Using network effects to build a defensible product

You’ve worked your ass off for years to make your company a success.

You built an audience over time by helping people and delivering real value. It took a lot of experimenting to find the right voice, but slowly you built up a loyal following. You don’t have customers — you have fans.

Then, as it’s all starting to pay off, competitors start coming out of the woodwork.

Inspired by your success, they come from everywhere. Their pockets deep with Venture Capital money, they’re undercutting you. After years of building, you have to fight for what’s yours.

This is one of the most common fears entrepreneurs express.

As a rule, most first time founders spend way too much time worrying about having their ideas stolen. On the other hand, building a defensible business is important.

The most common way to defend your business is with patents, trademarks, copyright, or other legal protections.

One of the first questions investors will ask is, “do you have a patent?” But legal protections aren’t the only way to protect your business.

Software is notoriously hard to patent. Even if you get a patent, filing a lawsuit against a competitor is an expensive, time-consuming process.

If I don’t patent my product won’t everyone rip it off?!?

What if I told you there was a better way?                               

Protecting your app with network effects

Network effects are an oft-overlooked method of building a defensible business. And while they aren’t applicable to every business, when they work, it's amazing how powerful they are.

In short, network effects protect your product by making it more valuable for your customers. No lawsuits required.

Understanding network effects

When a product experiences network effects, it means an increase in usage leads to a direct increase in value for other users. Typically (but not always), this means that every new user makes the product more valuable for EVERY user.

The clearest example is a social network like Facebook. The more people that join the platform, the more useful it is. With more people you can have more friends, discover more content.

The term was first used in 1908 by Theodore Vail in an annual report for Bell Telephones. If only one person you know has a telephone there’s not much point in buying one. But when everyone you know has one it becomes a necessity.   

How network effects make for a more defensible product

Once your platform hits critical mass, the value created by the network increases at an exponential rate. Meanwhile, costs only increase linearly.                                  

This effect creates a gap between you and any new competitors. By the time they hit critical mass, you’ve added more users and increased the gap.

This isn’t to say network effects make your business invincible. No business is invincible.

But they do increase the barrier to entry. Security professionals don’t ever make websites impenetrable. They make it hard enough to break in that it’s not worth it to a hacker.

Your goal as an entrepreneur is the same. There’s no such thing as an invincible business, but you can build in competitive advantages that make it a waste of time for low-quality copycats to come after you..

The 4 different types of network effects

To better understand network effects, you need to understand the 4 types of effects.

Direct effects mean an increase in usage of the product leads to a direct increase in the value of the product. Facebook is an example of a direct network effect. As more people use, it the product itself becomes more valuable.

With indirect effects, on the other hand, an increase in the usage of one product or service leads to an increase in the value of a complementary product. This can then increase the value of the original. The perfect example here is an operating system.

If you and I both buy an iPhone, I don’t get any direct value from you owning one. However, the more people that buy iPhones, the more software developers want to build iPhone apps. This then creates indirect value for me, the user, because I have great software to choose from.

Two-sided network effects happen when there are actually two networks at work. An increase in usage for one network will increase the value of the other network and vice versa. Consider Craigslist, or any two-sided marketplace. If you and I both sign up as sellers, I’m not getting any inherent value in you being on the platform. But the more sellers that sign up, the more valuable the platform is to buyers.

Finally, there are local network effects. Again, consider a marketplace like Craigslist or Uber. I’m based in Charleston, SC. If an Uber driver signs up in San Francisco, CA that doesn’t add much value for me. I only get value when drivers sign up in my local network.

How to achieve critical mass

One of the challenges of products with network effects is that it can be difficult to gain initial traction. It's the classic chicken or the egg problem. Facebook isn’t much fun if only five people are using it. You need a strategy to get initial traction fast enough that you can keep your users.

Come for the tool, stay for the network

The most common way to build early traction is to build a tool that’s valuable on it’s own without the network. This is called, “come for the tool, stay for the network.” Albatross, the product we built last fall, is a perfect example of this.

The tool makes it easier to estimate your projects even if you’re the only person using it. As more and more people join we can analyze the data of the whole network. Then, we can use that data to make everyone’s estimates more accurate.

Focusing on local networks

The way Facebook tackled the critical mass problem was going after small networks first. It’s easier to hit critical mass at Harvard than in the entire United States. They grew university by university in the early years, focusing on local networks. Once they had a large user base, they opened the platform up to the entire population.

There are limitations

Network effects are not a silver bullet. It’s hard to build a product that relies on a network, and two sided marketplaces are especially hard because you’re building two networks in tandem. Hundreds of startups have failed trying to take down Craigslist, because they can’t ever achieve critical mass.

You can’t force network effects into your product, either. If it’s not a natural fit for a network, you can’t make it a fit. But understanding how network effects work can help you discover powerful new products.

That said, there are common ways users can try to build these effects into their software.

Bonus reading: network effects are not the same as virality

How to build B2B products that leverage network effects

Data and Artificial Intelligence

Google’s advantage in the artificial intelligence space is not their engineers. It’s their massive troves of data. That’s why they’re giving away access to their AI tools for free. They want more data, not more code.

Anytime you have a tool where you’re storing user data, you can look for ways leverage it to create value for your users. The more users you have, the more accurate your analysis (in theory).

Note: be careful with this approach. Users are increasingly (and rightfully) concerned with the way companies use their data. If you’re leveraging user data, be transparent and up front with your customers.

Integrations

Opening up your platform is a common strategy for creating indirect network effects. The more integrations developers build, the more value your users get out of your app. The more users you have, the more developers want to build integrations.

If you can get in and build a large developer ecosystem quickly, you can create a sizable competitive advantage.

Note: this can be extra effective in industries dominated by old school players. Think legal or healthcare tech.

Opening up your platform to developers can add technical complexity to your product. And, when not done well, it can add security risks. So, as with any strategy, be careful and weigh the pros and cons.

Takeaways

• Network effects mean an increase in usage of your product leads to a direct increase in the value of the product.
• By increasing the value of your product, you protect yourself from copycats.
• When building a network, make sure you have a strategy to overcome the chicken or the egg problem.
• Not every app will be able to leverage network effects. Don’t try to force it or fake it.