Review on HBR’s: Network Effects Aren’t Enough

The explosion of digital marketplaces in the 21st Century has disrupted a number traditionally stable industries. E-commerce platforms like Ebay, Alibaba, & Amazon have been gaining market share on brick and mortar stores with worldwide B2C e-commerce sales reaching 1.9 trillion dollars in 2015. More recently, Uber & Airbnb have made large strides into the transportation and accommodation spaces, undoubtedly enticing reactions from their competitors.

Harvard Business Review’s Network Effects Aren’t Enough article mentions that the attractiveness of digital marketplaces stems from their flexible nature. Their low cost business models allow for a relatively speedy setup with higher average margins. They simply involve connecting buyers with sellers without owning the inventory. The only remaining piece is the users. This step is much easier said than done. Everybody has heard of the chicken and egg problem, where to attract buyers, you need to have a lot of sellers on your platform, but to attract sellers you need to have buyers. Harvard Professors Andrei Hagiu and Simon Rothman go one step further in suggesting that solving the chicken and egg problem is not even enough anymore. Before every entrepreneur in Silicon Valley begins planning on creating the next Uber of (fill in the blank), they must consider the following obstacles outlined as; managing growth, building trust, providing safety, minimizing disintermediation, and shaping regulation.

Growth is complex topic. As companies evolve they tend to move through different stages often accompanied by different types of growth. Often achieving the first 100 active users can take an equal or even longer amount of time as achieving the first 1000. The same goes for achieving the first 10,000 and first one million. This is known as the Network Effect. The article illustrates the network effect by describing a “critical inflection point” where user growth becomes exponential rather than linear. However, the authors argue that rather than aim to reach inflection, start-ups should focus on establishing an equilibrium or “liquid market” wherein all buyers have access to a sufficient selection of competitively priced goods and sellers are making money. While I do agree that managing growth isn’t as simple as taking the Managing High Growth course at the Ivey School of Business, I would challenge the notion that early stage start-ups should have their sights set on establishing a liquid market instead of growth for two reasons.

The first of which is that this equilibrium where all buyers and sellers are both magically satisfied does not exist. While it sounds wonderful in theory, in reality, its nearly impossible to have a user base that is 100% happy with your product. This would be the equivalent of having a 0% drop off rate. To make things more difficult, early stage start-ups often have numerous technological and process flaws that they are working out as the article states. I do not think I need to do the research to be confident that achieving a perfectly liquid market has never happened for an early stage tech business.

Furthermore, a digital marketplace does not need a liquid market in order to reach the critical inflection point. In fact, there are several examples of companies that did so with a large skew of suppliers and few buyers. Soundcloud is a social streaming service where artists can post their music to their followers. Soundcloud faced the classic chicken and egg scenario as artists wanted to use a platform that can lead to exposure to a large market of listeners, but listeners only want to use a platform with a wide variety of musicians. Rather than solve the chicken and egg problem Soundcloud took an alternative approach where they focused on supply side features such a collaboration tools, compatible upload systems, and easy API and embed tools. Their goal was to develop the best collaboration platform for artists, as they knew they could not bring artists the exposure they ultimately wanted. As a result, artists flocked to to Soundcloud as they deemed its features far beyond those of the competition. Artists who initially used Soundcloud to collaborate with other artists became enticed to migrate the fans they had onto the platform. Today, Soundcloud boasts 150 million registered users and a speculative valuation two billion dollars. Soundcloud proves that a two sided market place can be developed by offering one side features that can bring them value even before the platform has a significant amount of users on the other side.

The article goes on to to talk about providing safety through money back guarantees, minimizing disintermediation by offering incentives, and staying on top of regulations in an early stage in business. These things all have one thing in common. They cost money. Again, while these notions sound ideal, a look at companies like Uber, and Airbnb actually show a lack of regard for regulation and safety insurance until long after they reached the critical point of inflection. When Uber was created their business model was completely illegal, as drivers need additional insurance converge to carry commercial passengers. Initially Uber did not bother to appease regulators and rightly so. They didn’t have the power. Even now, Uber faces a class action law suits, and disputes to secure special insurance contracts to cover the drivers and passengers. On the opposing side there is validity in saying that if your company can meet all regulatory standards from the start, that will save you a lot of time and pain down the road. However, if there is one thing we have seen and about growth is that it really is somewhere in between a marathon and a sprint. The winner is the one that can grow the fastest while being able to put out all the fires on the way.