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106. Network Effect: How to Leverage the Power of a Group (A Behavioral Economics Foundations Episode)

Jun 26, 2020

On today’s behavioral economics foundations episode we are going to be talking about the network effect (or perhaps it is more accurate to say “networking effects” because as you will learn throughout the episode, there are multiple kinds and situations for how they can be useful in a business). I am also going to talk about some pitfalls to look out for and how to incorporate behavioral economics into all of that.  

This episode is related to the topic from last week about subscription models and even more directly to membership groups. I will explain that specifically throughout the episode, and if you haven’t listened to that one yet you will want to check it out. It’s episode 105 and there is a link for you in the show notes. Today, I’ll tell you what the network effect is and how it works, what it is not, some pitfalls to look out for, behavioral economics concepts to keep in mind, and so much more.

And before we jump right into the network effect, a quick shout out to Clayton Key, whom you can all thank for today’s episode. Clayton and I connected on LinkedIn and in our messenger conversation he recommended the topic of this episode. Do you have a topic or question you’d like to suggest for an upcoming episode? Connect with me (Melina) on the socials using the links below.

Show Notes:

  • [01:01] This episode is related to the topic from last week about subscription models and even more directly to membership groups.
  • [03:27] Thank you to Clayton Key for this great episode suggestion. 
  • [04:09] In its simplest form, the network effect is when the value of a business increases as the network grows.
  • [05:51] The network effect makes it so new people joining the network increases the value for everyone.
  • [06:51] Ebay, Etsy, Facebook, Twitter, Linkedin, YouTube, PayPal, Uber, Lyft, AirBNB, Google, Wikipedia, Pinterest, and Apple’s App store are just a few of the many businesses these days built on the network effect.
  • [08:18] A direct network effect is when an increase in usage and users leads to a direct increase in the product or service’s value for other users.
  • [08:59] When you get to a platform business they are a little more complex because there are multiple user groups to consider, which is when you get to a two-sided network effect. 
  • [10:37] The key difference from a two-sided network effect and a direct network is that the type of user joining matters.
  • [12:19] In the case of a social network, which is a two-sided network as well, they need to be monitoring their user quality to remain viable and increase value.
  • [13:47] To attract the advertisers and make money, you need good users.
  • [15:14] As each local network grows and increases engagement, the value of the entire network grows along with it.
  • [16:50] People can of course be a part of many groups, and so attracting diverse users who understand all the content they can get access to on the platform is key.
  • [18:19] Network externality is an economics term that is showing how demand increases when other people buy a product.
  • [19:36] A business can have network effects but not be “viral”.
  • [21:18] If you are looking to start on a network effect business, you need to understand when you will hit critical mass, what it looks like when you get there, and what you need to do to get there quickly so you can move into that value point.
  • [23:14] So, when setting up this model remember that you need to be able to stick it out for a while up front while it may be costing you money, knowing it will pay off once you hit critical mass.
  • [25:13] This platform model is looking for quality growth.
  • [26:34] Network effects are not quite a house of cards, but being dependent upon users working harmoniously together does make a somewhat precarious beast that needs constant monitoring and attention. 
  • [29:07] 5 C’s of network effects are connection, communication, collaboration, curation and community.
  • [30:16] Help make it easy for people to feel like they are part of the global community so they can take ownership over their content and be part of quality creation within the platform itself.
  • [32:29] Put effort in to retain the customers you’ve added.
  • [34:56] You want a platform people actually use so the network effect can grow and thrive.
  • [37:10] Brand extensions are a delicate balance of finding something that is related enough to make some sense for tying it to the original brand, but not so close it feels like it should have been part of the main offering to begin with.

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