The Hidden Network Effect: Uncovering the Unconventional Network Effects

The Hidden Network Effect: Uncovering the Unconventional Network Effects

Introduction:

In the world of startups and entrepreneurship, the concept of network effects is well-known. Companies like Facebook, for example, grew their user base by requiring users to have a Harvard University email address in the early days. These companies often start off looking like linear businesses rather than network businesses. However, there are instances where companies experience network effects that are not immediately apparent, creating a unique advantage that can lead to long-term success. These hidden network effects may not be as obvious as traditional network effects, but they are just as real.

Understanding Network Effects:

Network effects refer to the increase in value for users as the number of users increases. Companies that experience network effects that may not seem like traditional network effects are like uncut diamonds. The crucial question is how these effects impact competition.

1. Slow-burning Networks:

Slow-burning networks are defined by the delay between building the network and the realization of its value. In slow-burning networks, the product usage period is often long and/or the frequency of product usage is low, which dampens the momentum of network effects. The advantage of slow-burning networks is that once they are established, they are difficult to displace.

2A) Incomplete Networks:

Incomplete networks are characterized by temporary imperfections in the network due to product characteristics or strategic decisions. However, once the network is complete, the network effects become immediately evident. OpenTable, for example, created an opportunity for itself by gathering a sufficient number of restaurants while simultaneously becoming the easiest platform for users to find restaurants. In the first five years of its existence, OpenTable primarily focused on securing contracts with restaurants. The problem, of course, is that incomplete networks often end up remaining incomplete.

2B) Restrictive Networks:

Restrictive networks are networks where product characteristics or strategic decisions limit the scale or establishment of the network. An example of this is Chief, a network for female executives. Think of it as a Young Professionals Organization (YPO) specifically for women in executive positions. The model for establishing membership is currently fixed at monthly group sessions, leaving little room for expansion. While indicators such as the quality of applicants/members or customer referral rates can provide some insight, they are uncertain and incomplete measures. Differentiating between restrictive networks and limited networks is important.

3. Networks with Hidden Potential:

Delicious (a bookmarking service) and Instagram (known for its filters) are classic examples of companies that encourage users to visit their platforms for the tools they offer, but the network becomes the main attraction. Some companies even build networks before completing their actual products or tools. The idea is to start by building a community that functions like a network, where users interact and create value collectively. Eventually, the product is introduced, leading to a change in the way network usage is established or even doubling its retention. These networks with hidden potential are the most challenging to anticipate and execute. Users derive value not from the network itself but from the central nodes. While networks solidify, audiences consume. Assess whether the network users are engaging with each other or simply deepening connections with central nodes. Ask yourself who gains additional value when someone new joins the community. If the answer is everyone (or a significant number of participants), it is a network. If it's just the central nodes, it's an audience.

The Advantage of Hidden Networks:

Companies strive to reach that magical tipping point before their competitors. That is why the hidden network effect can be a significant advantage for entrepreneurs who bet on their network effects. However, it is important to note that relying solely on DAU/MAU (Daily Active Users/Monthly Active Users) as a metric to evaluate Product-Market Fit (PMF) has its limitations. If your product is highly frequent, has high retention, and will eventually be supported by advertising, then using DAU/MAU as a guide is appropriate. However, if you struggle to monetize, build network effects, or have a natural flow that is not showing signs of increasing, it's time to measure something else!

Conclusion:

Hidden network effects are not always apparent, but they can provide companies with a unique advantage. Understanding the different types of networks, whether slow-burning, incomplete, or restrictive, can help entrepreneurs navigate the competitive landscape. Additionally, building networks with hidden potential can be challenging but can lead to significant long-term success. To leverage these hidden network effects, entrepreneurs and startups should consider measuring other metrics beyond DAU/MAU and focus on creating value for all participants in the network. By doing so, they can unlock the full potential of their networks and position themselves for sustained success.

Actionable Advice:

1. Diversify your metrics: While DAU/MAU is a valuable metric, it's essential to measure other factors such as monetization, network effects, and natural flow to gain a comprehensive understanding of your product's performance.

2. Foster community engagement: Instead of solely relying on central nodes, focus on creating an environment where all participants can contribute and gain value. Encourage interactions and collaboration among users to strengthen the network effect.

3. Prioritize long-term success: Building a network takes time and effort. Instead of chasing short-term gains, focus on establishing a sustainable network that can withstand competition and provide long-term value to users.

By incorporating these actionable advice, entrepreneurs and startups can harness the power of hidden network effects and position themselves for success in the competitive business landscape.