by Pascal-Emmanuel Gobry
Network effects. Perhaps no other phrase can get a VC's pulse higher.
They're the holy grail of online business.
What is a network effect? It's what happens when the value of a product to one user depends on how many other users there are, as economists Carl Shapiro and Hal Varian put it.
Examples include Microsoft Windows and the phone network. Windows is valuable because most other software is made for Windows, which makes more people buy Windows, which makes more developers build their apps for Windows, and so on and so forth in a virtuous circle.
Network economics online get people's hearts racing so much for two reasons: first of all, because the internet is at its base a communications network and so network effects tend to happen more there, and second of all, it's one of the few strong barriers to entry in a market where there are so few. Or is it?
It's taken as a given that network effects online are a magical barrier to entry, but are they?
One reason Facebook is so valuable, we're told, is because of its huge network effects which make it unstoppable and undefeatable.
But Friendster had network effects. So did MySpace. Founding Facebook President Sean Parker says MySpace lost to Facebook because of its gross incompetence. Fair enough.
Except that's not the only way network effects businesses can lose. One way that network effects can be defeated is through what we'll call "verticalization."
Craigslist is perhaps one of the best network effects businesses: the reason why everyone goes there is because everyone is already there. Plenty of people have pointed out how awful Craigslist's design can be, how many things are wrong with it, and yet plenty of well-funded startups that have tried to take Craigslist on frontally with slicker offerings have foundered.
And yet... And yet, Craigslist's traffic seems to be plateau-ing. Why? This graphic by VC Andrew Parker shows why:
While no service has been able to defeat Craigslist head-on, plenty have built "niches" in specific verticals, with a more tailored offering, and now Craigslist seems to be stalling.
And some of these "niches" are big: Etsy, AirBnB and Ashley Madison are huge businesses.
Could the same thing happen to Facebook? We would argue it already is.
Network effects. Perhaps no other phrase can get a VC's pulse higher.
They're the holy grail of online business.
What is a network effect? It's what happens when the value of a product to one user depends on how many other users there are, as economists Carl Shapiro and Hal Varian put it. Examples include Microsoft Windows and the phone network. Windows is valuable because most other software is made for Windows, which makes more people buy Windows, which makes more developers build their apps for Windows, and so on and so forth in a virtuous circle.
Network economics online get people's hearts racing so much for two reasons: first of all, because the internet is at its base a communications network and so network effects tend to happen more there, and second of all, it's one of the few strong barriers to entry in a market where there are so few. Or is it?
It's taken as a given that network effects online are a magical barrier to entry, but are they?
One reason Facebook is so valuable, we're told, is because of its huge network effects which make it unstoppable and undefeatable.
But Friendster had network effects. So did MySpace. Founding Facebook President Sean Parker says MySpace lost to Facebook because of its gross incompetence. Fair enough.
Except that's not the only way network effects businesses can lose. One way that network effects can be defeated is through what we'll call "verticalization."
Craigslist is perhaps one of the best network effects businesses: the reason why everyone goes there is because everyone is already there. Plenty of people have pointed out how awful Craigslist's design can be, how many things are wrong with it, and yet plenty of well-funded startups that have tried to take Craigslist on frontally with slicker offerings have foundered.
And yet... And yet, Craigslist's traffic seems to be plateau-ing. Why? This graphic by VC Andrew Parker shows why:
click on graphic
While no service has been able to defeat Craigslist head-on, plenty have built "niches" in specific verticals, with a more tailored offering, and now Craigslist seems to be stalling.
And some of these "niches" are big: Etsy, AirBnB and Ashley Madison are huge businesses.
Could the same thing happen to Facebook? We would argue it already is.
