Making Money from the Network Effect
From Zanecorpwiki
A business model based on network effect is a hallmark of Web 2.0 business.refWeb 2.0: A Strategy Guide: Business thinking and strategies behind successful Web 2.0 implementations Shuen, Amy. April 2008. ISBN 13: 9780596529963. Google book preview also available./ref The general idea is that the value of the network is harnessed to generate money for a business.
In this view, the network effect is a fuel, and revenue streams are the engine that convert that fuel into revenue.
Companies can grow revenue and/or profit in three ways. The first is to increase the network effect. This can mean increasing the network size (more fuel) or increasing average per-node value within the network through increasing interconnectedness and synergy (enrich the fuel).
The second method is to increase the efficiency of revenue streams. This can be done through extracting more value from the network (more efficient conversion), or reducing costs per unit value extracted (less engine weight/overhead).
Finally, a company can add additional revenue streams. This means adding new products/services or adding streams of a different kind (more engines).
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Increasing the Network Effect
Increasing the size of a network is the most obvious way to increase the network effect. Depending on where a company is at, this can either be the hardest or easiest way to increase revenue.
When a network reaches a certain size, where the network effect becomes clear to would be members, the network can be described as having reached a critical mass where the size of the network grows of it's own accord. During this phase, the growth of the network is generally geometric until the growth levels off as the potential market becomes saturated. It is this self perpetuating, geometric growth which makes network effect business models so attractive.
At the low and high end, participant acquisition is more difficult. For small networks, the network itself does not represent sufficient value to draw participants into the network on it's own. At the other end of the scale, very large networks can become saturated. At that point, growing the network is generally not a viable option.ref group=notesThough sustaining the network becomes vitally important./ref
At these extremes, it is often more worthwhile to focus on enriching the fuel and increase the per-node value of the network. For the small network, the effect is doubly positive. First, it grows revenues directly. Second, it lowers the point at which the network will achieve critical mass by increasing the current value of the network as well as the rate of network value growth.
Increasing Revenue Stream Efficiency
If network effect is our fuel and a revenue stream our engine, then the more of that fuel we can convert to dollars, the more efficient our engine becomes. It's a question of value extraction and optimizing price.
In a classic business model, the optimal price extracts the highest revenue possible from each customer. In network effect models, however, we have to consider the effect such a strategy has son the feedback loop. In other words, maximizing local extraction may decrease expected value by negatively impacting the network value and reducing network effects. Rather than a question of maximizing extraction, it's a question of optimizing price in terms of the whole system.
In any case, the maximum price is generally set by market expectations. Moving even a little above the appropriate price can have dramatic negative effects on participation.
The other possibility open to us is the reduction of overhead to increase profit through the reduction of expense. This is analogous to creating a lighter engine which produces the same output, but adds less weight to the system. Due to interaction with the network effect, it's always preferable to save a penny before charging a penny--and in some cases, you may want to split the penny saved with the network.
Adding Streams
Adding streams is fairly straightforward conceptually, but requires careful planning and thought. With multiple streams, the company is forming multiple relationships, and keeping the communication clear and all the relationships healthy is paramount. New streams should only be added when all existing streams are healthy and well maintained. Half-assed or ill conceived revenue stream implementations can cause more harm than good. Who hasn't been offended by too many ads that obscure content or intrude on the user's flow? I know I dread filling out information forms on certain sites because I can just tell it's going to generate yet more spam and direct mailings.
In network effect systems, your client knows that as a participant, they are the ones creating value in the system. Ham handed or insensitive attempts to extract that value begin to look more like extortion or blackmail than good business.
My personal bugaboo is where a site forces me to create an account just to purchase a product I've already agreed to pay for. The problem is it seems like they're extorting personal information out of me in order to resell it. In truth, a company could sell my info without making me create an account, and just because I create an account doesn't mean they abuse the information. In fact, I very much appreciate when I emcan/em create an account but I emdon't have to/em. This works because it puts me in control. The company is telling me that they want me to do whatever's best for me and they're not trying to make me do what's best for the company.
A satisfied customer is happy to hand over some cash (or info, or something else of value) because they feel they got value of the engagement. The important thing is that the customer feel that every transaction is positive. A transaction presented in the wrong light will become a negative and can sour the entire relationship.
Challenges
We have already discussed some of the challenges inherent in business models predicated on network effect as they relate to generating money. These fall under the general rubric of keeping the network healthy--a concept which at times is at odds with maximizing revenues. In general, this is the difference between local revenue maximization and long term profits and presents a challenging analysis because of the inherent complexity factors involved.
The other big challenge to network effect models is the initial development of the network. Some models, like subscription based models, have some potential to scale down as well as up. Others, like ad based models completely fail under a certain threshold. In other words, with 100 users paying $20 a month, one could potentially sustain a service. Those same hundred users would probably not generate more than a few cents of ad based revenue per month and the system would collapse.
Network effect is by definition something that happens with large, mature products. Never underestimate the cost or difficulty of getting from here to there.
References and Notes
References:
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Notes:
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TODO: I really like this metaphor of revenue streams == revenue engines. It's a fruitful analogy, and perhaps more appropriate for the engaged or peer business.
