The True Value of Network Effects
Resources:
Harvard Business Review: https://hbr.org/2014/11/what-airbnb-uber-and-alibaba-have-in-common
According to the Harvard Business Review, there are four types of business model that govern companies today: Asset Builders, companies that build, develop, and lend assets to make and distribute physical objects. Service Providers: Companies that hire employees with specific expertise that provide service to customers. Technology Creators: companies that develop and sell intellectual property including software, security, analytics and more. Lastly, Network Orchestrators: companies that “create a network of peers in which the participants interact and share in the value creation”. Despite holding only 5% of the current market, Network Orchestrating companies, according to the research done by HBR, has the highest potential and is the most profitable route that should be pursued by new and existing companies.
According to numerous studies done by the Harvard Business Review (HBR), network orchestrating companies’ average evaluation-to-revenue (multiplier) is 2-4 times higher than those of other types of businesses. Some network orchestrating companies, such as Facebook, Airbnb, and Alibaba, even get an evaluation of 5 to 10 times greater than their annual revenue. Not only does this data suggest the grandeur of network orchestrators, but also demonstrates the potential growth of these companies. One reason for the successes of such companies is the low marginal cost per additional customer. Once the company passes the threshold in which the network effect begins, it costs nearly nothing to gain additional customers. Thus, the network effect is equivalently a zero cost, self-sustaining, and self-advertising machine that allows companies to grab on to new customers at no additional costs.
With average valuations 2-4 times greater than the revenue, its self-sustaining behavior, and potential for growth, the network orchestrating business model seems like the model of the future. However, despite the unparalleled benefits, as discussed in class, getting to the inflection point in which the network effect starts to take place remains a challenge. Therefore, as proposed by the author, companies should start to re-evaluate their own business models and begin directing resources towards investing in network related assets such as connecting users together that will ultimately give companies a competitive edge in the long run.