The Network Effects Bible - NFX  ## Metadata - Author: **NFX** - Full Title: The Network Effects Bible - Category: #articles - URL: https://www.nfx.com/post/network-effects-bible ## Highlights - Network effects are mechanisms in a product and business where every new user makes the product/service/experience more valuable to every other user. ([View Highlight](https://read.readwise.io/read/01hya59d6mnjry5tp0rq7d5p23)) - To date we’ve identified [13 different kinds of network effects](https://www.nfx.com/post/network-effects-manual). They’re listed as follows in order of strength: 1. [Physical](https://www.nfx.com/post/network-effects-manual#physical-direct) (e.g. landline telephones) 2. [Protocol](https://www.nfx.com/post/network-effects-manual#protocol-direct) (e.g. Ethernet) 3. [Personal Utility](https://www.nfx.com/post/network-effects-manual#personal-utility-direct) (e.g. iMessage, WhatsApp) 4. [Personal](https://www.nfx.com/post/network-effects-manual#personal-direct) (e.g. Facebook) 5. [Market Network](https://www.nfx.com//network-effects-manual#market-networks-direct) (e.g. HoneyBook, AngelList) 6. [Marketplace](https://www.nfx.com/post/network-effects-manual#marketplace-2-sided) (e.g. eBay, Craigslist) 7. [Platform](https://www.nfx.com/post/network-effects-manual#platform-2-sided) (e.g. Windows, iOS, Android) 8. [Asymptotic Marketplace](https://www.nfx.com/post/network-effects-manual#asymptotic-marketplace-2-sided) (e.g. Uber, Lyft) 9. [Data](https://www.nfx.com/post/network-effects-manual#data-network-effects) (e.g. Waze, Yelp!) 10. [Tech Performance](https://www.nfx.com/post/network-effects-manual#tech-performance-network-effects) (e.g. Bittorrent,Skype) 11. [Language](https://www.nfx.com/post/network-effects-manual#language-social) (e.g. Google, Xerox) 12. [Belief](https://www.nfx.com/post/network-effects-manual#belief-social) (currencies, religions) 13. [Bandwagon](https://www.nfx.com/post/network-effects-manual#bandwagon-social) (e.g. Slack, Apple) ([View Highlight](https://read.readwise.io/read/01hya5c1vn071m01jhkye9na99)) - **Nodes** are the network participants: consumers, devices, customers, buyers, sellers, brokers, etc. Different types of nodes can have very different roles within the same network. ([View Highlight](https://read.readwise.io/read/01hya5g34a548qa40agf89jzts)) - Nodes within the same network can differ in terms of their levels of impact, influence, power, and value. **Central nodes** are the nodes in a network with a high number of links and are often more valuable. **Marginal nodes** have relatively few links and typically have less value ([View Highlight](https://read.readwise.io/read/01hya5fnq72jr36c3tn357mzs5)) - Finally, **network size** can be measured by the total number of nodes in a network. The size of a network alone doesn’t determine value, because the amount of activity in a network can vary. ([View Highlight](https://read.readwise.io/read/01hya5gprsgwgwqyqh6zdz7vpv)) - **Links** are the connections between nodes or groups of nodes in a network. Not all links between the nodes in a network are equal. Links can vary (see below) in terms of directionality. ([View Highlight](https://read.readwise.io/read/01hya5h29mw20bt7cz14vrvzcq)) - In building products, it’s advisable to pay attention to how nodes form connections with each other so you can design your product to promote higher network density. Look for the **“white-hot center”** of your network — the densest, highest activity part —and focus the product features and language on activating other users to behave more like that group. Their activity will attract other nodes who will be inspired by the activity of the “white-hot” group, and it will radiate outward from there much faster than you might think. ([View Highlight](https://read.readwise.io/read/01hya5r78n7sv4j20b6tve2qy9)) - In graph theory, which is an aspect of network science, a link between nodes can be either **directed** or **undirected**. Whether a graph is directed or undirected depends on the nature of the connections between the nodes of a network. If the connections are directed, it means that one node points to the other in an unreciprocated fashion. ([View Highlight](https://read.readwise.io/read/01hya5svk79m7k0kamye2rq38s)) - The **direction** of a link between nodes in a network is determined by which way, if any, the interaction between nodes in a network flows. That interaction can include the transfer of money, information, communication, and anything else that can pass between nodes as they interact. ([View Highlight](https://read.readwise.io/read/01hya5wkz5cvgmpj4v8jkhdemw)) - Critical Mass The critical mass of a network refers to the point at which the value produced by the network exceeds the value of the product itself and of competing products. This can happen at different times depending on the type of a network. ([View Highlight](https://read.readwise.io/read/01hya5xqb51g1mcfghh1hajxgx)) - Metcalfe’s Law Metcalfe’s Law states the value of a communications network grows in proportion to the square of the number of users on the network (*N*^2 where *N* is the total number of users on the network). ([View Highlight](https://read.readwise.io/read/01hya61xb4chyvexya5z922rx3)) - Group-forming networks, according to Reed, increase in value a rate of 2^N, where *N* is the total number of nodes on the network. The reason why Reed suggested a formula of 2^N instead of N^2 is because the number of possible groups within a network that “supports easy group communication” is much higher than 1, so that the total number of connections in the network (the network density) is not just a function of the total number of nodes (N^2). ([View Highlight](https://read.readwise.io/read/01hya639adwf6mwh36q6qppv94)) - Tags: #business - You need to recognize these irregularities, find the “white-hot center” within the network, and focus on it initially to build up a network effect before you expand your focus to the broader network. ([View Highlight](https://read.readwise.io/read/01hyarhs4625qqvzxfbt3ghjrm)) - Homogeneous vs. Heterogeneous Networks Homogeneous networks are networks where all the nodes have the same function in the network. One user is interchangeable with the next in the basic function they perform. ([View Highlight](https://read.readwise.io/read/01hyaskf9gnweh3dwnnasvxeh1)) - Asymptotic Network Effects Asymptotic network effects are network effects with diminishing returns. ([View Highlight](https://read.readwise.io/read/01hyasptwmrc1hebmh82002z97)) - Same-Side Network Effects Same-side network effects are *direct* network effects that occur on the same side of a multi-sided (2-sided or N-sided network). Same-side network effects refer to the change in value that occurs for users on the same side with the addition of users on that side. ([View Highlight](https://read.readwise.io/read/01hyasw6ek8ts8czr5rxx730qy)) - Cross-Side Network Effects Cross-side network effects are *direct* network effects that arise from complementary goods or services in a network with more than one side. As opposed to indirect network effects, cross-side network effects refers specifically to the direct increase in value to users on one side of a network by the addition of users to another side. ([View Highlight](https://read.readwise.io/read/01hybpaargwm9qsfsgxx0zqwgk)) - Indirect Network Effects Indirect network effects occur when the value of a network increases as a result of one type of node benefitting another type of node directly, but not directly benefiting the other nodes of its same type. Same-side nodes *indirectly* benefit each other because they create an increased incentive for complementary users on the other side of the network to use the network, which in turn benefits all the nodes on the same side. ([View Highlight](https://read.readwise.io/read/01hybpat87nqmwd7yqg9vg52j6)) - Negative Network Effects In some situations, more network usage or greater network size can actually decrease the value of the network, leading to **negative network effects**. ([View Highlight](https://read.readwise.io/read/01hybpb3rm8z1d35wfmpj696pa)) - A single-player product helps the user alone, and can be used without other users there. The user gets value from a product/service in isolation. For instance, buying something off Amazon. Or filing your taxes on TurboTax. Or implementing Stripe on my ecommerce site. It works for me right away, but I get no value from the fact others are also implementing Stripe on their sites. Users pay for a single-player product based the value it provides them directly, which tends to be linear. All the burden is on you to make your product increasingly more valuable to your customers. This is true of most SaaS companies like WorkDay or Oracle. “Multiplayer” products, by contrast, let their users feel the presence and impact of the other users of the product, but have a hard time being useful without those other users. Multiplayer products let users add value to each other through their actions, even if it’s just viewing something, like on YouTube. Vimeo, without comments and without video view count, is a single player experience. YouTube, with view count and comments, is a multiplayer experience. ([View Highlight](https://read.readwise.io/read/01hya65erkn0zt8yxgs862dj43)) - Switching Costs Switching costs refer to the costs in time, effort, or money that arise when you switch from using one product to another incompatible product. When switching costs are high, it tends to create customer **lock-in** because the customer has more of an incentive to stick with the same supplier throughout their life cycle. ([View Highlight](https://read.readwise.io/read/01hya68w0gbh976d7srrsth6k6)) - Chicken or Egg Problem (Cold Start Problem) The “chicken or egg” problem refers to the problem of getting enough critical mass to trigger a positive feedback loop. If the people on a network produce the majority of value for other users, how do you get the first users to join? ([View Highlight](https://read.readwise.io/read/01hya69bnv9135y5b8x3qesavc)) - Multi-Tenanting Multi-tenanting occurs when there are low costs or no costs to simultaneously participating in competing networks at the same time. ([View Highlight](https://read.readwise.io/read/01hya6db65t3wgexvhykhphvt9)) - Disintermediation Disintermediation is a vulnerability that mostly applies to Marketplaces and Market Networks. It happens when, after initially connecting through a marketplace or market network product, users take future transactions off the product and transact directly. This is a significant problem because retention leading to repeat purchase is the name of the game in most transactional networks. ([View Highlight](https://read.readwise.io/read/01hya6d6nkz25p161wgkdqjspy)) - Retention Retention is about how often your users return to use your product, and this can make a big difference in network effects. If you have low retention, then it will be very difficult to capture any sort of network effects even as your userbase grows, because the overall usage of your product won’t increase and you’ll lose your defensive position. ([View Highlight](https://read.readwise.io/read/01hya6dxpn9yqbavhmgd5gj1kr)) - Viral Effects & Virality Viral effects are different than network effects, but many people confuse the two. Network effects add value to a product when more people use it. The more people use a product with network effects, the more utility each existing user gains from it, so the less likely they are to switch to a competitor. Network effects are about retention and defensibility. ([View Highlight](https://read.readwise.io/read/01hybpd2yrqrex9fanfhazqpjh)) - Reinforcement The important thing to know about network effects is that once you have one going, it’s much easier to build all the other defensibilities on top of it, including other network effects. This “reinforcement effect” is often underappreciated by Founders, especially when they’re preoccupied by growth. ([View Highlight](https://read.readwise.io/read/01hybpey7vjcpw5mw3m6zr2q3m)) - Scale Effects Scale, like network effects, is an important defensibility in the digital era. Scale effects are often confused with network effects because both scale effects and network effects become stronger with more users. However, they work very differently. The best way to understand scale is that as well-run companies get bigger, their *per unit* production costs get cheaper. As a scale effect starts to kick in, the company with a scale advantage becomes the obvious mathematical choice for customers. ([View Highlight](https://read.readwise.io/read/01hybpkqkvp7pwzgyn5v3hm01p)) - Brand Brand is a powerful defensibility, but it’s fundamentally different from network effects. Like with scale, your brand defensibility is correlated with the growth and usage of your product, and so it’s easy to confuse brand with network effects. However, they work very differently. Brand arises when people know who you are and what you do. A well-established brand identity comes with *psychological* switching costs. People are less likely to switch to an unknown or lesser-known brand from yours because psychologically they will default toward what’s familiar. ([View Highlight](https://read.readwise.io/read/01hybppfr325wad7wg5d8xx4f3)) - Embedding Embedding is accomplished by integrating your product directly into customer operations so the customer can’t rip you out and replace you with a competitor without incurring significant cost in time, energy, or both. In other words, embedding *directly heightens switching costs* as part of the process of user adoption. ([View Highlight](https://read.readwise.io/read/01hybpxd6fr9mrvvb1nywxk1hh))