Archives For network effect

You’ve likely read many times before about the importance of understanding your potential customers and correctly identifying key drivers for converting potential users to active users (most applicable in the case of consumer products).  Common wisdom is that targeting a widespread and diverse consumer base is the surest path to success, as the bigger your target market the more potential users you have.  However, spreading too wide of a net can be a costly mistake for many would-be entrepreneurs.  Many successful startups began with a targeted set of potential users and built a strong network effect before rolling out to broader markets.

A classic example is Facebook (at the time known as The Facebook), which began by targeting college students at Harvard.  Once Facebook hit a tipping point, nearly every student at Harvard was registered and an active user.  At this point, the founders decided to roll The Facebook out to several other Ivy League schools, but limited the target audience to students at these (3 or 4) Universities.  Even once Facebook was a clear hit amongst the college crowd, Facebook for years required a valid college email address to register.  They began with a focused target market and aimed for nearly complete saturation before expanding their crosshairs.  This resulted in several advantages.  First, competitors couldn’t gain a foothold in populations Facebook had already fully penetrated.  Second, Facebook was able to create a network effect (part of Eric Ries’ Lean Startup)within each niche market that they targeted, reinforcing the product and the value to its users.

Another example might be a consumer product that can be accessed via mobile phone in India.  Of India’s nearly 1.3 billion citizens, roughly 380 million live in urban settings spread across ~48 cities.  Nine of these have over 4 million people each and 6 of them – Delhi, Mumbai, Kolkata, Chennai, Bangalore and Pune – are expecting to grow to over 10 million each in the next 15 years.  Instead of trying to target India’s population as a whole (or focus any efforts on the rural population), the startup in this example could focus on dominating one of the key urban centers (where people are much more likely to have mobile phones that can access the web) and begin rolling their solution out to other cities once a tipping point / critical mass is achieved.
Geography doesn’t have to be the basis for determining the initial target customer base.  Often targeting a specific niche within a broader set and growing increasingly general with each customer iteration is a great strategy.  For example, a consumer device that could be useful to anyone that exercises at least a couple of times a month could be initially targeted at hardcore marathon runners and distributed at events catering to ultra-athletes.  Once it has achieved success within that small population, it will have essentially gained endorsement by those at the top and could next be targeted to casual half-marathon and full marathon runners (the next level down from ultra-marathon runners).  Next could be club athletes followed by casual after-work sports organizations.  Eventually the device would travel simply by word of mouth having achieved the endorsement of all serious athletes and the admiration of those that want to be more like the elites.
No matter what strategy you chose, having a specific and identifiable market is essential to your startup’s success.

Wanted to share with you an interview of Eric Ries, author of The Lean Startup.  Eric gives advice for all levels and phases of startups, from idea inception and shortening incubation times to managing the inevitable pivots. He talks about creating a minimum viable product (MVP) to figure out whether you have customers for your idea.  Ries says if you have an incredible idea, make a landing page with no product and see if people will sign up for more information.  If they do, you may be on to something.  He also advocates split testing, which is assessing whether customers actually care about update before working on them.  The more continuous your releases are, the more feedback you get.

It’s important to realize that customers aren’t always right, but their feedback can provide useful insights into how other customers might react to your product.  “Asking customers what to do is a total abdication of our responsibilities as founders.  It’s our job to keep the vision of the Company.  Our goal as entrepreneurs is not to ask customers how they think they might behave, but to experiment to discover how they actually behave.  That’s very different from doing focus groups and just asking people what they think.  It’s about trying to construct experiments to say, ‘hey, does this make sense?'”  MVP isn’t about doing the smallest amount possible, it’s about doing the minimum that will be a learning exercise.  Any testing today is much better than the highest quality testing a month from now.  Ries encourages anybody with a great idea to launch as soon as possible to garner feedback.  Telling somebody about an idea isn’t nearly as good as showing them an MVP.

Engines of Growth

There are three different types of startups that have three different categories of important metrics.  The viral engine of growth is followed by companies like Facebook, where the viral coefficient (how many additional people are forced to perform an action because user x performs an action) is a key component of success.  In a viral business, monetization isn’t important early as you can always charge later on.  The second type of business is the sticky / engagement type, which are followed by products like World of Warcraft, where users become addicted and all that matters is how much retention can be achieved.  Engagement businesses would never do anything that would sacrifice addictiveness for monetization.  Paid engine of growth is where you make money from each customer and reinvest it in acquiring new customers.  Growth is easily calculated as the lifetime value of a customer minus the cost to acquire customers.  The larger the number, the faster the company will grow.

Split testing is where 50% of your customers see one version and 50% see the other. It’s critically important to define which engine of growth your business is targeting and see which version in a split test is more successful along the relevant metrics.

One of the interesting anecdotes about Twitter from the video is that when they offered to give investors back their money, they had terrible vanity metrics (only a couple hundred users).  However, when you looked beneath the hood, the customer engagement of those few hundred users was off the charts.  It was an indication that something really interesting was going on here.  If you can prove that the engagement model works on a micro-scale, then you should worry about growing big.  You have to find early adopters before you can go to mainstream customers.  For a product that is network oriented, you have to get the network effect going.  Value of the network is proportional to the square of the number of members.  A single telephone isn’t valuable, but everyone having a phone makes your phone valuable.  Your immediate network is more important to you, so it’s possible to prove a network effect on a small community of early adopters (think Facebook on Harvard’s campus).

Pivoting

There is no formula to determine whether to pivot or whether to persevere.  Current model is to try some stuff and if it work, then great.  If not, then it’s a bummer.  Scheduling the pivot meeting every 8 weeks indefinitely will alleviate any apprehension about it.  What would I want to know 8 weeks from now that would help me to determine whether to pivot?

If a key metric to your success is how many users sign up to be paying customers, increasing that metric should be the goal of the business.  When you start getting diminishing marginal returns on your set goal, it’s time to pivot.  Many business see initial spurts of growth in a given metric and then have the growth taper off to a fraction of what it was before.  Every entrepreneur that successfully gets through a pivot wishes that they pivoted earlier.  The indicators of traction are always visible early if you look in the right place.

Winter is coming

Ries also threw out the proverbial “winter is coming” from Game of Thrones when describing the current startup scene.  He points out that it feels very summery right now; lots of capital out there and more entrepreneurs than at any other time in history.  What will matter when winter comes is whether a company actually creates value for users or is simply getting vanity metrics (like total number of messages sent).  Just like in the dotcom bubble, people are often using certain vanity metrics as a proxy for later success.

Ries says that we should have a new accounting system for startups and should be focused on helping startups that create value thrive so that they survive when winter comes.  He implied that the tremendous access to capital right now is allowing many companies to raise funds and look successful despite their inherent value proposition is flawed.  An accounting revolution could help to determine which companies are succeeding and which are in the land of the living dead.

Zombie Companies

The video also brings up the concept of Zombie Companies, which are startups that never really make it and just meander along.  These are a tremendous waste of people’s time and consumption of the global entrepreneur resource.  People stay with a stalling startup for many reasons; loyalty, the hope that one more product might make the difference, fear of pivoting based on customer feedback, etc.  However, many of the great success stories actually had ~2 years of failures before they hit it big.  Classic examples are Angry Birds, which didn’t make it big until their ~30th iteration, and Twitter, which was doing so badly that they offered investors their money back (some took them up on it, woops).

Reality Distortion Field

Ries says that all good entrepreneurs have a reality distortion field (famously coined to describe Steve Job’s way of convincing others to achieve the impossible).  The most fun time for entrepreneurs is when they’re in stealth mode, working on their alpha product, dreaming about how successful their idea is going to be.  When customers enter the picture, the bubble gets popped and reality starts to seep through.  There is a fine line between being a visionary and being a crazy person.  Sometimes it’s hard to know which type you’re following.

Quotes

“Ghostbusters is the greatest entrepreneurship movie of all time.  Zuul (the bad guy in Ghost Busters) shows up at the perfect time for the Ghostbusters.  Most entrepreneurs are waiting for Zuul to show up.  In the movies, the key customer shows up when there is one dollar left.  In real life, when you’re down to your last dollar, you generally go down to your zeroeth dollar and then out of business.”

“If anybody is going to make the mistake of going into entrepreneurship to make money, definitely not the best way to make money. Go work at Goldman Sachs.  So much easier.  So much more certain that you will have a payday.”

“If you’re building a product that nobody wants, making it easier to use just makes people realize that they don’t want to use it sooner.”

“The companies that cause the maximum embarrassment are where you do a gigantic launch and then find out it’s a disaster.  Having a small number of customers is such a great asset.  Then you can feel free to experiment and try some really great stuff.”

It’s a great video and there’s a lot more in addition to the above.