The Cold Start Problem: How to Start and Scale Network Effects by Andrew Chen
Uber spent hundreds of millions just on driver referral programs, and nearly a billion in paid marketing. The Driver Growth Team was one of the most important levers to grow the business
Conversations with startups begin with a “first pitch” meeting, where the entrepreneurs introduce themselves, show the product, and talk through their strategy. These are pivotal meetings, because when they go well, the startup could eventually receive an investment in the millions or even hundreds of millions of dollars. It’s high stakes
A network effect describes what happens when products get more valuable as more people use them
A successful network effect requires both a product and its network
It’s the connection that matters. The entire ecosystem stays on because the value is in bringing everyone together
People stay on the network and use it more, because other people are also using it more
How do you tell if a product has a network effect, and, if yes, how strong is it
Does the product have a network? Does it connect people with each other, whether for commerce, collaboration, communication, or something else at the core of the experience?
Does the ability to attract new users, or to become stickier, or to monetize, become even stronger as its network grows larger?
First-mover advantage myth: there are weak advantages to being first, since the winning startup is usually a later entrant
Metcalfe’s law: each time a user joins an app with a network behind it, the value of the app is increased to n²
Allee threshold: the tipping point where populations start to grow faster and create their own sustainable communities
Carrying capacity is “overcrowding” from too many users and needs to be combated with spam detection, algorithmic feeds, or limiting the results so that finding the right thing doesn’t become a chore
Cold Start Theory stages:
1. The Cold Start Problem
If users don’t find who or what they want, they’ll churn
Requires getting all the right users and content on the same network at the same time
An “atomic network” is the smallest possible network that is stable and can grow on its own
2. Tipping Point
As a network grows, each new network starts to tip faster and faster, so that the entire market is more easily captured
The most successful network effects grow city by city, company by company, or campus by campus
3. Escape Velocity
Work furiously to strengthen network effects and sustain growth
The network effect forces:
- The Acquisition Effect: products tap into the network to drive low-cost, highly efficient user acquisition via viral growth
Powered by viral growth and a positive early user experience that compels one set of users to invite others into the network
2. The Engagement effect: increases interaction between users as networks fill in
Introduce people to new use cases via incentives, marketing/communications, and new product features
3. The Economic Effect: improves monetization levels and conversion rates as the network grows
Increase conversion in key monetization flows and ramp up revenue per user as the network grows
4. Hitting the Ceiling
Spam and trolls are problems to be managed, not fully solved
5. The Moat
Brand, technology, partnerships, and others can help fend off competitors as the network matures
The first step is to build a single, tiny network that’s self-sustaining on its own
The next move was to work on what was right in front of them — to take the functional but unremarkable internal tool, and redesign it so anyone could use it
Technology startups adopted Slack because they have the belief that software can better their lives
“The Atomic Network” the smallest network where there are enough people that everyone will stick around
The most important part of any early network is attracting and retaining “The Hard Side” of a network — the small percentage of people that typically end up doing most of the work within the community
To attract the hard side, you need to “Solve a Hard Problem” — design a product that is sufficiently compelling to the key subset of your network
“The Killer Product” the most successful network effects-driven apps are also sometimes dead simple
When the Cold Start Problem is solved, a product is able to consistently create “Magic Moments.” Users open the product and find a network that is built out, meaning they can generally find whoever and whatever they’re looking for
How many users does your network need before the product experience becomes good?
Facebook’s famous growth maxim: “10 friends in 7 days”
The higher the requirement, the harder it is to get started, but the more defensible the product is in the long run
If you study the launch of products with network effects, you’ll see that one of the most common threads is that they often start small, in a single city, college campus, or in small beta tests at individual companies — like Slack’s story. Only once they nail it in a smaller network do they build up over time to eventually conquer the world
If you can create one stable, engaged network that can self-sustain — an atomic network — then likely you can build a second network adjacent to the first one
The networked product should be launched in its simplest possible form — not fully featured — so that it has a dead simple value proposition
The attitude in executing the launch should be “do whatever it takes” — even if it’s unscalable or unprofitable — to get momentum, without worrying about how to scale
The next big thing will start out looking like it’s for a niche network
Your product’s first atomic network is probably smaller and more specific than you think
Who is the hard side of your network, and how will they use the product? Why will they come back more frequently and become more engaged? What makes them sticky to your network such that when a new network emerges, they will retain on your product?
1/10/100 rule: 1% might start a group, 10% might author content, 100% benefit from the activity of the first two groups
Internet technology pyramid: base is self-expression and communication (talking to friends, express how you feel), next layer is status (represent who you are, show people you’re cool, likes, comments), top is talent (learned a new dance, funny storytelling, entertaining)
A combination of tool, aggregation of audience, and a networked product is what is needed to unlock the hard side of a network
The atomic network is the most important group of users to start with, and it’s important to have a thesis for why your product will appeal to them starting on day one
Build a product that solves an important need for the hard side
What people are doing on their nights and weekends represents all the underutilized time and energy in the world. If put to good use, this can become the basis of the hard side of an atomic network. Sometimes the army is built on people with excess time, but sometimes it is built on people with underutilized assets as well
Rideshare networks depend on the underutilization of cars
Airbnb is built on the underutilization of guest bedrooms and second homes
Craiglist and eBay are built on letting people sell their “junk”
Zoom didn’t have more features, but in fact had the most important feature of all: the “it works” feature
Networked products facilitate the experience that users have with each other. They grow and succeed by adding more users, which create network effects
The product idea itself should be as simple as possible and at the same time, it should bring together a rich, complex, infinite network of users that is impossible to copy by competitors
Invite mechanics work like a copy-and-paste feature — if you start with a curated network, and give them invites, that network will copy itself over and over automatically
LinkedIn stayed invite-only for a week
New users were asked to import their email contacts to invite more people and “Find Friends”
New users who appeared in other people’s contacts — even if they skipped importing it themselves — had suggested connections right after sign-up as “People You May Know”
Invite-only launches have been a key feature of many products precisely because for networked products, there are huge advantages. It allows the early network to gel as a community, develop a high density of connections, and grow organically via virality
Creators of networked products have an additional task: curating the right people so that the experience of a new member joining the community, marketplace, or other network is just right
“Come for the tool, stay for the network” is one of the most famous strategies for launching and scaling networks
Importantly, Instagram was built with a network from day one. It had user profiles, a feed, friend requests, invitations, and many other features of a modern social product
“A popular strategy for bootstrapping networks is what I like to call “come for the tool, stay for the network.” The idea is to initially attract users with a single-player tool and then, over time, get them to participate in a network. The tool helps get to initial critical mass. The network creates the long term value for users, and defensibility for the company” — Chris Dixon
Tool, network pairings
Create + share with others (Instagram, YouTube, G Suite, LinkedIn)
Organize + collaborate with others (Pinterest, Asana, Dropbox)
System of record + keep up to date with others (OpenTable, GitHub)
Look up + contribute with others (Zillow, Glassdoor, Yelp)”
Kanban was inspired by the Toyota lean production system
Pivoting users from tool to network can be hard. Sometimes only a small percentage will make the transition since it requires them to change their behavior
You need to nail the killer product, and prove that you can gain an atomic network, before reaching for the financial lever
At scale, it’s almost always the goal to reduce incentives once the market has been won
What looks like unprofitability in the short term might lead to dominance in the long term, if the market reaches a Tipping Point in your favor
“Finstoning” in software is replacing missing product functionality with manual human effort
Reddit: No one wants to live in a ghost town. No one wants to join an empty community. In the early days, it was our job each day to make sure there was good content on the front page. We’d post it ourselves, using dozens of dummy accounts. Otherwise the community might dry up
The goal is always to build software to replace all the pen-and-paper workflows
The value proposition to social content creators often revolves around status and feedback — in the form of likes, comments, and so on
Each subreddit needs at least a thousand subscribers to self-sustain
Airbnb: Online campaigns such as “Make $1,000 in one weekend renting your apartment to Oktoberfest attendees” instead of more generic campaigns like “Rent your apartment to strangers” dramatically improved supply-side conversion metrics
It’s a huge advantage to have a strong personal network in B2B, which you can also build by bringing a connector investor or joining an incubator such as YC.
Getting press is rarely the way to get started
In recent years, B2B products have started to emphasize memes, funny videos, invite-only mechanics, and other tactics traditionally associated with consumer startups. I expect that this will only continue, as the consumerization of enterprise products fully embraces meme-based go-to-market early on, instead of leading with direct sales
For a startup to succeed, at least one founder (usually the CEO) will have to spend a lot of time on sales and marketing
Growth teams have emerged across the industry as a focused way to scale products toward Escape Velocity
Dropbox questions: Which files did people tend to go back and edit or move, again and again? What types of files did multiple users within a network tend to share, collaboratively edit, and interact with?
When Dropbox put out their product demo video on Reddit, Hacker News, Digg, and others, their beta waiting list went from 5,000 people to 75,000 people overnight
Dropbox went after High-Value Actives rather than Low-Value Actives
The “Acquisition Effect” is the network effect that powers the acquisition of new customers into your product — in other words, viral growth
Products are inherently viral when people bring their friends and colleagues into a network simply by using it
This keeps customer acquisition costs low over time, fighting against the natural rise that comes with market saturation and competition
The types of projects that amplify the Acquisition Effect are oriented around viral growth: referral features that reward users when they invite others, tapping into contacts to create suggestions for who to add to an app, and improving conversion along the key moments in the invitation experience
All of these help increase metrics like new user sign-ups, the so-called viral factor of a product, and bring down the cost of acquiring a customer (CAC)
YouTube had the embeddable player that could be added to any blog or MySpace profile. LinkedIn used email contacts to connect with your work colleagues. Eventbrite emailed invitations to an audience of potential attendees
The Acquisition network effect, which utilizes the participants of a network to acquire new users — and the bigger the network, the better it works
Some of the most viral products ever created — like WhatsApp — have been able to generate over 1 million installs per day, without paid marketing. Contrast this to traditional products that often have to buy advertising, take on partnerships, and undertake other expensive marketing activities to scale their user acquisition
It’s hard to hit hundreds of thousands of new users a day when you have to pay for each one
Early-stage companies, in particular, are on a kind of treadmill where they must bring in enough new users each week or month to offset the ones they are losing to churn
While it is tempting to throw money at the problem, without a scalable, repeatable source of new users, it is likely that budgets will get out of control and advertising channels will eventually tap out. Viral growth builds on the power of networks to acquire users, often free of charge
Networked products are unique because they can embed their viral growth into the product experience itself
When a product like Dropbox has a built-in feature like folder sharing, it can spread on its own. PayPal’s badges and core user-to-user payments accomplishes the same. This is the Product/Network Duo at work again, where the product has features to attract people to the network, while the network brings more value to the product. Workplace collaboration products like Slack ask you to invite your colleagues into your chat, and photo-sharing apps like Instagram make it easy to invite and connect to your Facebook friends
A new user hears about a service, signs up, finds value in it, and shares the product with their friends/colleagues, who also sign up. These new users then repeat the same steps — this is the viral loop
To increase the Acquisition Effect, you have to be able to directly measure it
The real magic starts to happen as the viral factor starts to approach 1. After all, at a viral factor of 0.95, 1,000 users show up and then bring 950 of their friends, who will then bring 900, and so on — ultimately the amplification will be 20x. This is the mathematical expression of when a product “goes viral” and starts growing incredibly fast. The viral factor can also be above 1, in rare cases, but this typically can’t last for long — eventually market saturation and changing user demographics start to drag down the metrics
Traditional marketing channels like online advertising, can be bought by practically anyone, naturally driving up costs and lowering effectiveness over time
A network needs retention to thrive; it can’t just continually add new users.
“The Engagement Effect” is what happens when a product gets stickier, and more engaging, as more users join
Nearly 1 in 4 people abandon mobile apps after only one use
Losing 80% of mobile users is normal
Of the users who install an app, 70 percent of them aren’t active the next day, and by the first three months, 96 percent of users are no longer active
People spend 80 percent with just three apps
As a rough benchmark for evaluating startups at Andreessen Horowitz, I often look for a minimum baseline of 60 percent retention after day 1, 30 percent after day 7, and 15 percent at day 30, where the curve eventually levels out
Networked products are unique in that they often become stickier over time, which cancels out the inevitable customer churn
In rare but exceptional cases, the retention curve will “smile” — meaning that retention and engagement will actually go up over time, and churned users will reactivate. I’ve learned that when a startup shows a smile curve, you should probably try to invest. It’s exceedingly rare
What starts as infrequent and noncommittal usage often deepens into daily usage. Luckily, nudging users into more frequent usage can be part of the product design. The key is to target relevant users with messaging or incentives, or otherwise to try out new use cases over time. This moves them from low engagement into high engagement
Educate users — with content or otherwise — or simply introduce and promote new features
To encourage users to take these high-value actions, Dropbox could improve the functionality of syncing and sharing. It could send or show educational content, showing users the fastest way to get set up on multiple devices. Or it could use incentives — free storage, for instance — to compel users to properly set up their accounts
The Escape Velocity phase is about accelerating these loops, by making each stage of the loop perform better. For a marketplace listing, how might you make creating a listing easier? How might you make sure more potential buyers see the listing? Can the purchase process be one click, so that the conversion rates are higher, and the seller sees more purchases?
Based on data I’ve seen from startups, a typical product might only have 25–50 percent of its registered users active in any given month
Company-sent communications rank among the lowest clickthrough rate messages. Networked products, on the other hand, have the unique capability to reactivate these users by enlisting active users to bring them back. Even if you don’t open the app on a given day, other users in the network may interact with you — commenting or liking your past content, or sending you a message. Getting an email notification that says your boss just shared a folder with you is a lot more compelling than a marketing message
Almost always, churned users don’t receive any communication at all. You can boost reactivation success rate significantly just by sending a weekly digest of the activity in a user’s network, or “Your friend X just joined” notifications
The “Economic Effect” is the ability for a networked product to accelerate its monetization, reduce its costs, and otherwise improve its business model, as its network grows
This helps in driving higher efficiency when promotions, incentives, and subsidies into a network. The Economic Effect also can grow revenue by increasing conversion rates, by building features for the network as opposed to tools for the tool.
Subsidizing (promotions, discounts, etc.) is an important dynamic in rideshare, but it’s also true if you think about getting content creators onto a video platform, or paying app developers to build new products against your new API platform. As a network grows over time, its ability to subsidize the ecosystem grows as well
In YouTube’s case, creators can be paid different amounts based on the quality of their viewer engagement. For a bottom-up SaaS product, data can be used to determine when and how to target customers for upsells. These can all move the needle, improving the business model of a networked product as it scales
Premium features can be designed in a way where they are more useful as the network gets larger, as opposed to being based on individual usage. Thus, the larger the network, the greater the incentive to convert to premium
When more sellers are part of a marketplace, there’s more selection, availability, and comprehensive reviews/ratings — meaning people are more likely to find what they want, and each session is more likely to convert into a purchase
Social platforms often monetize users by providing social status, but status has value when there’s more people in a network
In multiplayer games like Fortnite, which has generated hundreds of millions in revenue on “emotes” — the virtual dances that differentiate a player. This only holds value if many of your friends play and appreciate the premium emotes you’ve purchased. As a result, a more developed network creates an incentive for people to invest in their standing within the game — this is the Economic Effect at work
Products with a strong Economic Effect are able to maintain premium pricing as their networks grow, because switching costs become higher for participants who might be looking to join other networks
It may be easy to copy features, but it’s nearly impossible to copy a network
Growth Accounting Equation: Gain or loss in active users = New + Reactivated − Churned
This month’s actives = Last month’s actives + gain or loss
Negative forces appear during the late stage of a network’s life cycle: market Saturation, churn from early users, bad behavior from trolls, spammers, and fraudsters, lower-quality engagement from new users, regulatory action, a degraded product experience, as too many users join
More users and more content mean that you need to bring in features like search, algorithmic feeds, curation tools, and a plethora of other tools to manage this. If you don’t solve this problem, then users will start to leave, potentially preferring competitive products that are smaller but more curated
The failure rate of venture-backed startups is over 50 percent
Only 1 in 20 venture-backed startups end up with the > 10x exits the industry is focused on
Hitting a $1 billion valuation generally requires at least $100 million in top-line recurring revenue annually, based on the rough market multiple of 10x revenue. You’d want to hit that in 7–10 years, to sustain the engagement of the key employees and also reward investors who often work in decade-long time cycles
Neeraj Agarwal’s path to reach unicorn status
Establish great product-market fit (1–3 years)
Get to $2 million in ARR (annual recurring revenue)
Triple to $6 million in ARR
Triple to $18 million
Double to $36 million
Double to $72 million
Double to $144 million
Both network saturation and market saturation can slow down growth. Market saturation caps the total number of people on the network — you eventually run out of companies that can sign up to your collaboration tools, or gamers for your new massively multiplayer game. But network saturation also caps the effectiveness of your engagement over time as the interconnections slowly diminish in incremental value. These two dynamics together drive the saturation effects that slow a network’s growth. The way to fight these inevitable forces is to constantly evolve your product, the target market, and the feature set — there’s no way around it
The Adjacent Users are aware of a product and possibly tried using it, but are not able to successfully become an engaged user because the current product positioning or experience has too many barriers to adoption for them. New groups of billions of users didn’t quite understand the product and how it fit into their lives
In the framework of the Adjacent User, teams need to continually evolve their offering to attract the next set of sellers or creators to their platform. Doing this requires a team to think about new markets, rather than listening to their vocal core markets — a hard feat when the core market generates most of the revenue
New formats, which allow people within a network to engage and connect with each other in new ways
Layering on new geographies — as eBay did by adding international regions — is another way to build up the layer cake. Other networked products can think more globally, adding new languages and payments as they cross from one continent to the other
The Law of Shitty Clickthroughs says every marketing channel degrades over time. This means lower clickthrough, engagement, and conversion rates, regardless of if you’re talking about email, paid marketing, social media, or video
The Law of Shitty Clickthroughs is best countered through improving network effects, not by spending more on marketing
A networked product is successful when people on a network know how to interact with each other. A content creator needs to learn the types of content that are successful on that particular platform
The penalty for acquiring new members of the hard side but not setting them up to be successful is steep: they churn
Not all networked products experience context collapse as rapidly as others. When users are able to group themselves, they prove particularly resilient
Software allows users to create and enforce standards on a network — this is “netiquette” embedded into the product, in software form
Networked products have to constantly tweak and iterate on their product to respond to the behavior and needs of their audience. In many ways, this is where centralized control — usually in the hands of a well-funded company — is in a better position to address the myriad of challenges that might crop up as the network expands. A startup can quickly make changes to their discovery algorithms, user interfaces, and hire moderators — as we’ve seen many social apps do
Overcrowding can hurt network effects and ultimately make a product unusable. It’s what happens when there are too many comments, threads, and emails in your work inbox. It’s when you’ve followed too many people on a social media app, and there’s too much content to deal with. Or if too many players in a multiplayer game leads to server overload and difficulty finding the right match
YouTube started out as a dating site, where people could upload videos of themselves as part of a profile
Every social platform at scale has some kind of implementation of “People You May Know” or “Friend suggestions” feature
People You May Know was a key part of LinkedIn’s success, generating billions of connections within the network
“The key to investing is not assessing how much an industry is going to affect society, or how much it will grow, but rather determining the competitive advantage of any given company and, above all, the durability of that advantage. The products or services that have wide, sustainable moats around them are the ones that deliver rewards to investors” — Warren Buffet
In low-tech companies like See’s Candies or Coca-Cola, the moat is often a strong brand or a unique business model. For software products with network effects, a strong moat means something different: how much effort, time, and capital does it take to replicate a product’s features and its network?
It’s certainly not a contest to see who can ship more features. Although the apps for DoorDash and Uber Eats look similar, the former’s focus on high-value, low-competition areas like suburbs and college towns made all the difference — today, DoorDash’s market share is 2x that of Uber Eats. Facebook built highly dense and engaged networks starting with college campuses versus Google+’s scattered launch that built weak, disconnected networks
There is a myth that network effects will magically help you fend off competition. It’s a lie that entrepreneurs tell themselves
Growth Hacker is the new VP Marketing
Any new product that starts to cherry-pick must eventually be able to build its own stand-alone destination and scale it
Cherry picking is an enormously powerful move because it exposes the fundamental asymmetry between the David and Goliath dynamic of networks. A new product can decide where to compete, focus on a single point, and build an atomic network — whereas a larger one finds it tough to defend every inch of its product experience
The Big Bang Launch is the wrong way to build a network, because a wide launch creates many, many weak networks that aren’t stable on their own
Google+ had 90 million users, but they were signing up but then not doing much
You’d rather have a smaller set of atomic networks that are denser and more engaged than a large number of networks that aren’t there
To build a massive successful network effect, you must start with a smaller, atomic network
Distribution advantages don’t work when the product is inferior
The goal is to compete not just on features or product, but to always be the “big guy” in a competitive situation — to bring your bigger network as a competitive weapon, which in turn unlocks benefits for acquisition, engagement, and monetization
#SharedFromTwos ✌️
