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Ep. 3 - Mapping Out The 16 Network Effects — Transcript

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0:00(upbeat digital music)
0:03- So when people first encounter network effects,
0:05they think there's a network effect,
0:06or there's not a network effect.
0:08That's like saying there's life, and there's not life.
0:11There's actually different types of life
0:12and there's different types of network effects, okay?
0:15Not all network effects are created equal.
0:18And we started studying and noticing
0:20these things back in the 2000's,
0:21and by the time we got to about 13 network effects,
0:24what we realized was we needed a map.
0:26And so we've come up with a map to help us visualize
0:29the different network effects and where they all fit in
0:33in terms of how strong they are, what types they are,
0:35and then delineating how they're different from each other.
0:38And that was a few years back,
0:39now we're up to 16 network effects and we're gonna walk
0:41through all of them with you right now.
0:43(upbeat digital music)
0:48Okay, so the first time we saw a commercial application
0:50of network effects was way back, 1907.
0:54The chairman of the board of AT&T
0:56who was deploying physical phones and copper wires
1:00to connect them all together so they could talk
1:01to each other, he said in his report, his annual report,
1:05"You know, you might wanna buy our stock
1:07because what we've noticed is that when we go into a town
1:10and we get a few nodes and a few of these copper wire links,
1:14nobody can compete with us, and we end up taking
1:16all the business in the town.
1:19So in every town we get into it, we own everything.
1:21We're probably gonna have a pretty good business here".
1:23He noticed it, he explained it,
1:25and he gave business reasons why it was important
1:28and boy, was he right.
1:29Now, this physical direct network effect,
1:33the physical being the copper wires,
1:34the physical being these telephones,
1:36these heavy black telephones
1:37that would sit in people's homes,
1:39this was the first commercial network effect discovered
1:41and it turns out to be the strongest network
1:44that we know of, okay?
1:46Now there's a whole type in the center
1:47of the network effects map, these blue network effects.
1:52And these are known as the direct network effects,
1:54because every node can touch every other node
1:58in the network and wants to.
2:00The physical is the most powerful,
2:02because once you've actually embedded atoms in the ground,
2:04like if you're Comcast and you're putting cables
2:06to people's homes, or you're AT&T,
2:08once you have these physical things in the ground,
2:10it's very hard to rip them out. Okay?
2:12And so I think Comcast has the worst NPS score
2:14of any major corporation in America,
2:16and they can afford to do that
2:18because we can't replace them because they have
2:20this incredible, direct physical network effect.
2:23And so that's at the core of our network effects map,
2:25physical direct network effect.
2:26(upbeat digital music)
2:30The second direct network effect, we call protocol.
2:33And you can see this with faxes or with ethernet
2:36or with Bitcoin, where you develop a protocol,
2:39you publish it widely, everyone can now attach
2:42to this protocol, and the more people use that protocol,
2:45the more benefit everyone gets from that protocol.
2:47So even crappy protocols like fax
2:50are still surviving in the 2020's,
2:53even though they were invented in the '70's,
2:56because so many people are using
2:57that protocol network effect.
2:59(upbeat digital music)
3:03So the third most powerful network effect we've seen
3:06is the direct personal utility network effect, okay?
3:11Where you have your identity, like WhatsApp,
3:14or like Facebook Messenger, or WeChat,
3:17where it's personal to you, it's direct
3:19because I can connect with anyone on WhatsApp,
3:21I can connect with anyone on Facebook Messenger,
3:24on WeChat, and it's utility, meaning I get some utility
3:28out of it, like making a payment,
3:29or picking the kids up from school.
3:31I'll tell you if my wife, you know,
3:33hits me on WhatsApp and says,
3:34"You need to pick the kids up from school", and I don't,
3:36I'm in deep do-do, so I need to be on that network,
3:40I cannot leave that network, all right?
3:43That is a good defensibility,
3:44that is a good retention of me
3:47and that's what network effects are there to do.
3:49(upbeat digital music)
3:52The fourth one is what we call
3:53the personal direct network effect,
3:54which is what Facebook has, which is it's my person,
3:56it's my name, it's my picture, and I've got all my friends,
3:58it's a direct network effect, I can see them all,
4:00they can see me, I can friend somebody,
4:02can unfriend somebody, every lot works,
4:04but it's not as powerful as the one with utility.
4:07I could stop using Facebook next week, not a big problem,
4:10but if I stop using WhatsApp, big problem,
4:12I didn't pick up the kids, I'm in deep do-do.
4:14But on the other hand, it's a very powerful network effect,
4:17this Facebook network effect, this personal direct one,
4:19because am I gonna spend a ton of time
4:21building a new friend group if I've already immersed myself
4:24in that friend group?
4:25I'm really not, I might stop using Facebook
4:26for various reasons, but I'm probably not gonna spend
4:28a huge amount of time building a new friend group.
4:30When I get sick of being away from Facebook,
4:32I'll probably just go back to it, and we see this,
4:33people do this all the time, they quit Facebook
4:35and then nine months later they say, "I'm back", why?
4:38Because you have this retention, this defensibility,
4:40this network effect that adds value to every node
4:43on the network, and no one wants to leave it.
4:45(upbeat digital music)
4:48The fifth network effect is the market network, okay?
4:50And this is also known as an end sided marketplace,
4:53but it's still a direct network effect.
4:54And basically how it works is, if you have a wedding,
4:58let's say, you're gonna need a florist,
5:00you're gonna need a venue, you're gonna need
5:01a wedding planner, you're gonna need a caterer,
5:04these are all nodes on a network
5:07collaborating on a project,
5:09and in the real world they know each other,
5:10they connect with each other,
5:12but we haven't seen it put in digital format yet
5:15so a market network puts it in digital.
5:17Now they can see each other,
5:18they can transact with each other,
5:19they can plan on their calendar.
5:21There's typically a workflow software,
5:22which allows them to coordinate,
5:24in this end sided marketplace, okay?
5:27And once you're on there, once you've got your name
5:30and your reputation and your transaction history there,
5:32you're not gonna wanna leave
5:33because it's your source of income,
5:35just like a marketplace would be.
5:36But in this case, it's end sided,
5:38everybody in 360 degrees can transact with each other.
5:42(upbeat digital music)
5:46Okay, so the sixth network effect
5:48is a two-sided marketplace network effect, very common,
5:50whether it's Craigslist or monster.com or, you know, Uber,
5:54you've got a supply side and a demand side,
5:57the more supply you have, the more value the demand gets
5:59and vice versa, it's called indirect network effects
6:02or cross side network effects.
6:03And the marketplaces one is now in red
6:05because it's got a very different shape
6:07because supply and demand,
6:08it's not an end sided type of a situation
6:10like a direct network effect is,
6:11that's why we changed the color and made them red.
6:13These are very durable, as you know,
6:15because so many of the marketplaces online
6:17are still around years later.
6:19Now, they can be attacked, right?
6:20I mean, eBay's been attacked by Amazon Marketplace
6:22very successfully, by building pro seller tools
6:26that were basically better than what eBay had,
6:28so people multi-tenanted and moved off,
6:31but still these are very durable network effects,
6:33eBay is still with us, so is Amazon Marketplace.
6:35(upbeat digital music)
6:39Now another red one,
6:41is what we call the platform network effect.
6:43Now there are some people again,
6:45who have used this word platform
6:46to mean all sorts of stuff,
6:47but it's really not helping you if you use it that way.
6:50The way we use it here, and I think will be useful
6:52for you to adopt, is to understand that a platform
6:54allows businesses to be built on top,
6:56particularly software businesses to be built on top.
6:59The best example would be Microsoft OS,
7:01which in 1976 and seven came out,
7:04he sort of stumbled into it.
7:05And as long as that OS was operating all his IBM computers,
7:10and had all those people on the keyboards,
7:12software developers wanted to build their software products
7:15to work with that OS to get access to that distribution,
7:19to get access to those customers, okay?
7:21And you see this now in sort of developer programs
7:24that, you know, even these web three companies
7:26wanna get developers developing on top of Ethereum
7:29or on top of Avalanche, these are trying to make
7:33the network effects be a platform.
7:35Same thing happened with Salesforce,
7:36they had a SAS tool, they launched Force and said,
7:39"This is a platform that you can build
7:41your software business on top of,
7:42please developers come develop on our platform,
7:44you'll be able to get access to distribution,
7:46access to your customers through us",
7:48and Salesforce has done incredibly well
7:50by building in this OS.
7:52iOS, right?
7:53Apple was worth 40 billion, then they got iOS,
7:55now they're worth a trillion or two,
7:57because they have this beautiful platform network effect
8:01that they've developed.
8:02So if you understand the word platform
8:05to mean this sort of development environment
8:07and understand that this is a really great flavor
8:10to build your company with, a great type of network effect
8:13to use, rather than saying, "Oh, any business
8:15with a network effect is a platform business",
8:17which is what some other people say,
8:19I think you're gonna get a lot further.
8:20So I would encourage you to think about it that way.
8:23(upbeat digital music)
8:27So the eighth network effect
8:28is the asymptotic marketplace network effect.
8:30Let me explain it in the context
8:32of the three basic types of marketplaces.
8:35You can have a regular marketplace
8:37where the long tail is very long,
8:39like an eBay or a Craigslist,
8:41where it just keeps going up and to the right, forever.
8:45The other one is what we call a delayed value marketplace,
8:49where you're basically embedding software
8:52onto the demand side or onto the supply side
8:54for a long time, like an OpenTable,
8:57who provided SAS software to restaurants
8:58for six or seven years before they opened up
9:00the marketplace, and it suddenly became a marketplace
9:03where people could book their restaurant reservations
9:06through OpenTable.
9:07That wasn't always the case.
9:08They had to delay for six or seven years
9:10before they could create that.
9:12Then you get the asymptotic marketplaces,
9:14where like we described before, Uber and Lyft,
9:18their value of their networks grow very quickly
9:21at the beginning, but then as the network size grows,
9:25the value doesn't increase that much,
9:27because of the way you consume the value of the marketplace.
9:31Meaning you don't want the car coming
9:33in more than four minutes, doesn't really help,
9:35you still need to go to the bathroom before you get in.
9:37Okay? We've seen this again
9:39with data network effects where it asymptotes,
9:43these marketplaces for data asymptote,
9:45because the value doesn't keep increasing
9:50as the network size increases and you see this quite a lot.
9:52So that's why we broke it out
9:54as its own separate marketplace type.
9:56(upbeat digital music)
9:59All right, so the ninth network effect
10:01is what we call the expertise network effect,
10:03it's another form of two-sided marketplace
10:05between employers and employees,
10:08or, you know, labor and employers.
10:11So let's say we're using Intuit, we're using QuickBooks.
10:14Once you get used to, as an employee,
10:16using QuickBooks, you get good at it,
10:18you know where the buttons are,
10:19you've kind of grooved into the software,
10:21you've become an expert at that software.
10:24You now wanna go work for a place that uses QuickBooks
10:26so you don't have to use another accounting software.
10:28Now the employer, they know that their accountants
10:32might be interchangeable between different people,
10:34so they wanna use the piece of software
10:37that most accountants use.
10:38So because QuickBooks got a dominant market share,
10:41they were able to then create this network effect
10:43so that employers are looking for people
10:46on QuickBooks, and they wanna use QuickBooks
10:48so that they can always hire new people
10:50to work on QuickBooks, to augment whoever else they have,
10:53so they have a more liquid pool of labor
10:55to work on their accounting.
10:56So everyone's incentivized to get good at QuickBooks,
10:59to use QuickBooks, and to grow that ecosystem,
11:01which creates great defensibility and retention,
11:03which is the definition of network effects.
11:06Other examples would include Figma.
11:08As people get used to managing that piece of software,
11:11they want to go to a place that uses it.
11:12And of course the companies wanna now use Figma
11:15so they can attract the talent who likes to use Figma.
11:17And we see this across all sorts of different pieces
11:20of software now that you've seen the pattern.
11:22(upbeat digital music)
11:25So now we come to data network effects,
11:27which is every founder's favorite idea
11:30for the last 30 years, why?
11:32Because software and the internet makes it so easy
11:34to capture data, if you can pretend that it's worth a lot,
11:37then you feel like you're making progress.
11:39But let's break down really how data network effects work.
11:43The idea would be that the more data you get
11:45into the system, the more value your system
11:48is gonna provide to everyone using the product.
11:51Now, people think this might be true,
11:54and I'll give you a great example
11:55of where this does actually work, which is Waze, right?
11:58So you get your Waze app on your phone,
12:00it tracks where you're driving,
12:01it can tell the system how fast you're driving,
12:04where you're driving, people can note
12:07if there's a accident or if there's a police officer
12:10or whatever, it's all in the system,
12:12and that data is changing all the time,
12:15so once they've established 10 or 30 or 50,000 people
12:18using it in a particular city area,
12:20you really don't wanna go to a different Waze app,
12:22a competitor, because you're not gonna get
12:25the same granularity, because every 10 minutes
12:27or every 20 minutes, the data is worthless,
12:30because the conditions are changing all the time.
12:32So in this case, the data network effect
12:34of traffic conditions is a really good data network effect
12:38and created a billion dollar company that Google acquired.
12:41But generally, it's hard to use your data to great effect.
12:45People talked about, oh, you know,
12:47Netflix knows what you like,
12:48Netflix knows what people like.
12:50We're gonna have these matching algorithms.
12:51We're gonna have these suggestions algorithms,
12:53how much value did that really add to Netflix?
12:55It didn't add that much,
12:56even though they made a big deal of it.
12:57We see this in healthcare, we see this
12:59in all sorts of algorithms, around logistics,
13:03where the data's gonna make our product
13:04that much more, it can, it can help,
13:07it can improve the product experience,
13:09but typically these data network effects
13:10aren't as strong as we want to believe, okay?
13:14Nevertheless, they are valuable.
13:16Nevertheless, you should strive to get them.
13:18And on top of them, you can build other product features,
13:21which might be more valuable than the data underneath them.
13:23(upbeat digital music)
13:28And so tech performance is the next network effect
13:31and think of a Bit Torrent, or a Skype,
13:33where the idea is the more people have downloaded
13:36the software to their computer and is running it
13:38on the network, if it's close to your home,
13:41you're gonna be able to download a movie faster,
13:44or a photo faster, or have better connections
13:47to a conversation you're having,
13:49because that bandwidth will be more available to you.
13:52So your tech performance actually increases.
13:54This occurs in other mesh networks where people
13:56are doing communications, phone calls.
13:58You could even use a mesh network for,
14:00let's say, solar battery charging.
14:03So if you were to have lots of Tesla batteries
14:05on your block and they had the same protocol,
14:07you could actually share, and the tech performance
14:10would increase of all the different batteries
14:12and all the different solar panels on your house.
14:14This is in theory, it hasn't happened yet,
14:16but this is the idea of using a network effect
14:19to improve the technical performance of the system
14:22and thus adding more value to the users.
14:25(upbeat digital music)
14:28So now we've gotten to the network effects
14:30that we consider social or human,
14:33and they're at the outside of the network map
14:35because we consider them less measurable,
14:37less defensible, less strong, all right?
14:40But they're interesting.
14:41And you will see them play out in various ways
14:44in your product and in your competitor's products.
14:46So let's walk through them.
14:48The first one would be language.
14:49If you can get someone to say, "I'm gonna Google something",
14:53it's hard for them to go off and use Bing.
14:56If you say, I'm gonna pick up or I'm gonna grab an Uber,
14:59it's harder for them to open up the Lyft app, right?
15:01So language can have an impact on retaining people
15:04into a network business that you're running.
15:07Because we, as a network, I'm a node, you're a node,
15:10and that piece of language is the link between us.
15:14And that can have a powerful effect on people's behavior.
15:17(upbeat digital music)
15:20The next one is a belief network effect.
15:23And we see this with gold, we see this with Bitcoin,
15:26we see this with religions.
15:28If I believe that gold is valuable,
15:30even though I can't sleep on it, I can't eat it,
15:32I can't build with it, I can't really do much with it,
15:34doesn't have that many industrial uses honestly,
15:36if I believe it's valuable, then it's valuable.
15:38And we've been believing it's valuable
15:40since recorded history, so we continue to believe it.
15:42There's reasons to believe gold will become valuable
15:45in the future and stay valuable,
15:46because it's been happening of long, but it's just belief.
15:49The same thing is true of Bitcoin, why is Bitcoin valuable?
15:51Because some people believe it will be valuable
15:54in the future, I certainly believe it will be,
15:56but there's really nothing other than that belief.
15:58So you can create a lot of value,
16:00with just a belief network effect and in fact,
16:02with Bitcoin and religions and other things,
16:05that is the foundational network effect
16:07on top of which all the other network effects are built.
16:09So it can be really critical.
16:11(upbeat digital music)
16:15Okay and then there's the tribal network effect,
16:17another network effect that's very human, very social.
16:20And the way this one works is that you create an in-group
16:22and an out-group with a word typically,
16:24like I like the Celtics.
16:26Now I'm in the tribe of people who likes the Celtics.
16:28I cheer for them, I cheer against the other tribes
16:31because they are the out-group.
16:33And if more people like the Celtics
16:35and more people wear the T-shirts, I feel better,
16:38I have more fun walking to the park,
16:40I have more fun running into a Celtics fan
16:42when I'm in London, or in California,
16:45even though that's a Boston based team.
16:47So these tribes grow, the more people in those tribes,
16:52the more value there is, and people feel very strong
16:56about them, in fact, they defend them.
16:58And that's the really unique thing
16:59about tribal network effects, is that if someone says,
17:01"I'm not using eBay, I'm using Amazon", I'm like, meh.
17:04But if someone says, "I don't like the Celtics,
17:06I like the New York Knicks", I get upset,
17:09I wanna fight them, okay?
17:11Or the same thing for sororities, fraternities,
17:13for universities, right?
17:15There's lots of tribes that we as humans create
17:18that become very emotional for us,
17:19and will actually cause us to stay inside a network
17:22and add more value to that network,
17:24maybe even detract value from another network,
17:26so you have network on network violence,
17:28and notice that what people are doing is they're saying,
17:30"I am a Celtics fan", or, "I am a Stanford graduate",
17:36or, "I am a member of this tribe",
17:39and they take a word and it becomes part
17:41of their identity, that they will defend.
17:44So again, a very human, very social activity,
17:46but one that affects business and could affect yours
17:49if you design it properly.
17:51(upbeat digital music)
17:55And so the 15th network effect, which is also social,
17:59is the bandwagon effect.
18:01And this is the sense that humans have
18:03about not wanting to be left out.
18:05So Apple is the master at creating this fear
18:09of being left out, people are waiting in line
18:11to get the latest iPhone or whatever,
18:13because they wanna get on the bandwagon.
18:16They don't wanna be left behind.
18:18Slack was very much like this.
18:20You know, there was Hip Chat well before Slack,
18:23but Slack was cooler, and the companies
18:26didn't wanna be left behind, you couldn't be
18:28a modern software company if you didn't have
18:31your employees using Slack, that's how cool they were.
18:34Just like Apple is cool.
18:36And so most companies had to adopt Slack,
18:38whether they needed it or not,
18:40because they needed to be on the bandwagon.
18:43And so that network formed, that network stuck,
18:46and a lot of value was created in Slack
18:48and other businesses that create this effect
18:50to get people to jump on, don't be left behind.
18:53Now, an example you might also know is
18:55if you go into Silicon Valley and you've got a Dell
18:58as your laptop versus an Apple, you know,
19:01you're just not the cool person,
19:03you're not on the bandwagon and people look at you
19:05kind of funny around here.
19:07It's kind of an interesting cultural affectation.
19:09Now, is that enough to get you
19:11to move off of your Dell onto Apple?
19:12I don't know, it might be,
19:14if you're in the middle of fundraising, it might be.
19:16(upbeat digital music)
19:20So there's a 16th network effect,
19:22calling it hub and spoke.
19:24And here's how it works.
19:26Think of Medium in the old days.
19:30You would be a node on the Medium network
19:32by signing up, you would publish into the hub
19:37of Medium where everyone can see it.
19:39And then once a day, Medium would send out
19:44an email with the best publications
19:47of the prior day or the prior few days.
19:50Which means that, instead of your friends
19:54seeing what you posted, you might be sent out
19:57to everyone, all right?
19:59So there would be this posting,
20:00and then there would be this pushing
20:02of an email or a notification out to all the nodes
20:08so that you might get 100,000 visitors
20:11if you won the lottery.
20:13And then your node, you would get more attention,
20:16you'd get more status, you'd get more money,
20:18you'd get more notoriety, which is what you were trying
20:21to get out of writing your post in the first place.
20:24Now, through a design of the software and the system
20:27and how the algorithm works, a company like Medium
20:30can adjust how powerful this network effect can be.
20:35Now, this was used by academic journals
20:38for hundreds of years, where academics would seek status
20:43and notoriety from their peers and maybe an increase
20:46in salary, by publishing into the hub,
20:49they would look at the hundreds of applications
20:52and they would pick two or three or four
20:54to publish and then send out to everyone,
20:57getting this node a lot of notoriety,
20:59if again, they won the lottery.
21:02And so you might do research for 30 years,
21:07and submit 28 times, in an attempt
21:10to get one lottery win so that you get all the attention
21:14and increase your career.
21:16You can also see this in effect with TikTok,
21:19where people put up their material,
21:21they hope that it gets brought into the algorithms
21:24and that they get a lot of likes and a lot of followers,
21:26and that they will again keep growing their own network
21:29within this hub and spoke system.
21:31(upbeat digital music)
21:34So now that you've seen the 16 network effects,
21:38what I wanna point out is a concept of reinforcement.
21:42Typically when we build these startups,
21:45we start by building a product and software
21:48and a network and clusters, right?
21:50The minimum viable cluster, and we build one network effect
21:54and we get that going and we get it going,
21:56once you've got the first one going, the sky's the limit,
22:01because you can reinforce that network effect
22:04with other network effects.
22:06And part of the journey of the different seasons
22:09of running your business is to pick
22:11what is the next network effect I'm gonna add
22:14to the one I've already got?
22:15How does it relate?
22:17How does it easily flow?
22:18How do I take the people I already have
22:20and move them into a new space?
22:21How do I bring in new nodes?
22:23Okay, that whole process is fun and it's exciting
22:27and it's amazing, but it's what we call reinforcement
22:30and you're gonna be hearing more about that
22:32in our case studies later, about how companies
22:34have done that successfully in the past.
22:36So that completes the overview
22:38of the different types of network effects.

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