Jan 10, 2017
Notes on synergy, network effects, and ecosystems
A first-principle formalism of a high-level technology strategy that enabled Google, Amazon, Netflix, and Uber to dominate markets. Co-authored by Niraj Pant.
An installation of the “Notes” series. Formalisms in technology, business, and philosophy. Lots of attempted formalisms. A difficult search for generality and rigor, as the two are at odds.
Let’s begin with a formalism of the notion of synergy. While the word synergy has been largely associated with strategy consultants or investment bankers, it is a rich concept that when correctly applied can yield great insight. Often, synergy is used to describe the value being created when two complimentary aspects of businesses will interface following a merger or acquisition. One company’s strong distribution channels could be leveraged to sell more of another company’s superior products if they merged. Simply, it is best described by notion of “2 + 2 = 5”. The individual components become stronger or more valuable together than they could when they are apart.
With respect to graph theory, this analysis closely resembles nodes and edges, where edges describe the weight of the connection between the nodes. While not the most rigorously correct mathematically description, we can understand the “degree of synergy” between two nodes on a network as the strength or weight of the edge between them. Additionally, the sum of the edges in a network describes the total synergy of the network, and the sum of nodes and edges represents the value of the network.
Over recent decades, mathematicians have studied graph networks specifically applied to telecom and social networks. Metcalfe’s Law was originally asserted to describe the value of a telecom network, where it becomes exponentially more valuable with N number of connected nodes.
While not directly analogous, Metcalfe’s framework and ours have lots of intuitive overlaps. While the underlying force escapes formal description, it is clear that the the value of some things are altered by introducing connections between those things.
Having discussed synergy and network effects, it is clear how they can both be extended and still hold for many applications. Concisely, the Ecosystem Effect is a network effect of products/services that a company offers that generate synergies that allow them to dominate a market and move into other adjacent markets. The Ecosystem Effect is another formalism that binds extensions of first-principles like synergy and networks, while drawing inspiration from many other colloquially used, but less-formal, topics like “platform lock-in”, “the stack fallacy”, “go-to market strategy”, “disruption”, and so on. We will begin to investigate the concept at a foundational level with objective first-principles and discuss its real world manifestations in the form of a few case studies.
Google’s Ecosystem
Google pioneered their innovative PageRank technology and leveraged it to build a search engine. This was built atop previous innovations in computing (mainframes, operating systems, the internet). After this product started to get its footing and hit product-market fit, it launched AdSense, a collection of tools for internet marketers to advertise online. This helped scale their ad revenue dramatically, showing their large product-market fit. Eventually, through Google’s notorious 20% time, they expanded horizontally with Gmail, Drive, Maps and many other offerings . In the process, they built a single login and identity to access all of these services, as well as slick integrations between each product (i.e. easily embed Google Drive documents in Gmail). After this horizontal effort, they went back and rebuilt layers below their core offerings. Rebuilt the browser — Chrome, rebuilt the OS —Android and ChromeOS, rebuilt the hardware— Chromebook/Pixel, and attempting to rebuild the Internet — Fiber.
Clearly, there is some kind of synergy present within their ecosystem of products but it is hard to quantity and discuss rigorously. One very tangible aspect of their ecosystem is the seamless integration between products. Since they control almost every level of what we interact with, there’s more opportunity to offer a supreme UX and advanced automation. Take this example: “I used Google+ to schedule a live stream on Google Calendar, presented my Slides presentation in Hangouts and YouTube recorded it. I was also in the web browser the entire time (Chrome). I didn’t once have to leave the Google ecosystem”. This ecosystem and dependency graph is far from the original core product, Search. So much so, that now the core product of Google is the ecosystem, not any one specific product.
For Google, creating new product offerings within their ecosystem often begin as moonshot projects that often have small chances of materializing. However, each product is made with the intent of supporting some existing aspect of the ecosystem. If successful enough, they can become full products, with examples being Gmail, Maps, Drive, etc. These products serve as a stepping-off point for entering new markets adjacent to their core competencies. A great example is what is happening with GSuite. They’ve made their consumer Google productivity offerings into a enterprise package that is rivaling the capabilities of Microsoft Office. The famous slogan “Nobody ever got fired for buying IBM” has turned into “Nobody ever got fired for buying Google”. The overlapping feature sets and products, tight integration, and overall ease of use are the synergies being generated by having a cohesive ecosystem. The results are promising:
While Google has been making strong moves into other markets a grossly disproportionate amount of their money is made as a part of Ads and Search. There many critics that believe the movement into new markets is just detracting from their bottom-line profit. Although it can be easily argued that the top-line growth is coming from user presence in the ecosystem due to less profitable offerings that serve as growth levers for Search. Quantifying these synergies is difficult, but Larry Page defended these moonshots best:
Incremental improvement is guaranteed to be obsolete over time…a big part of my job is to get people focused on things that are not just incremental…Investors always worry, “Oh, you guys are going to spend too much money on these crazy things.” But those are now the things they’re most excited about — YouTube, Chrome, Android.
Amazon’s Ecosystem
If not Google, this might be the strongest example of the Ecosystem Effect. Amazon’s first product was an online bookstore. They dominated the category and started building out orthogonal business from there. Examples of this include a two-sided product marketplace, Amazon Prime, Amazon Web Services, as well as a foray of hardware devices (Fire, Kindle, Echo). Now, they’re going into streaming movies, TV, and music. The prescient Mary Meeker outlines their legacy early from the beginning:
Examples of synergies within Amazon’s ecosystem are visible between Prime (quick product delivery), media (Prime Video, Goodreads, and Kindle), and devices (Fire, Fire stick, Echo). With their further R&D efforts in everything from apparel brands to mobile phone operators, we’ll continue to see the major advantages this interplay provides. A great example of this is seen in how Amazon has opened up the home and turned products into sales channels using Dash and Alexa. These hardware devices create fluid access to the Amazon marketplace, driving more revenue while consolidating different commerce verticals to one experience for users.
Amazon is still relentlessly pursuing new markets, even brick-and-mortar grocery stores. While it may seem counterintuitive for them to pursue something they are working to eliminate, they have a unique opportunity due to their ecosystem. Leveraging their existing Amazon Prime user-base they are able to create a frictionless shopping experience almost impossible for any other grocer to recreate. Amazon is bridging physical and digital commerce in cities and in the home.
Their ecosystem is growing like wildfire and it seems like very little will be able to stand in their way. While Google set up [X] to be a moonshot factory, Amazon only needs to reinvest ~3% of its profits to fund their expeditions into new markets. This allows them keep making bread on their monopoly business while they built out new synergies like Amazon Go, AWS, and enhance distribution channel efficiency with robotics.
Counter-examples
Following our study of the dominant ecosystems, we wanted to dive into the study of tech giants that failed to build ecosystems and were consequently toppled. What would have happened if Yahoo had built out a more cohesive ecosystem? Why didn’t VMWare create something as dominant as AWS? Coming soon.
Other Ecosystem Case Studies
A list of other case studies we will release at a later time:
- Uber
- Netflix
- Salesforce
I hope that some formal discussion of ecosystems, synergy, and networks has been fruitful and thought-provoking. While there are many holes and degrees of subjectivity in the various arguments presented, it is just meant to be an extension of core concepts to create a new framework for analyzing companies and their decisions.
We’re looking forward to presenting more analysis on this topic in the future, but in the meantime talk to us on Twitter [at] wileycwj and [at] niraj and don’t forget to check out our Bumpers.fm discussion of Ecosystem Effects!
