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A genealogy of network effects

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A genealogy of network effects

  1. 1. A genealogy of network effects
  2. 2. Absolutely not MECE.
  3. 3. Mutually Exclusive Comprehensively Exhaustive
  4. 4. “In network theory, the value of a system grows at approximately the square of the number of users of the system..” - Robert Metcalfe
  5. 5. Why are network effects important at all?
  6. 6. A company is worth the present value of its future cash flows.
  7. 7. What determines future cash flows?
  8. 8. There are no “economic profits” in a perfectly competitive market.
  9. 9. “Economic profits” are profits greater than a company’s risk- adjusted returns on capital.
  10. 10. “Economic profits” are greater the greater a company’s moats.
  11. 11. Let’s talk about moats
  12. 12. "So we think in terms of that moat and the ability to keep its width and its impossibility of being crossed as the primary criterion of a great business. And we tell our managers we want the moat widened every year. That doesn't necessarily mean the profit will be more this year than it was last year because it won't be sometimes. However, if the moat is widened every year, the business will do very well.“ - Warren Buffet
  13. 13. Moat = defense against competition
  14. 14. Competition for profits
  15. 15. Five forces compete for y(our) profits Profits Existing competitors New competitors (entrants) SuppliersCustomers Substitutes
  16. 16. New entrants may enter your market if there are little barriers to entry
  17. 17. Current competitors may battle with more fierceness for a market’s profit
  18. 18. Internal market competition may be tougher if assets are highly specific; if there’s a “winner takes all” dynamic; if marginal costs are very little
  19. 19. Customers or suppliers may take your profits away the more bargaining power they have against you…
  20. 20. Moat = defense against competition
  21. 21. Different types of moats.
  22. 22. Types of moats (Pat Dorsey): -Economies of scale -Intangibles (brand, tech, regulation) -Switching costs -Network effects
  23. 23. Types of moats (Hal Varian): -Lock-in (switching costs) -Positive feedback -Demand-side economies of scale -Supply-side economies of scale
  24. 24. Economies of scale: the more you produce, the cheaper your costs of production
  25. 25. 1 sticker => R$ 10 1,000 stickers => R$ 0.2 /each
  26. 26. Switching costs prevent customers from – switching – to competitors or substitutes
  27. 27. How easy would be for us to leave Heroku?
  28. 28. An app is deeply integrated in Heroku. It makes us think 1,000x before switching. Therefore they have bargaining power with us.
  29. 29. Switching costs affect suppliers’ bargaining power.
  30. 30. Positive feedback.
  31. 31. According to Hal Varian, positive feedbacks come in two forms: supply-side or demand-side economies of scale.
  32. 32. Supply-side economies of scale: cost advantages attributable to scale.
  33. 33. Demand-side economies of scale are generally called “network effects”.
  34. 34. Network effects make a product worth more to each user the more users it has.
  35. 35. “Whether real or virtual, networks have a fundamental economic characteristic: the value of connecting to a network depends on the number of other people already connected to it. This fundamental value proposition goes under many names: network effects, network externalities, and demand-side economies of scale” - Hal Varian, Information Rules
  36. 36. How valuable would a new Instagram be if none of your friends were there?
  37. 37. Our tentative taxonomy of positive feedback.
  38. 38. Positive feedback •Supply-side Economies of scale • Lower unit costs attributable to scale •Demand-side Economies of scale • User-as-primary-driver • Intra-side • Cross-side • User-as-secondary-driver • Content • Data/insights
  39. 39. Types (?) of network effects.
  40. 40. User User User User User User User User User Whatsapp
  41. 41. Advertiser User User User User User User User User User Advertiser Advertiser Advertiser Facebook
  42. 42. Advertiser User User User User User User User User Advertiser Advertiser Advertiser Google
  43. 43. Advertiser User User User User Advertiser Advertiser Advertiser Ebay
  44. 44. User User User User User User User User Quora (or Google without advertisers)
  45. 45. Are flywheels another type of demand- side economies of scale?
  46. 46. Regorge calls these “macro growth loops”
  47. 47. ‘A flywheel is “a company” with positive feedback’ -Jim Collins
  48. 48. Amazon’s flywheel: More customers > Lower prices > More customers > Lower prices Possible because e-retail is a business with huge economies of scale.
  49. 49. Weak leader => +money => +investing power
  50. 50. Strong: winner takes all leader => stronger platform (Windows)
  51. 51. Back to moats.
  52. 52. Moats •Regulation •Brand? •Positive feedback • Supply-side Economies of scale • Lower unit costs attributable to scale • Demand-side Economies of scale • User-as-primary-driver • Intra-side • Cross-side • User-as-secondary-driver • Content • Data/insights
  53. 53. Thanx!!!

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