This week’s theme: how network effects, reflexivity and bubbles go hand in hand. Plus news from Fresno, mParticle and mPharma.
Welcome back to our Snippets series on non-linear relationships and reflexivity, following up on our previous one on bubbles. So far we’ve worked through an introduction to non-linear problems and why they tend to consistently trip us up, and last week discussion on what happens when perception and reality reciprocally affect each other. We get a phenomenon called reflexivity, for which we saw a few examples: in social interactions, in prices for goods and services, and in the stock market’s “long term weighing machine; short term voting machine” characteristics.
This week, we’re going to look at a particular category of companies where reflexivity plays an especially important and volatile role: in businesses that display network effects. Network effects show up in businesses where the addition of incremental users makes the product offering better and whose value will compound as the network grows in size. They predate the software industry (railroads and telegraph networks, for instance), but really hit their stride with the internet, web and mobile. As you can probably imagine, any network whose value proposition depends on their number of users will face a chicken-and-egg problem of sorts: how do you attract initial users, and how do you break through the doldrums when the network is small? How do you put a price on a network that is growing towards becoming valuable, but not there yet? And most importantly for our reflexivity discussion — what happens when those two relationships, each one between perception and reality, interact with each other?
Let’s make up a startup right now called Vetlist, an online marketplace for pet owners and veterinarians to find each other, book appointments, schedule pet sitting or dog walking, and offer pet adoption services to match newborn and rescued kittens or puppies with new homes. We can see how Vetlist would have network effects: adding more vets to the network increases their local availability; adding more pet owners to the network brings more business for the vets and also more participants for pet fostering or adoption services, bringing in new customers on all sides, and so on. We can see how this company will compound in value as it gets larger: growth today will lead to durable enterprise value tomorrow. Now suppose that Vetlist is a public company: they have listed shares whose price fluctuates with public sentiment about how Vetlist is doing. If public sentiment about Vetlist is positive, they can issue new shares to fund more growth, which should in turn make them look even better, attracting positive press and attention, as their network effect will mean an improved value proposition for their customers. If you’re the public, you’ll therefore want to anticipate this by buying up shares issued for that exact purpose. Perception and reality — between the share price, the business, the customers, the media, and the shareholders — is now fully intertwined with itself.
Now, which will improve more quickly: Vetlist’s actual business, or the perception of Vetlist’s business? It’s clear that reflexivity will play a large role in setting expectations for investors minds: just like we discussed last chapter, when you buy a share of Vetlist, in the short run you’re dealing with a voting machine, and what you’re voting on is other people’s votes. This can work hugely in your favor on the way up, but you’re on borrowed time: if perception gets too far ahead of reality, things start to look like a bubble; and if things get too inflated, bubbles reach their bursting point. The reflexivity machine works just as well on the way down; mind you; but this time, the ride is a lot less fun.
With the rise of cryptocurrencies and introduction of new token models for monetizing networks, many have suggested that tokens represent a fundamentally superior approach to dealing with reflexivity, incentives and network effects by ensuring that ownership of the network accrues to those who participate in making the network valuable. Bitcoin, for instance, rewards miners in the form of newly issued Bitcoins for doing the work of making the Bitcoin network useful: a wonderfully effective mechanism for getting the Bitcoin network off the ground and into the big leagues. This is a great example of how to make reflexivity work for you. But our story above should make us at least a little bit suspicious that these new token-powered network designs may be setting us up for a new and even more ridiculous kind of reflexivity that we’re not totally ready for.
Remember the Herbalife saga from a few years back, when hedge fund manager Bill Ackman publicly announced his belief that Herbalife was a pyramid scheme, and that he intended to short its stock all the way down to zero? And how that didn’t… totally work out? More than anything else, that story was an adventure in reflexivity at every possible level; and it shows that you never really know what’s going to happen when perceptions get swept up in giant campaigns. Well, don’t take our word for it too closely, but at least stop and think for a minute about the similarities between a multi-level marketing company like Herbalife or Avon and a token protocol like Bitcoin or Ethereum. They’re similar in this critical aspect that we’ve talked about today: reflexive relationships between perception and reality for the company’s stock (or token price), value proposition, users, shareholders, and momentum are co-implicated to a nearly inextricable degree. That’s the thing with network effects; there’s really no way to have network effects without having reflexive bubbles. And the more we believe that the software and internet century will be defined and governed by networks, especially if we think that participants in the networks will also own pieces of them, we’d better be prepared for a whole lot of reflexivity. Maybe in the long run, the entire world economy becomes Herbalife. I’d certainly listen to that startup pitch.
Next week, we’ll continue on this thread when we apply the lessons of reflexivity and network effects to something even harder to understand or control: fake news.
Around the United States:
And elsewhere in the world:
“___ may not work the way you think it does”:
Rebuilding Puerto Rico:
A warming world:
Other reading from around the Internet:
In this week’s batch of news from the Social Capital family,
We’re excited to announce our new investment in Fresno, a video content and data science company that looks to rebuild the way content studios operate for the age of Netflix and Facebook.
Fresno is run by Rob Goldberg, formerly of Launch Media and GMG Entertainment, and has a tall challenge but huge opportunity ahead of them as they seek to replicate the kind of algorithmic decision-making in video content that has made Netflix successful. Their approach drew high praise from Chamath: “[Fresno] understands not only what type of video content can thrive on new platforms but, equally importantly, how to package that and distribute it in profitable ways. The result is a very fast-growing company with large revenue scale and a growing library of intellectual property that will grow in value over time.” We look forward to seeing what Fresno can do, and we’re impressed so far.
mParticle has also raised a new round of funding:
The funding round coincides with mParticle’s active beta launch of IDSync, a powerful identity management framework to help companies manage customer profiles across different channels and devices.
IDSync is a new approach to identity management for advertisers in the the mobile era, built with new ways to ensure data governance, policy and security compliance while also getting the most out of the mParticle’s powerful toolkit. There’s long been demand for a “universal identifier” for targeting customers across their many different online identities, but that’s a really difficult proposition to pull off when you consider governing laws, corporate policies, logged-in versus logged-out state, and different norms between brands, countries, and industry verticals. With IDSync, these worries may become a thing of the past; given their impressive progress to date (mParticle currently helps their partners interact with over a billion people every day), we’re looking forward to it being rolled out broadly to help their customers everywhere. To find out more about IDSync, you can contact mParticle here.
And finally, mPharma has a new and exciting partnership announcement with the Red Cross:
The partnership will help establish several pharmacies in Zimbabwe, in the capital of Harare as well as in Marondera, Mutale, and Gwira, that operate in partnership with existing Red Cross health clinics. The clinics should be open by May 2018, and will be able to help Zimbabweans gain access to affordable medication from day one. The partnership is also an opportunity to improve several other aspects of care from the ground up, including drug inventory planning and digitized patient health records. We’re thrilled and thankful every day to get to work with companies like mPharma that are doing such good work to advance our mission, and we look forward to supporting them as they do such good work.
Have a great week,
Alex & the team from Social Capital