How to Disrupt Network Effects
Network effects are among the most powerful economic forces in technology and have created trillions in value. The reason for this value creation is not just compounding, but also the defensibility created by network effects. These advantages have allowed network effect-based startups to disrupt incumbent SaaS players. But there are also immensely valuable incumbents who are built on network effects themselves. Is there any way to disrupt them?
The short answer is yes. Often, incumbent networks are disrupted in the same way other types of businesses are. Startups create new value propositions that initially target novel, low-value markets, and gradually encroach on the incumbent’s market. For example, Airbnb started by allowing its original hosts to rent out spare beds to guests. Their approach unlocked new types of supply and eventually created new holiday experiences rivaling hotels. This was a true disruption to Booking.com’s hotel reservation marketplace. Startups following this approach have to contend with a near-term risk, i.e. the risk that there is no market for their product. But if they cross that hurdle, they have the opportunity to create strong network effects. The right variant of network effects can create a deep moat that not only protects them from the incumbent but copycats as well.
In addition to this, there is one more way of disrupting network effects — by making the incumbent’s network redundant and creating a better customer experience in the process. Networks typically need to introduce some element of friction to create a network effect. For example, users of an interaction network like Skype can only call other Skype users. In a marketplace, users can only transact by interacting with a seller present on the marketplace. Eliminating these points of friction can dramatically improve the customer experience but at the cost of sacrificing network effects. This is the flip side of the “managed” marketplace vs. marketplace in name only (MINO) argument. Since the incumbent has already validated the market, this approach trades the near-term risk associated with establishing product-market fit for the long-term risk associated with defensibility. Startups following this approach need to have the foresight to identify this risk and address it in other ways.
