The network effect—a phenomenon whereby the usefulness/value of a product or service increases the more people use it—is one of the most important concepts in modern business. For entrepreneurs, its significance mustn’t be overlooked; virtually every high-profile, successful startup in recent years (be it Airbnb, Pinterest, Instagram, Facebook, Twitter, TikTok, etc) exploded in value (both for its users and the company’s market capitalization) due to the network effect. It even forms the basis for the stock market itself. After all, there wouldn’t be much of a market without market participants.
The reality is that many of today’s venture capitalists are looking for startups with potential network effects. While it’s certainly not a requirement for investors to be interested in your company, a startup whose value increases in proportion to its user base presents a compelling case for modern day investors.
I believe there are a number of steps entrepreneurs can take to leverage the network effect in their startup.
1. Create a product/service with inherent value
Before startups can leverage the network effect, they’ll need to develop a product/service that has inherent value. In other words, something that the individual user can derive value from. If you can’t create individual value, it will be near impossible to create network value (value that individuals derive from other people using the product/service).
While this may sound simple, even cliché, I find that entrepreneurs often get hung up on how they’re going to create network value before they know how they’re going to create inherent value.
2. Be different to attract, but better to retain
Having a radical new UI or form factor is a great way to attract new customers, but your product/service offering will need to be significantly better than your competitor’s if you plan on creating a sticky product/service. A healthy, growing network is all about your ability to retain users. Retention is king.
3. Embrace a loss-leading go-to-market strategy
Loss-leadership can be an invaluable strategy when it comes to stimulating the network effect. By selling your product/service at a discount to the market, you encourage new customers to try your product while also lowering switching barriers in the process. Once you have established a foothold in your market, feel free to experiment with different price points.
In the early days, don’t look at taking a loss on your product/service up front as a loss. Look at it as an investment. Many business models in today’s economy require this type of strategy.
4. Beware the bandwagon
If you find the network effect is beginning to take hold, don’t be surprised if the bandwagon effect does too. At this stage, it’s crucial to be wary of the feedback you receive from this new influx of users. A product/service can go woefully off course when entrepreneurs try to cater their product/service to every whim.
Instead, focus on delivering improvements that make your core audience happy. These are the customers you’ll rely on when the bandwagon effect fades.
How do you know who your core audience is? Take a look at the top 15% of your most active users/customers—it's them.
Your Startup As a Platform
Investors seek startups with a network of users because it signals one incredibly valuable thing: acceptance. And acceptance, as exemplified by the successes of Instagram and the like, is the catalyst for any great platform.