The network effect is a phenomenon whereby a product or service becomes more valuable to its users as more people use it. Facebook and Google are examples of the network effect. According to the Speaker, network effects can create winner-take-all markets. That is how Facebook and Google have become behemoths and come to dominate advertising, now valued at $620 billion and $1.05 trillion respectively.
There is a Silicon Valley consensus that network effects are diminishing, and it is hard to build winner-take-all businesses. For example, there is competition in ride-hailing with Uber, Lyft, Grab and Didi and the highest valued is $70 billion. The same is the case in food delivery with DoorDash, UberEats, and Grubhub or vacation rentals with Airbnb and Booking.com. It is evident there is no first-mover advantage, barriers to switching are low, and it is costly to keep acquiring users.
The Speaker has a contrarian take. She argues that network effects are not diminishing, but actually becoming even more powerful. First, there was Sarnoff’s law which stated the value of a network is proportional to the number of viewers, as in the 1990s with the case of Yahoo! and broadcast companies. Then, Metcalfe’s law proposed that the value of a network is proportional to the square of the number of connected users of the system. This was understood to be the primary driver behind Facebook’s growth. Robert Metcalfe himself used Facebook’s data of monthly active users to show a good fit for Metcalfe’s law.
Source: Y Combinator
For the next two decades, the Speaker believes that the Reed’s law will enable powerful network effects. David Reed proposed that the value of networks that allow the formation of groups can scale exponentially with the size of the network. The reason for this is that this grows much more rapidly than either the number of users or the peer-to-peer connections so that even if the utility of sub-groups available to join is very small on a per-group basis, eventually the network effect of potential group membership can dominate the overall economics of the system. She noted Slack is the best example of the Reed’s law in action.
“There will be lot more devices and peer to peer connections in the future. And therefore, there is a large economic opportunity for startups working on verticals or groups with similar interests—in gaming, remote work, and crypto—with an ability to be winner-take-all. Broadband, mobile and 5G will turbocharge Reed’s law.” The Speaker, who is a partner at the largest incubator in Silicon Valley, said she is seeing more founders apply this law in terms of product build and design.
One of the participants noted that the outbreak of coronavirus will likely accelerate innovation in remote working. Zoom Video has nearly doubled since the health scare was first reported in Wuhan in December. Slack is up 30 percent. Both companies benefit from work being more decentralized.