On-line Market Startups and Network Effects
With the internet, it is possible for companies to facilitate large-scale markets between sellers and buyers who may otherwise have nowhere to interact, such as eBay, Craigslist, AirBnB, and Uber. But as a start-up attempting to enter one of these markets, what strategy should you take?
The article I read “Network Effects Are Not Enough” argues that network effects cannot save a business if they do not plan things out well. The idea some businesses have is that if you enter a new market and create the first service, you will have the most users, and since the market is only worth however many other users you can access, you can beat any new competition. However, there are issues that arise when this model is attempted.
Firstly, a fast approach to a new market means hastily putting together a business model for something which has never been attempted before, so you probably will not get it right the first time. This problem is amplified because with network effects your customer-base will grow exponentially once it reaches a critical point, so you will have difficulty fixing your business model later because you must continue to provide your service while also attempting to expand quickly to accommodate the users and probably dealing with a multitude of other problems. Additionally, once you create your service, other businesses will likely pop up attempting to enter the market, and will see your mistakes and fix them. Even after you have the momentum of network effects, if your system is not as good as another entrant and the market is still somewhat new, users are likely to switch platforms. You would rather be a late entrant that picks up the users of someone else’s failure than be the first entrant in the market, so spending time perfecting the business model and doing research first is usually best.
There are other issues such as making sure the correct kind of users are incentivized to use the platform; for instance, if semi-professional businesses dominate the supply-side of your market and edge out non-professional users, they have more negotiating power and may attempt to undermine your business model by demanding more benefits or lower prices. Another important thing is maintaining trust in the system. If people are purchasing items from strangers, there must be something built into the market to make them confident they will not be defrauded, such as insurance, rating systems, and user-histories. For a new market, it may be hard to come up with solutions to these problems or even realize what problems will arise, so although it is tempting to go for quick explosive growth, a more cautious approach is usually better.
The article goes into more detail and was interesting. You can find it here: https://hbr.org/2016/04/network-effects-arent-enough