Words Dan Cobley
July 26th 2022 / 8 min read
This article is excerpted from Dan Cobley’s talk on Network Effects at our 2022 Founder Day.
Defensibility—how can you build the ultimate competitive advantage for your startup? Broadly, there are four ways to build defensibility.
Firstly, scale: how vast and far-reaching are your operations? Amazon has the upper hand on nearly every e-commerce provider on account of its unparalleled scale and the prices they’re able to offer as a result. Then there’s brand: how recognisable is your brand, and is it synonymous with quality? My kids no longer talk about buying something: they talk about ‘Klarna-ing’ or ‘Monzo-ing’ it. Thirdly, there’s embedding: is your product or service embedded in such a way that makes it hard to replace? The way that GoCardless, for instance, is embedded in checkouts.
But most effective of all is network effects. Network effects are found in 20% of startups, but are accountable for 70% of the total value created in tech since 1994. If you’re looking to build a moat around your startup, network effects are really your most valuable tool.
Understand that network effects, crucially, are different from viral effects—and are a far more effective tool for building sustainable value in a business
Learn about the different methods for building network effects, and how successful startups like Uber, Facebook, and OpenTable have deployed them
What the ‘cold start problem’ is for building network effects, as well as how to overcome some of the other challenges you’ll face as you scale a network
My preferred definition of network effects is:
\It’s important to distinguish this from viral effects, which is where a product or service encourages users to recruit other users in order to grow the product. Take Wordle, the game that took the world by storm in early 2022. Many of us, myself included, started playing as a result of friends’ recommendations. This is somewhat of an in-built growth hack, deployed by many startups as a way of acquiring customers (often incentivized by referral benefits—e.g. HelloFresh or other DTC brands).
Crucially, the experience of the product doesn’t improve with the more people that join it (aside from some bragging rights). The result? There’s little defensibility to the product, evident in the inevitable slump in Wordle’s daily users.
Products with network effects have both this in-built growth hack and a core defensibility, from the fact that the experience improves with each new addition to the network. Those who used Skype back in the day will understand that, with each new user, the experience improves as there are more people you can speak to on Skype.
There are several different ways for you to build network effects into your business:
📞 Physical infrastructure. One of the early examples of this was the telephone. This is a simple, physical, very direct network, in which users are all homogeneous (carry the same value). For the very first person with a telephone, it had zero value; for the second user it had slightly more, but still limited value. Only after there were lots of users did the network have real value, growing with each additional user.