which competitors have a network overlap and could potentially move into your market 
      1. DoorDash and Uber Eats 
  2. Switching costs 
    1. Low switching costs can also lower network effects 
  3. Multi-tenanting to meet demand 
    1. Network effects are weakened when users are unable to use a single platform to accomplish their goal 
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