why Network Effects is the native Defense in the Digital world

You would have definitely heard/read a statement in entrepreneurial/product talks, blogs, summits: "Network effects is the most important type of Defensibility in the digital world"

In this post we will try to understand what that statement means. Lets start...

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Isn't Defensibility same as Competitive Advantages? No it isn't.

• Competitive advantage are those factors that help your company become successful
• Defensibility are those factors that help you stay successful.

If you build a business with good competitive advantages, your value grows linearly as you grow revenues. That’s good.  But if you’re able to move past competitive advantages to true defensibility — to really being able to protect your business from the competition — your value grows exponentially. These makes your business hard to catch once it gets going. They make it defensible.

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In the old days, there were many ways to create defensibility:

• Unique access to raw materials
• Favorable geographic location
• Government regulations like tariffs, patents and licenses, etc. 

But in the digital/software/information world these have largely melted away because the data transparency is much higher and it’s easy for customers to click-to-switch to a competitor.

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Some of the Competitive Advantages of the digital world:

Speed
Going faster is a significant advantage in the short and medium term. It’s the No. 1 competitive advantage every startup can give itself. At NFX Guild, this is one of the critical things we screen for in our Guild members.

Capital
Like we’ve seen with Uber, Square or NextDoor, the ability for a team to raise more capital lets a company hire faster, buy market share and move to set up real defensibilities. Further, raising a lot of capital helps scare other investors from investing in your competition. (It can also lead to errors in judgment that hurt the company, but that’s another story.)

Unique Team
Either technical talent or having unique insight into a customer/market.

Content
Companies like Zillow, Yelp and Facebook were places for users to get unique content at launch or shortly after launch.

Buzz
When companies like Slack or Meerkat capture the elusive imagination of influencers in tech and media, it makes it easier to fundraise, hire talent, get press and get noticed by customers.

Relationships
People do matter. Having a personal advantage with a customer can be an advantage for a time against competition.

Location
Companies located here have a competitive advantage because of access to capital, press, talent and creative insights from the dense network of people working on similar problems.  The numbers prove it.

Patents
These can apply, but we’re seeing them apply less over time in software and the digital world.

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The 4 Defensibilities of the digital world:

Economies of scale
(example: Amazon) When you get bigger, a host of advantages accrue to you.  More users means more volume, means you can get cheaper prices from suppliers, means lower prices for customers, means higher conversion rates, makes your advertising more effective than your competition, etc. The numbers all move in your favor, and math is hard to compete with.

Brand
(examples: Booking.com, Google). With brand, a certain company can stand top of mind when we think of something we need, like booking.com when I need a hotel room. Priceline, the owner of Booking.com, spends more than $2 billion per year in advertising to make sure that’s true. Further, people come to identify themselves with brands. People who want to associate with Apple products will not comparison shop. Those psychological barriers make it very hard for competitors to break in.

Embedding
(examples: Workday, Oracle, SAP). Embedding works when you integrate your software into a customer’s operations so the customer can’t rip you out and replace you with a competitor. This is obviously more prevalent when customers are organizations, not individuals, and is typically accompanied by a direct sales force to drive the embed.

Network effects
A network effect is when another user makes the service more valuable for every other user. Once your company gets ahead, users won’t find as much value in your competitors’ smaller networks.

Examples: LinkedIn, Alibaba, Whatsapp, ebay, Skype, Slack, Craigslist, etrc.

Click here to read a detailed post about Network Effects:
http://saurabhkautilyagupta.blogspot.com/2018/03/growth-hacking-network-effects-viral.html 

Network Effects' map (source: NFX)

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The 5 major types of Network Effects:

Direct
Used by: (LinkedIn, WhatsApp, Facebook)

Two-sided
Used by: (eBay, Craigslist, Microsoft, iOS)

Data
Used by: (Google Maps, Waze)

Tech Performance
Used by: (BitTorrent, Skype)

Interpersonal
Used by: (Slack, Apple)

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Fortunately, creating network effects are available to startups from Day One & each startup should plan/design/engineer its products/features accrodingly.

Source:

Techcrunch.com/2016/09/15/defensibility-creates-the-most-value-for-founders/

Youtube.com/watch?v=vLsnYCPdNtc
Medium.com/@nfx/the-network-effects-map-nfx-case-study-uber-49f82e0c4664