The following is an excerpt from “”.Winner Takes All: A Case Study On How Online Marketplaces Are Creating Modern Monopolies” By Sirish Nadkarni.
According to Wikipedia, “Network effects (also called network externalities or demand-side economies of scale) are the effects, described in economics and business, of how additional users of a product or service give the value of that product to other users. It’s an effect.When a network effect exists, the value of a product or service increases according to the number of other people who use it.” I have seen many examples of how it can create winner-takes-all giants. As explained earlier in this book, eBay was an early entrant into the US auction market. Many late entrants such as Yahoo and Amazon have been unable to compete with eBay due to the strong network effects eBay has established. eBay buyers came because eBay had the number of sellers it needed, and sellers came because eBay had the largest audience of buyers. Unlike eBay, which charged a listing fee, Yahoo and Amazon have made listing fees free. Still, the seller saw more sales coming through his eBay and continued to use eBay’s platform. Similarly, companies such as Airbnb and Instacart have established market dominance due to their strong network effects.
Network effects become very strong once the network reaches a critical mass of users and suppliers, but establishing them in the early stages is very difficult. Marketplaces generally start by acquiring the required number of suppliers. Like, for example, DoorDash did by signing restaurants with promises to create new demand for them. Another possible strategy is to sell products to suppliers who offer unique value. A good example of this strategy is OpenTable. OpenTable sold a customer and reservation management system to restaurants without a promise to drive customer demand for the restaurant. Created a unique destination site that facilitates reservations for a restaurant’s customer base only when OpenTable has registered enough customers.
Not all network effects are as strong or global as we’ve seen with eBay or Airbnb. Some network effects may be very weak or localized. Let’s look at some nuances about the strength of network effects.
multi-tenant
Multi-tenancy is the simultaneous use of multiple networks by buyers and/or sellers. The ease of multi-tenancy and simultaneous use of multiple networks makes it very difficult to establish strong network effects. Food delivery apps are a good example of a category where multi-tenancy is common. For restaurants, participating in multiple platforms is relatively easy and advantageous as it has been in the past. Likewise, it is easy for users to try different food delivery apps, especially since many of them had a “10$ off first order” promotion to attract users. As a result, the food delivery market has not been a winner-take-all market with multiple giants such as DoorDash, Grubhub, and UberEats.
Multi-tenancy is also a problem in the ride-sharing market. Many drivers log on to their Uber and Lyft at the same time and pick up whoever offers the ride first.As a result, both companies spent
You need a huge amount of money to acquire a dedicated driver for your platform. Again, like food-sharing apps, the ride-sharing market is not a winner-take-all market.
Local network influence
In many situations, the scope of network effects is not national or global, as we have seen with eBay and Airbnb. Network effects should be established for each market. OfferUp is a good example of this phenomenon. It initially launched in Seattle, where the model proved to work and was able to raise funding to enable expansion into other markets. The company also kept a relatively low profile in the press so as not to lure competitors into markets it had not yet entered. Over time, OfferUp was able to amass a large funding round, allowing it to rapidly expand to all major US markets before other players had a chance to enter those markets. rice field. However, if multiple players entered different local markets, it would have been much more difficult for OfferUp to create a nationwide network effect.
The same phenomenon holds true internationally, with copycat competitors often establishing themselves before they even have a chance to enter the market. In many situations, U.S. companies typically acquire foreign competitors to enter the market when they find network effects in the local market too difficult to overcome. Considering the size of the US market and easy access to US venture capital, it becomes relatively easy for US companies to acquire smaller foreign companies.
Adjust for network effects
Not all network effects show increasing strength as the number of players increases. Depending on the product, it may slow down or vice versa. For example, ride-sharing will initially have a strong network effect as drivers and users join the platform. However, when the market is saturated with drivers and the wait time is below his 5 minutes, more drivers joining the platform won’t help much. As a result, Uber has been unable to kill Lyft in the United States and has managed to attract enough drivers to the platform to establish a viable service in the United States.
Similarly, Facebook is a good example of a network where a very strong network effect has disappeared or even reversed to some extent. Most teenagers and young adults no longer use Facebook and instead use Snapchat as their social networking platform. The reason is that Facebook forces teens to accept their parents, aunts and uncles, and grandparents as friends. Teens are less comfortable sharing private moments with relatives, but they’re much more likely to do so on Snapchat, which is largely populated by young teens.
Commoditized supply and differentiated supply
It’s much easier to establish strong network effects when you have differentiated rather than commoditized supply. Ride-sharing is an example of commoditized supply, where consumers care less about who their driver is and trust the app to make the right choice for them. . As a result, once the network reaches a certain level of liquidity (for example, latency of 5 minutes or less), no more network effects occur.
On the other hand, if you’re offering a long tail of differentiated supply on Amazon marketplaces, Airbnb, etc., network effects will continue to occur. The higher the supply, the more likely there will be fierce price competition among suppliers, making the market more attractive to consumers. Today, you can go to the Amazon marketplace and find almost any product that makes the marketplace’s value proposition so powerful for consumers.