The Beatles, Metcalfe’s Law, Geoffrey Moore, and the “Dark Side” of Network Effects

Value networking is nothing new. It is simply creating a hub where people from either side of a transaction can meet, interact, and conduct business. eBay does it. Google does it. Groupon does it. In fact, any website that acts as a B2C or B2B marketplace could qualify as a value networking site. The beauty about value networking is that once a certain point in the growth curve is reached, it is supposed to expand exponentially based on the premise of network effects. This is often what the owner or facilitator of the network is counting on for growth and ultimate success. However, there is a definite dark side to this, and all businesses who are network hopefuls need to be aware of it from the outset.

The question is not whether network effects are real. Most certainly they are. Facebook, Twitter, LinkedIn, and others, have clearly demonstrated that network effects are not a fantasy. The question for network hopefuls is rather, what is that magical “certain point” or what is the “critical mass” needed to trigger that network effect? And as an even more important corollary to this question is, how long do I need to give my products or services away until it starts to pay off?

Some might point to (Bob) Metcalfe’s Law—whereby the value (v) of the network is proportional to the square of the number of connected persons (n2). Clearly, the faster you build “n”, the faster you see the network effect happen. Others may choose to cite Geoffrey Moore’s thesis on “Crossing the Chasm”, where at some point between 13.5% and 20% market penetration and after slogging through the painful “innovators” and “early adopter” phases, the “bend of the knee” happens, and the growth curve ignites upwards to glory and profitability. Again, the faster you build “n” the better it is for those on the Moore bandwagon. Google’s Chief Economist, Hal Varian’s premise is similar, in that he states the value of a network to one user depends on how many other users there are.

While all of these gentlemen have proven the merits of their respective theories, and in doing so have provided tools to provide a path to answer to that first question, they have fallen short on answering the more important second question, “How long do I have to give my stuff away for free?”

The Beatles (and my Mother) have drummed into me that “the best things in life are free,” and I agree with that statement for the most part. But businesses cost money. Real money. And, lots of money. Somewhere, sometime, somehow, somebody will have to pay something or the entire business or network collapses under the weighty cost of employees, infrastructure, and all things product.

Offering your product or service for free to the network sounds great and earns you love, but you risk creating an expectation that everything will be free in perpetuity. And, referencing the Beatles once again, “Lovin’ don’t pay my bills”. What’s more, the network that is using your product or service will want more capabilities and features to be added—you guessed it—for free as well. And if you don’t, they will defect to competing services. Hal Varian talks about this chilling prospect of ferocious customer defection in his book Information Rules. In fact, it is in the network model and if the “n” grows too quickly, and you have no way to monetize it, you will quickly find yourself a victim of your own success.

So, if you are one of the SMEs out there that account for more than 90% of businesses worldwide (WorldBank Group, March 2012), and you are trying to answer that all important second question, you better hope for a wealthy and patient benefactor who can wait awhile for payback, or the answer has to be “very, very quickly”. Both of these are not easily achieved.

In light of this, and thousands of failed network hopefuls that have been driven into bankruptcy, I would propose another, and somewhat failsafe strategy: Facilitate a transaction on the network, and take a small slice of it. Simple. In other words, rid yourself of the “dark side” side by turning on a light.

The ‘dark side’ occurs because businesses do not put themselves in the middle of the actual transactions taking place through their website and/or business and thus become a victim of their own growth.

Dealing with the Dark Side

What, then, is the solution for owners of B2B marketplaces who face this very problem? The obvious one has been answered already: put yourself in the middle of whatever transaction you are facilitating. This needs to be done at the outset—not as a subsequent monetization effort. If you do it after you establish your brand, your users have little compulsion to pay—and they’ll just go elsewhere with their business if you threaten to stop the service.

Equally important is to make sure that your online business or marketplace provides a safe trading environment for buyers and sellers to transact, both domestically and cross-border.  Incorporating electronic payments at the point of service (or shopping cart) and adding features like escrow services will help build trust for buyers and sellers alike while creating higher conversions.

To learn more about how to deal with the dark side and to ensure your success in the B2B commerce domain, drop us a note. Traxpay can help.

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