What Makes a Strong Social Network in 2015?
Source article: http://www.fool.com/investing/general/2014/01/06/when-network-effects-are-overvalued.aspx
Dan Newman, writing for The Motley Fool, explains that some of the best social networks currently are ones that involve the consumer sacrificing more to join said network.
There are currently lots of startups whose business is based entirely on their mobile applications that are being valued at billions of dollars (like Snapchat). Many of these companies have hardly made any profit, and therefore are being valued based on factors like the amount of users they have. Newman writes, however, that this is not an ideal way to look at these companies. Snapchat requires nothing more than a few clicks to download the application and begin using it. This provides little to no investment on the user’s part to join the network. On the other hand, for something like the Microsoft office suite, there is relatively a lot of investment that needs to be done on the part of the user in order to be a part of the Microsoft ecosystem. Once the user is acquired in this case, they are much more likely to stay locked into this network.
For an investor, larger lock-in costs on the part of the user are significantly more valuable. This is because the user is much less likely to integrate into a similar, but competing network. Even if something like Microsoft Office has less users than Snapchat, each user that Microsoft has is significantly more valuable to the company.
This has large implications on the technology world and the economy. If companies like Snapchat are being valued so high through very novel metrics of valuation (i.e. clicks, button pushes, users, etc.) that are not based on anything strictly monetary, there is a very high risk of these companies not being valued at their true value (whatever that is). Therefore, it is very important for many of these venture capital and other investment firms to look into the network effects of all of these technology companies. More specifically, how these network effects would influence future monetization. If an app like Snapchat is monetized to a significantly higher level than it already is, there is a good chance that it may lose many of its customers.