The network effects business model is the latest buzz among the newly minted unicorns, AirBnB / Uber / Etsy, all fall into this category of business models, making every startup wannabe want to create one. Every company that wants to be valued over $1 billion dollars is trying to capitalize on its network effects potential, but what the f*&k are network effects and can companies really follow this model?
If You Build It, Nobody Will Give A Shit
Just because there is a platform that connects suppliers to consumers, it does not automatically create network effects. There are many examples of marketplaces that launch and fail. This happens for many reasons, but at it’s core, the network itself must provide a unique and sustainable value to the participants of the network.
Network Effects Are Driven By The Unique Value They Offer
There are 2 main participants in any network: the suppliers and the consumers. In it’s most basic form, a network grows as suppliers entice consumers to consume, which brings on more suppliers, which brings more value to consumers thus bringing more consumers. This “flywheel” gets its initial speed from suppliers but as consumers realize value, it speeds the flywheel up by having each side bring on more of the other side until it reaches a point of critical mass. Ok, fine, we get it. The network is supposed to be an exponential self-perpetuating miracle, but how does the voodoo happen?
First, you have to understand how the network provides value to its users. What is the value that the network gives to suppliers? For example, does it allow them to easily list their inventory? Or does it simplify how suppliers reach their consumers? Ok, now you have x supply of x stuff in your network. Now what value does it bring to consumers? Consumers must get unique value from your platform that separates it from other choices where they can get supply of said stuff. Is your platform cheaper? Easier to use?
A Framework For Metrics To Monitor
Now that you know suppliers and consumers need to receive value from the network in order for it to reach it’s critical mass, we’ll switch gears to identifying how to monitor that users of the network actually receive this value. Below is a sample outline of potential metrics that can be monitored. Notice that each metric has it’s counter metric. This is called push/pull metrics as increasing your acquisition with trash can really cause issues with retention.
- Supply Side
- New Supplier Acquisition
- Supplier Churn (Merchants That Left / (Beginning Suppliers + New Suppliers for the period)
- Repeat Suppliers
- Average Supplier Lifetime
- Supplier growth rate
- Supplier Metric – What value does the merchant get from the platform? Sales per merchant? Does this value erode as suppliers grow? Andrew Chen refers to these as benefits-driven metrics.
- Demand Side
- New Consumer Acquisition
- Consumer Churn
- Repeat Consumers
- Average Consumer Lifetime
- Customer Growth Rate
- Consumer Value Metric – What value does the customer get from the platform? Purchase per visit? Does this value erode as more consumers are on-boarded?
As displayed above, there are 2 sides to the network: Suppliers and Consumers. Each side is broken down into Inputs/Retention & Growth/Perceived Value Metric. The first set of metrics ensures that your precious marketing dollars aren’t being churned through to acquire new users. The second set of metrics ensures that as the network grows, its value to users does not diminish over time. When the metrics are visualized in the context of the model, they would look something like this:
Each network is different therefore it is important to tailor the metrics to the specific metrics that are meaningful to your business within the framework.