produces is the (eventual) need to eliminate the subsidies in order to make the unit economics work. When I was at PayPal, one of the things we did to encourage adoption was to proclaim that the service would always be free. This meant eating the transaction costs of accepting credit card payments. I wish I could say we had a grand plan. We had hoped that we could make up for the credit card transaction fee subsidy by making money off the float—the funds being kept in PayPal. Unfortunately, this came nowhere close to offsetting the fee subsidies, and the company was hemorrhaging money. So we switched PayPal from “always free” to “ACH always free” and started charging fees to accept credit card payments. Fortunately, we already had a loyal following, and our customers accepted the change.
When the business can’t change the economics of the product (free services like Facebook can’t lower their prices), it can instead sway the expectations of potential users. The value users place on the service when deciding whether or not to adopt it depends on both the current level of adoption and their expectations for future adoption. If they think others are going to jump on board, the perceived value of the service increases, and they become more likely to adopt it.
This technique is reflected in one of the most influential business books of all time, Geoffrey Moore’s Crossing the Chasm. Moore argues that technology companies often run into problems when they try to transition from a market of early adopters to the mainstream—the proverbial “chasm.” He recommends that companies focus on niche beachhead markets, from which the company can expand outward using a “bowling pin” strategy in which these markets help to open up adjacent markets. This strategy is even more important for network effects businesses.
A company can also reshape the demand curve by designing the product to be valuable to the individual user regardless of network adoption. At LinkedIn, for example, we discovered that public LinkedIn profiles had some value independent of the user’s network, since they served as an online professional identity. This gave people a reason to join LinkedIn even if their friends and colleagues hadn’t done so yet.
Connectivity Enables Network Effects Businesses
In addition to supporting network effects, the high connectivity of the world we live in today also makes it easier to reach the tipping point where network effects kick in, and to sustain those network effects and the market dominance they produce.
First, the Internet has driven the cost of discovery for products and services lower than ever. Unlike in the past, when companies needed to offer goods in retail stores or broadcast advertising in order to be visible to customers, today buyers can find whatever they’re looking for on Amazon or other online marketplaces like Alibaba, in app stores, or, when all else fails, by Googling. Because products and services that are already popular will almost always come up first in search results, companies with a competitive advantage can quickly grow to the point where the increasing returns of network effects produce a winner-take-most or winner-take-all market. This also explains why the growth factor of distribution is as or more important to company success as the product itself—without distribution, it is difficult to reach the tipping point.
After network effects take hold, the efficiencies enabled by the Networked Age make it easier to sustain the pace of rapid growth. In the past, rapid customer growth inevitably led to rapid organizational growth and to dramatic increases in the overhead required to coordinate a large number of employees and teams. Today’s networks allow companies to sidestep these traditional growth limiters, such as when Apple used Foxconn to get around the potential limitation of its manufacturing infrastructure (more on this in the next section). The more you can remove those limiters, the more dominant a network effects–driven business can grow. This is why companies like Google that have surpassed the $100 billion mark in annual revenues are still growing at over 20 percent per year.
Finally, the remarkable profitability of these companies gives them the financial resources to expand into new fields and invest in the future. The S-curve of innovation argues that the rate of adoption of every innovation eventually slows as the market saturates. However, companies like Apple have mastered the strategy of investing in new products that let them hop onto additional S-curves. Apple hopped from music players to smartphones to tablets, and it is no doubt spending some of its vast profits chasing the next S-curve. The premium that the public markets grant these companies also helps them use mergers and acquisitions (M&A) to jump these curves, much as Facebook did with Instagram, WhatsApp, and Oculus, and Google did with DeepMind.
Of course, network effects don’t apply to every company or market, even if they are superficially similar—as many companies and their investors discovered to their chagrin during the dot-com bust, the Great Recession, and the funding slowdown of 2016. This is why the best entrepreneurs try to design innovative business models that leverage network effects. One of the reasons that Google is Google and Yahoo! is now part of AOL (which in turn is owned by Verizon) is that Google focused on AdWords (a marketplace with strong network effects) while Yahoo! tried to become a media company (a traditional model based on economies of scale).
Much of Silicon Valley’s historical success in building giant companies can be traced to its cultural emphasis on business model innovation, which results in the creation of network effects–driven businesses. The irony is that many people in Silicon Valley couldn’t define a network effect or what caused it if asked. Yet simply because so many entrepreneurs are trying so many different business models, they can end up stumbling into powerful network effects. Craig Newmark simply started e-mailing his friends about local events in 1995; almost twenty-two years later, network effects have kept Craigslist a dominant player in online classifieds despite operating with a skeleton crew and making seemingly no changes to the website design during that entire period!
This is where an emphasis on speed also plays an important role. Because Silicon Valley’s entrepreneurs focus on designing business models that can get big fast, they are more likely to incorporate network effects. And because the fierce local competition forces start-ups to grow so aggressively (i.e., blitzscale), Silicon Valley start-ups are more likely to reach the tipping point of network effects before start-ups from less aggressive geographies.
One of the motivations for this book is to help entrepreneurs from around the world emulate these successes by teaching them how to systematically design their businesses for blitzscaling. When you design your business model to leverage network effects, you can succeed anywhere.
DESIGNING TO MAXIMIZE GROWTH: THE TWO GROWTH LIMITERS
Building key growth factors into your innovative business model is only half the battle. It is fiendishly difficult to grow an amazing business, in part because it is fiendishly easy to run smack into obstacles that limit your growth. A key component of business model innovation is designing around these growth limiters.
GROWTH LIMITER #1: LACK OF PRODUCT/MARKET FIT
Product/market fit enables rapid growth, while the lack of it makes growth expensive and difficult. The concept of product/market fit originates in Marc Andreessen’s seminal blog post “The Only Thing That Matters.” In his essay, Andreessen argues that the most important factor in successful start-ups is the combination of market and product.
His definition couldn’t be simpler: “Product/market fit means being in a good market with a product that can satisfy that market.”
Without product/market fit, it’s impossible to grow a start-up into a successful business. As Andreessen notes,
You see a surprising number of really well-run start-ups that have all aspects of operations completely buttoned down, HR policies in place, great sales model, thoroughly thought-through marketing plan, great interview processes, outstanding catered food, 30″ monitors for all
