Layering Network Effects: How to Multiply Unfair Advantages

Layering Network Effects: How to Multiply Unfair Advantages

In today's highly competitive business landscape, companies are constantly searching for ways to gain a competitive edge and strengthen their position in the market. One effective strategy that has been proven to be successful is layering network effects. By combining multiple forms of network effects, companies can not only enhance their defensibility but also improve scalability. In this article, we will explore the concept of layering network effects and discuss how companies like Slack, Carta, and Poshmark have utilized this strategy to their advantage.

The first approach to layering network effects is by adding new types of network participants. This can be achieved by introducing a new type of user and connecting them to existing users. Slack, for example, started as a 1-sided SaaS-enabled network that connected users within an organization. However, in 2015, Slack added a developer program and app directory, allowing third-party developers to create integrations for Slack users. This created a user-developer network effect on top of the existing user-user network effect, enhancing Slack's value proposition and increasing switching costs.

Adding a developer program is a common way for businesses to introduce new network effects. Companies like Amazon have also utilized this strategy by adding a marketplace on top of their existing data network. By incorporating third-party sellers, Amazon was able to create a brand new business and protect itself from the downsides of data network effects.

Another example of layering network effects is through the creation of new connections between existing network participants. AngelList, originally an interaction network connecting investors and entrepreneurs, launched syndicates in 2013. This allowed investors and entrepreneurs to connect in a marketplace to raise funds, in addition to providing a SaaS workflow for managing the process. This approach requires a deeper understanding of customer behavior but can be easier to execute as it does not involve acquiring new participants.

It is important to note that these two approaches can be combined. Poshmark, for instance, started as a social C2C commerce app, connecting users on an interaction network. In 2015, Poshmark launched a wholesale portal that allowed sellers to buy clothes directly from brands to list on their Poshmark boutiques. This added brands and layered a new B2C(2C) marketplace on top of their product. By combining a C2C marketplace and a 1:many interaction network, Poshmark created a sticky experience that was difficult to replicate.

Now let's shift our focus to the concept of aggregation theory. According to this theory, the value chain in consumer markets can be divided into three parts: suppliers, distributors, and consumers/users. To make outsized profits, companies can either gain a horizontal monopoly in one of these parts or integrate two parts to deliver a vertical solution.

The disruptive power of the internet has changed this dynamic. The internet has made distribution of digital goods free, neutralizing the advantage that pre-internet distributors had. It has also made transaction costs zero, allowing distributors to integrate forward with end users at scale. This shift in competition has made the user experience the most important factor for success.

Companies that provide the best user experience are the ones that win in this new landscape. They attract the most consumers/users, which in turn attracts the most suppliers, creating a virtuous cycle. This shift in value has led to the decline of incumbents who integrated backwards, such as newspapers, book publishers, networks, taxi companies, and hoteliers. Aggregators who aggregate modularized suppliers to consumers with an exclusive relationship at scale have emerged as the winners.

In industries where there is no obvious digital component, companies like Uber and Airbnb have still managed to disrupt the market by nailing the user experience. These companies have created strong winner-take-all effects, where they can serve all consumers and become better services the more users they have. The digitization of differentiators has shifted competition to the user experience, giving new entrants an advantage.

In conclusion, layering network effects and leveraging aggregation theory are powerful strategies that can multiply unfair advantages for companies. By adding new types of network participants or creating new connections between existing participants, companies can strengthen their defensibility and scalability. The focus on providing the best user experience is crucial in today's competitive landscape. Before we wrap up, here are three actionable pieces of advice for entrepreneurs:

1. Identify opportunities to add new types of network participants to your business model. This could be through developer programs, marketplaces, or other forms of integration.
2. Deeply understand customer behavior to create new connections between existing network participants. This can be achieved through product development and effective communication of value.
3. Prioritize the user experience above all else. Invest in creating a seamless and enjoyable experience for your consumers/users, as this will attract more users and suppliers, leading to a virtuous cycle of growth.

By implementing these strategies and focusing on the user experience, companies can gain a competitive edge and thrive in today's dynamic business environment.