November 18, 2022 • 21 mins
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These are case studies and stories that outline network effects in the wild - it is a montage of how big tech companies like Trulia, Meta, Uber, and even Bitcoin navigate their defensibility over time. For the best experience of this episode, watch our case studies at nfx.com/masterclass or by searching on YouTube to get the visual side of these deep dives.
That was episode 6 of 11, from the Network effects masterclass. Stay tuned and subscribe as next up is Ep. 7 - Network Problems Demand Network Solutions, here on the NFX podcast.
This is an audio version of episode 6 from The Network Effects Masterclass, curated for audio and listening on the go. For the full video experience, transcripts, and recommended reading, join the free Network Effects Masterclass at - NFX.com/masterclass.
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(00:00):
You're listening to episode 6 on case studiesshowing network effects in action from the
network effects master class here on the NFXpodcast.
This episode is a montage of network effects inthe wild that are under the hood of these top
tech companies like Trulia, Meta, Uber, andeven Bitcoin.
For the best experience of this episode, besure to watch these case studies at
nfx.com/masterclass Omri by searching onYouTube to get the visual side of these deep
(00:24):
dives.
Okay.
So now that you defense abilities as well asthe 16 network effects.
Now my partners are not gonna walk you througha bunch of case studies so you can see how
these things play out in action.
In the real world, and I want you to pay closeattention to how these defensibilities
(00:49):
reinforce each other and how the networkeffects reinforce each other as you move
through the seasons of building your companyfrom tiny seed to giant impactful company in
the future.
You're now listening to the network effects ofTrulia.
So it's the summer of 2004.
I was, grad student at Stamford, and I'd justgone through a kind of painful home search.
(01:11):
It was also the summer that Google went public.
So the buzz in Silicon Valley was aroundGoogle.
Now I got a ticket to a real estate conference,so I sat at the back of this real estate
conference.
And I remember driving from San Francisco backto Palo Alto.
There was this kind of unique moment.
What if we applied this sort of Google searchmodel to real estate?
(01:33):
That was it.
I was committed to it.
So the core problem in a 2 sided marketplace issolving the so called chicken and egg problem.
How do you get supply?
Which drives demand?
Which drives supply?
How do you kick start this?
The the first way we solve that problem was toindex websites.
So we'd go to brokers and say, Hey, can weindex your website and put your listings on
(01:56):
Trulia for free?
To demonstrate the value proposition.
The other key network effect that we added wasa data network effect, and we used the scale
and data that came from my users to improve theuser experience.
Everything from a recommendation system.
So just like Amazon, you like this home, you'lllike these other James, So the protocol network
(02:17):
effect was key for us in the early days,standardizing real time XML updates, bring in
real time data from the fragmented MLSs andbroker websites published on TRULIA.
We realized early on We would not take money onevery household, but we got massive
fragmentation, which makes it incredibly hardto to monetize.
We focus on working with the biggest corporateclients in the industry.
(02:40):
In Q2, Q3 of 2008, everything changed.
This could be the most serious recession indecades.
And that means life, as most Americans know, itis about to change, in some cases,
dramatically.
These large real estate companies werestruggling.
They were laying off Pete, housing transactionscollapsed.
(03:01):
Our advertising agreements evaporated.
Business was was in decline as every other realestate company out there.
So up until the point, a revenue came from asmall number of big franchisees, brokers, and
mortgage banks, who were paying a lot toadvertise with us.
But when they crash it, their marketing budgetswere just too far removed from the actual
(03:21):
transaction for them ROI.
Looking back, this was a bet the companydecision, because we had to change direction
completely while the market was collapsingaround us, and we were running out of But in
the end, it paid off big time.
We went from 0 revenue growth during therecession to doubling year over year, allowing
(03:46):
us to go public in 2012 and merged Brazil in2015 in a $3,500,000,000 deal to create Zillow
group.
M and A helped to quickly increasedefensibility of the core marketplace business,
providing scale and moving to a more powerfulkind of network effect defensibility.
So I think of Zillow Group today as a companythat has really evolved into something of a
(04:08):
market network, which combines the coremarketplace businesses that you think of as
truly and Zillow, with a SaaS based tool, thepremier agent app.
The 3rd component was the acquisition ofdotloop, a transaction management platform,
providing the network So you've got today thisincredibly defensible platform, a market
network for the real estate industry.
(04:30):
You're now listening to the network effects ofFacebook, now known as Pete.
Facebook's really the big kahuna of networkeffect.
And that makes them incredibly defensible.
I think there's some temporary talk about thepolicies of Facebook, but I think what's
important in order see clearly is to reallylook at the mechanics underlying what makes
(04:52):
Facebook Facebook.
So 2004, Mark Zuckerberg wakes up with apersonal direct network effect with real
identities.
Harvard didn't have a Facebook, so that's thegap that we were trying to fill.
It was a very powerful form of network effect.
But he immediately realized that he needed toadd other defense abilities.
He then, as he expanded into other colleges,created a real bandwagon effect.
(05:14):
Each new college wanted Facebook to come to it,and no one wanted to be left out.
And Like,
you know, this is pretty cool.
Like, I thought this would work at otherschools.
And once that was rolling, he started to scalethe business until in 2005, there were a series
of big articles about him in the Wall StreetJournal, New York James.
You're establishing the brand of Facebook andthe fact that it was a phenomenon.
He could then go back and scale up even more,including leaving just colleges and starting to
(05:39):
take on the whole world.
They saw the opportunity to create an embeddingstrategy, create software to allow Facebook
users to log in to other websites, using theirFacebook login.
So hundreds of thousands of websites have nowadopted this Facebook Morgan, and Facebook is
now embedded in the whole ecosystem of entireweb.
It allows them to have an embedding strategy,which is very defensible.
(06:00):
Once they'd established severaldefensibilities, including the personal direct
network effect, they were free to explore otherwork effects.
I think Mark in in 2007 actually said somethinglike I think that network effects shouldn't be
underestimated with what we do.
In 2007, they were to launch a 2 sided platformnetwork effect very much like a Microsoft.
(06:21):
So they opened up Facebook platform.
By the next morning, we had so much traffic.
They were literally driving around the SanFrancisco go Bay with a U Haul truck begging
and asking people for servers to handle all thegrowth.
And that allowed entrepreneurs to build codethat would run on top of Facebook, making
Facebook even more sticky and providing morethings for their users to do on Facebook.
Ultimately, I think after 8 years, the activitythere is quite low, but it was still a really
(06:45):
good idea, and they might return to that ideaover time.
Then they started working on a 2 sidedmarketplace effect.
Which with the media companies that wereadvertising on them, they built out wonderful
self serve advertising tools, much as Googleand Craigslist had done before them, but access
saying such an active and large audience.
Your customers are on Facebook every day.
(07:06):
The world has gone social.
Be part of the conversations.
23 or 20 percent of all the ad revenue spentonline comes through Facebook.
But with all the traffic that they had, theystarted developing a data network effect,
impacting Facebook in three ways.
1, they've got so much content that they canchoose better content to show to me.
2nd thing is that the number of humanengagements they have with the content, the
(07:28):
likes, the shares, the comments.
These things actually add value because of thatdata that I'm getting.
And the third thing they have on the data sideis the real time data of all the activity on
the site allows them to adjust and update thevalue of my feed and real time as much like
James will So in 2011, they launched FacebookMessenger, which actually has utility when it's
(07:49):
often about getting things done.
And then in 2014, they saw what app.
And WhatsApp was this personal utility directnetwork effect?
It says it has 450,000,000 monthly activeusers.
Even just independently, I think it's it'squite a good bet.
And they resolved that they would pay whateverit took.
Facebook will pay $19,000,000,000 in cash andstock.
(08:13):
And it also made them double down on FacebookMessenger by hiring in whoever it took to make
that the best product it could be and to growit from a 100,000,000 to over a 1a half
1,000,000,000 today.
And so between 2011 2014, you can see themreally doubling down on the network effects and
being very smart about not Pete somebody elsewith a network effect Pete past them.
(08:33):
So in their continued pursuit of networkeffects, in 2016, Facebook relaunches
marketplace.
They had tried classifieds in the past severalJames, and it hadn't taken.
But this time, it seems to be working, and theyreport over 500,000,000 users year.
And so this is going into the area thatCraigslist has owned for years.
They've been impenetrable, but perhaps Facebookwith their real identity and the frequency of
(08:58):
use they have might be able to pry that markand open.
So this makes Facebook the big kahuna ofnetwork effects.
They've understood it all these years.
They've built products that are excellent atdeveloping their network effects.
This company is not going anywhere.
Are there threats to the company?
Sure, of course, there always are.
The major one that that that we see right nowis literally just government action.
(09:19):
So if there is a threat to Facebook, we see itcoming possibly from 3 directions.
Now the first would be if Facebook becomes apublic health concern in the same way that
tobacco is.
Because of addiction and depression andanxiety.
There's also a privacy issue, obviously, withFacebook, you know, with the GDPR in Europe,
you could see that taking effect in Europe andthen bleeding over into the US.
(09:40):
And then the 3rd direction could come from theantitrust direction with Facebook being so
dominant.
You could see the Department of Justice andpotentially asking Facebook to divest itself of
Instagram and WhatsApp.
But beyond that, it's hard to see because it'shard to break up these interconnected software
products.
If there is another threat, there's negativenetwork effects.
There's so many people there that it pollutesthe experience or keeps it from being cool,
(10:03):
like when older relatives join Facebook andcommenting on your photos.
We've already seen that a lot of James don'tuse Facebook, but I think with good product
design, it's it's a solvable problem.
As a media company, Facebook is very uniquebecause they have amenity to many direct
network effect.
All the media companies that came before, liketelevision, radio, magazines, these were one to
many network effects, 2 sided marketplace, ifyou will, not nearly as strong.
(10:26):
If you see clearly what the mechanics of whatFacebook has done and you see past the noise.
You can see that Facebook is as strong as everand getting stronger.
You're now listening to the network effectsbehind Bitcoin.
(10:48):
When we had metal technology, we made money outof metal.
After metal, we had paper technology, and so wemade money out of paper.
Humans tend to do this.
And now, of course, we have software.
We're not just keeping track of money withsoftware, we're making money out of software.
Bitcoin was the first to do it in adecentralized way.
This is the reinvention of money yet again,regardless of what it's made with.
(11:11):
Money is simply the distillation of a sharedconfidence in the future.
It's what we call a belief network effect.
(11:34):
Money is simply a belief held by a lot of Pete,a collective trance, always in the past, Beller
in a currency formed around a hierarchicalnetwork topped by a king or a queen in his or
her armies.
A pharaoh and emperor czar, a president, Andprior to the US civil war, there were hundreds
of regional currencies operating in the US,each centered around one strong man, or
(11:55):
another, with his hierarchy under For thehierarchical pack animal that we are, hierarchy
with an alpha king on top is understandable byall the people in the network.
And, thus, it's stable.
That's why when the king issues a currency andtells people to use it, people believe in it.
This strong man backed Flint currency approachhas worked for 6000 years or more, but with
(12:17):
Bitcoin, it's different.
Instead of a king or central authority creatingthe Beller, and then controlling the currency,
Bitcoin doesn't have a hierarchical networkstructure with a strong man at the top.
It's a decentralized network structure.
The fact is the majority of the world is stillskeptical of Bitcoin, and this is why.
The asset itself is creating nothing.
(12:38):
Watch out.
You all can do whatever you want, and I don'tcare.
Okay?
People aren't used to having currencies backedby a decentralized network.
There isn't a hierarchy with a believableperson on top to define what they should
believe in.
It's not the same pattern.
To create the belief network effects necessaryfor the existence of money, hierarchical
networks use power from the top, whiledecentralized networks use ubiquity.
(13:01):
Crypto changes the nature of money in ahistorical way because unlike gold or paper
money, crypto is a native creature of the newglobal network.
Unlike fiat currencies, it isn't constrained bygeography or by time.
This is a huge difference.
Bitcoin's product is a currency and Morganspecifically, a store of value.
Its currency doubles as, let's say, shares, andwe can all buy and sell the coins as we would
(13:25):
traditional stock.
And in this view, Bitcoin's market cap wouldput it in the top few most valuable companies
in the world, like other network effectbusinesses.
So Bitcoin has core defensibilities.
And of course, there are only 4 defensibilitiesnative to the digital age that Bitcoin might
use.
There's network effects, there's brand, there'sscale, and there's embedding.
(13:47):
Network effects are, of course, the greatest ofthese.
So let's focus on the network effects map.
You can see the various network effects typesand categories, organized by Beller with the
strongest network effects at the center of themap.
Bitcoin's first and primary network effect is abelief network effect.
It's the same mechanism you see with gold andwith religions.
The more people believe it's valuable, the morevaluable it gets for everyone.
(14:10):
The more times its price crashes and thenbounces back, the more people will believe it
has lasting value.
Yes.
Bitcoin is a bit like sand.
It's not solid.
But if you get a lot of sand and then layersome Ethereum sand on top of it and then the
sand of the thousands of other cryptocurrenciesin existence, The Bitcoin sand gets
progressively more solid as a result of growingbelief network effects, but was once fluid and
(14:33):
intangible transforms into something closer torock.
The Bitcoin second network effect is a protocolnetwork effect.
Protocol arises when a computational standardis declared, and all the nodes can plug into
the network using protocol.
Traditional examples are ethernet and faxmachines as the number of nodes that connect to
the protocol increases the network effect getsstronger.
(14:56):
Bitcoin's 3rd network effect is a 2 sidedmarketplace network effect, and this is the 2nd
most powerful effect for Bitcoin.
And Bitcoin creates 2 form of marketplacenetwork effects.
1st, a speculation between buyers and sellersof its store of value.
Number 2, a payments marketplace.
The more nodes on the network buying, selling,and holding, the better for everyone.
Bitcoin's 4th network effect is a 2 sidedplatform network This is where there are
(15:21):
developers adding their products to the Bitcoinplatform.
The developers receive distribution to users ascompensation for building and adding value to
Bitcoin.
Bitcoin also has a data network effect, a datanetwork effect occurs when as the data in the
network grows, the value of the data for eachuser grows.
If Bitcoin's case transaction data is accretingon the blockchain in a way so that the amount
(15:45):
of computation required to hijack the networkincreases.
To increase the security for everyone and thusvalue for everyone.
Bitcoin 6 network effect is a tribal networkeffect.
Now the main mechanism for tribal networkeffects is the creation of an in group and an
out group so that the in group can know who tohelp and to be loyal to the outgroup typically
(16:05):
turns into the enemy.
There are now Bitcoin maximalists who believethat Bitcoin should be the only digital asset
we'll need in the future and they activelydenounce all other coins.
So within the 5 years, Bitcoin will have 99% ofthe hashing power and 99% of the market cap.
Finally, Bitcoin 7th network effect is abandwagon network effect.
(16:26):
Now these bandwagon effects typically arisewhen people are jumping on early and not
wanting to be left out.
In Bitcoin's case, these early supporters werefinancially and ideologically rewarded for
joining early.
And as the value of the token has grown, peoplehave been wanting to jump on and not be left
out.
Because Bitcoin has the biggest worldwide brandin crypto and is the biggest market cap, the
bandwagon effect is strongest compared tolesser crypto brands.
(16:49):
Moving on to other forms of defensibility,Bitcoin has a strong embedding effect already
because they are listed on all the exchangeswhere people trade crypto They benefit
initially by being listed at all so that theycan attract more users.
But more importantly, because of where they'relisted on the exchanges, at the number one
spot.
For preferred attachment, this will tend tokeep them number 1.
(17:10):
Another key defense ability of the digital ageis brand.
Most people tend to be risk averse and avoidthe unknown, so they are less likely to switch
to an unknown or lesser known brand.
Bitcoin is regularly conflated with the entirecryptocurrency face.
Given its size, Bitcoin has competitors comingat it from all directions.
First, the fiat currencies issued by nations,such as the US dollar and the Chinese yuan.
(17:32):
Incumbents.
Number 2, they've got other digital currencieslike Ethereum Cardano who are trying to take it
down.
And number 3, gold, traditional gold.
Of course, there are some external shocks thatmight negatively impact Bitcoin's network
effects.
We see 3.
First, fake trans 2nd risk is responsiveness ofthe Bitcoin Dow.
The 3rd risk is government intervention.
(17:54):
They are the winners.
They're the incumbents.
They're the winners of the old regime.
Our opinion, it's too late for governments tostop Bitcoin.
The network math protects it.
To sum up, cryptos here to stay The reinventionof money is underway.
Bitcoin will continue to be a big part of thatstory.
Bitcoin created and is now embedded into thecrypto ecosystem and the world's consciousness.
(18:19):
You're now listening to the network effects ofUber.
Companies build their value throughdefensibility in the long term, and there's
only a few ways of doing it well in the digitalworld and through scale, through brand, through
embedding, but the most important one isnetwork effects.
So we see network effects as the number onefactor in defensibility, and there are at least
(18:41):
13 different types.
The strongest ones are in the center of theMorgan, and they generally get less strong as
you go out from the center.
Of the examples where it really matters is acompany like Uber.
So when Uber first got going, they thought thatthey had a real 2 sided marketplace network
effect.
But what it turns out if you look closer isactually have an asymptotic through side of
marketplace network effect, which is not nearlyas strong.
(19:02):
To be clear, there are actually 3 differenttypes of 2 sided marketplace network effect.
One is like Craigslist or eBay where the morepeople you have on both the sellers and the
buyer sides, the more defensible the businessbecomes.
Then there are places like OpenTable is wherethey had to collect a supply of restaurants for
7 years before they had enough to open up themarketplace.
And then the 3rd type is the weakest type,which is an asymptotic one.
(19:25):
So after a certain point, more drivers don'tsignificantly benefit the pesticide and perhaps
your wait times drop from 4 minutes to 3 or to2, the demand side value doesn't keep
increasing as you move towards 0.
Some other company like Lyft can come in, andthey can provide a few hundred cars and can
pick someone up in 4 minutes, they can alsocompete.
(19:46):
Compounding the asymptotic problem for Uber isthat there's multitenanting on both the supply
and the demand side.
The drivers, it's costless for them to switchbetween Uber and Lyft.
And same for the demand side, the thepassengers.
So because of the asymptotic nature of thenetwork effect, Uber has had to get pretty
creative in how they actually increase theirdefense ability.
I mean, the first thing they tried was to growtheir brain.
(20:08):
I mean, they've done an amazing Jaho staying inthe press for all sorts of reasons, so everyone
knows Uber, everyone talks about Uber.
The other thing is they just raise incrediblequantities of money, which allowed them to
scale up and be everywhere.
The other thing they've done is they've theytry to embed Uber into things like Messenger
and Google Maps.
So by embedding, they're also getting anadvantage to get on that demand side or or
(20:28):
maybe even on the supply side.
The other thing they've done is is they'vereally worked on language.
If you can get someone saying your name, like,I googled something or I took an Uber, that is
giving you, social reason for people tocontinue to use that particular service.
All these things have, I think, been very smartand they've effectively executed on it to try
to make up for the fact that their core Peteeffect just isn't that strong.
(20:49):
You know, going forward, we'd wanna take Uberinto a direction where you have much stronger
network effects.
So getting into some of these more personaldirect network effects, perhaps with Uber mute.
Hoover's a great example of how you can use thenetwork effects map to really tease out the
differences between business element to thelast 25 years, over 70 percent of value that's
been created in technology has been created bycompanies with a network effect at their core.
(21:13):
And so for founders, understanding this stuff,the the nuances here is a critical importance.
Stay tuned to the podcast as we'll post 1episode per week until we complete the course.
You can also watch this entire Masterclassonline atnfx.com/masterclass.
Where you can log in, track your progress, andwatch full videos, retranscripts, and find
(21:36):
other related material.
Thanks for listening to the NFX podcast.
You're listening to episode 6 on case studiesshowing network effects in action from the
network effects master class here on the NFXpodcast.
This episode is a montage of network effects inthe wild that are under the hood of these top
tech companies like Trulia, Meta, Uber, andeven Bitcoin.
For the best experience of this episode, besure to watch these case studies at
nfx.com/masterclass Omri by searching onYouTube to get the visual side of these deep
(00:24):
dives.
Okay.
So now that you defense abilities as well asthe 16 network effects.
Now my partners are not gonna walk you througha bunch of case studies so you can see how
these things play out in action.
In the real world, and I want you to pay closeattention to how these defensibilities
(00:49):
reinforce each other and how the networkeffects reinforce each other as you move
through the seasons of building your companyfrom tiny seed to giant impactful company in
the future.
You're now listening to the network effects ofTrulia.
So it's the summer of 2004.
I was, grad student at Stamford, and I'd justgone through a kind of painful home search.
(01:11):
It was also the summer that Google went public.
So the buzz in Silicon Valley was aroundGoogle.
Now I got a ticket to a real estate conference,so I sat at the back of this real estate
conference.
And I remember driving from San Francisco backto Palo Alto.
There was this kind of unique moment.
What if we applied this sort of Google searchmodel to real estate?
(01:33):
That was it.
I was committed to it.
So the core problem in a 2 sided marketplace issolving the so called chicken and egg problem.
How do you get supply?
Which drives demand?
Which drives supply?
How do you kick start this?
The the first way we solve that problem was toindex websites.
So we'd go to brokers and say, Hey, can weindex your website and put your listings on
(01:56):
Trulia for free?
To demonstrate the value proposition.
The other key network effect that we added wasa data network effect, and we used the scale
and data that came from my users to improve theuser experience.
Everything from a recommendation system.
So just like Amazon, you like this home, you'lllike these other James, So the protocol network
(02:17):
effect was key for us in the early days,standardizing real time XML updates, bring in
real time data from the fragmented MLSs andbroker websites published on TRULIA.
We realized early on We would not take money onevery household, but we got massive
fragmentation, which makes it incredibly hardto to monetize.
We focus on working with the biggest corporateclients in the industry.
(02:40):
In Q2, Q3 of 2008, everything changed.
This could be the most serious recession indecades.
And that means life, as most Americans know, itis about to change, in some cases,
dramatically.
These large real estate companies werestruggling.
They were laying off Pete, housing transactionscollapsed.
(03:01):
Our advertising agreements evaporated.
Business was was in decline as every other realestate company out there.
So up until the point, a revenue came from asmall number of big franchisees, brokers, and
mortgage banks, who were paying a lot toadvertise with us.
But when they crash it, their marketing budgetswere just too far removed from the actual
(03:21):
transaction for them ROI.
Looking back, this was a bet the companydecision, because we had to change direction
completely while the market was collapsingaround us, and we were running out of But in
the end, it paid off big time.
We went from 0 revenue growth during therecession to doubling year over year, allowing
(03:46):
us to go public in 2012 and merged Brazil in2015 in a $3,500,000,000 deal to create Zillow
group.
M and A helped to quickly increasedefensibility of the core marketplace business,
providing scale and moving to a more powerfulkind of network effect defensibility.
So I think of Zillow Group today as a companythat has really evolved into something of a
(04:08):
market network, which combines the coremarketplace businesses that you think of as
truly and Zillow, with a SaaS based tool, thepremier agent app.
The 3rd component was the acquisition ofdotloop, a transaction management platform,
providing the network So you've got today thisincredibly defensible platform, a market
network for the real estate industry.
(04:30):
You're now listening to the network effects ofFacebook, now known as Pete.
Facebook's really the big kahuna of networkeffect.
And that makes them incredibly defensible.
I think there's some temporary talk about thepolicies of Facebook, but I think what's
important in order see clearly is to reallylook at the mechanics underlying what makes
(04:52):
Facebook Facebook.
So 2004, Mark Zuckerberg wakes up with apersonal direct network effect with real
identities.
Harvard didn't have a Facebook, so that's thegap that we were trying to fill.
It was a very powerful form of network effect.
But he immediately realized that he needed toadd other defense abilities.
He then, as he expanded into other colleges,created a real bandwagon effect.
(05:14):
Each new college wanted Facebook to come to it,and no one wanted to be left out.
And Like,
you know, this is pretty cool.
Like, I thought this would work at otherschools.
And once that was rolling, he started to scalethe business until in 2005, there were a series
of big articles about him in the Wall StreetJournal, New York James.
You're establishing the brand of Facebook andthe fact that it was a phenomenon.
He could then go back and scale up even more,including leaving just colleges and starting to
(05:39):
take on the whole world.
They saw the opportunity to create an embeddingstrategy, create software to allow Facebook
users to log in to other websites, using theirFacebook login.
So hundreds of thousands of websites have nowadopted this Facebook Morgan, and Facebook is
now embedded in the whole ecosystem of entireweb.
It allows them to have an embedding strategy,which is very defensible.
(06:00):
Once they'd established severaldefensibilities, including the personal direct
network effect, they were free to explore otherwork effects.
I think Mark in in 2007 actually said somethinglike I think that network effects shouldn't be
underestimated with what we do.
In 2007, they were to launch a 2 sided platformnetwork effect very much like a Microsoft.
(06:21):
So they opened up Facebook platform.
By the next morning, we had so much traffic.
They were literally driving around the SanFrancisco go Bay with a U Haul truck begging
and asking people for servers to handle all thegrowth.
And that allowed entrepreneurs to build codethat would run on top of Facebook, making
Facebook even more sticky and providing morethings for their users to do on Facebook.
Ultimately, I think after 8 years, the activitythere is quite low, but it was still a really
(06:45):
good idea, and they might return to that ideaover time.
Then they started working on a 2 sidedmarketplace effect.
Which with the media companies that wereadvertising on them, they built out wonderful
self serve advertising tools, much as Googleand Craigslist had done before them, but access
saying such an active and large audience.
Your customers are on Facebook every day.
(07:06):
The world has gone social.
Be part of the conversations.
23 or 20 percent of all the ad revenue spentonline comes through Facebook.
But with all the traffic that they had, theystarted developing a data network effect,
impacting Facebook in three ways.
1, they've got so much content that they canchoose better content to show to me.
2nd thing is that the number of humanengagements they have with the content, the
(07:28):
likes, the shares, the comments.
These things actually add value because of thatdata that I'm getting.
And the third thing they have on the data sideis the real time data of all the activity on
the site allows them to adjust and update thevalue of my feed and real time as much like
James will So in 2011, they launched FacebookMessenger, which actually has utility when it's
(07:49):
often about getting things done.
And then in 2014, they saw what app.
And WhatsApp was this personal utility directnetwork effect?
It says it has 450,000,000 monthly activeusers.
Even just independently, I think it's it'squite a good bet.
And they resolved that they would pay whateverit took.
Facebook will pay $19,000,000,000 in cash andstock.
(08:13):
And it also made them double down on FacebookMessenger by hiring in whoever it took to make
that the best product it could be and to growit from a 100,000,000 to over a 1a half
1,000,000,000 today.
And so between 2011 2014, you can see themreally doubling down on the network effects and
being very smart about not Pete somebody elsewith a network effect Pete past them.
(08:33):
So in their continued pursuit of networkeffects, in 2016, Facebook relaunches
marketplace.
They had tried classifieds in the past severalJames, and it hadn't taken.
But this time, it seems to be working, and theyreport over 500,000,000 users year.
And so this is going into the area thatCraigslist has owned for years.
They've been impenetrable, but perhaps Facebookwith their real identity and the frequency of
(08:58):
use they have might be able to pry that markand open.
So this makes Facebook the big kahuna ofnetwork effects.
They've understood it all these years.
They've built products that are excellent atdeveloping their network effects.
This company is not going anywhere.
Are there threats to the company?
Sure, of course, there always are.
The major one that that that we see right nowis literally just government action.
(09:19):
So if there is a threat to Facebook, we see itcoming possibly from 3 directions.
Now the first would be if Facebook becomes apublic health concern in the same way that
tobacco is.
Because of addiction and depression andanxiety.
There's also a privacy issue, obviously, withFacebook, you know, with the GDPR in Europe,
you could see that taking effect in Europe andthen bleeding over into the US.
(09:40):
And then the 3rd direction could come from theantitrust direction with Facebook being so
dominant.
You could see the Department of Justice andpotentially asking Facebook to divest itself of
Instagram and WhatsApp.
But beyond that, it's hard to see because it'shard to break up these interconnected software
products.
If there is another threat, there's negativenetwork effects.
There's so many people there that it pollutesthe experience or keeps it from being cool,
(10:03):
like when older relatives join Facebook andcommenting on your photos.
We've already seen that a lot of James don'tuse Facebook, but I think with good product
design, it's it's a solvable problem.
As a media company, Facebook is very uniquebecause they have amenity to many direct
network effect.
All the media companies that came before, liketelevision, radio, magazines, these were one to
many network effects, 2 sided marketplace, ifyou will, not nearly as strong.
(10:26):
If you see clearly what the mechanics of whatFacebook has done and you see past the noise.
You can see that Facebook is as strong as everand getting stronger.
You're now listening to the network effectsbehind Bitcoin.
(10:48):
When we had metal technology, we made money outof metal.
After metal, we had paper technology, and so wemade money out of paper.
Humans tend to do this.
And now, of course, we have software.
We're not just keeping track of money withsoftware, we're making money out of software.
Bitcoin was the first to do it in adecentralized way.
This is the reinvention of money yet again,regardless of what it's made with.
(11:11):
Money is simply the distillation of a sharedconfidence in the future.
It's what we call a belief network effect.
(11:34):
Money is simply a belief held by a lot of Pete,a collective trance, always in the past, Beller
in a currency formed around a hierarchicalnetwork topped by a king or a queen in his or
her armies.
A pharaoh and emperor czar, a president, Andprior to the US civil war, there were hundreds
of regional currencies operating in the US,each centered around one strong man, or
(11:55):
another, with his hierarchy under For thehierarchical pack animal that we are, hierarchy
with an alpha king on top is understandable byall the people in the network.
And, thus, it's stable.
That's why when the king issues a currency andtells people to use it, people believe in it.
This strong man backed Flint currency approachhas worked for 6000 years or more, but with
(12:17):
Bitcoin, it's different.
Instead of a king or central authority creatingthe Beller, and then controlling the currency,
Bitcoin doesn't have a hierarchical networkstructure with a strong man at the top.
It's a decentralized network structure.
The fact is the majority of the world is stillskeptical of Bitcoin, and this is why.
The asset itself is creating nothing.
(12:38):
Watch out.
You all can do whatever you want, and I don'tcare.
Okay?
People aren't used to having currencies backedby a decentralized network.
There isn't a hierarchy with a believableperson on top to define what they should
believe in.
It's not the same pattern.
To create the belief network effects necessaryfor the existence of money, hierarchical
networks use power from the top, whiledecentralized networks use ubiquity.
(13:01):
Crypto changes the nature of money in ahistorical way because unlike gold or paper
money, crypto is a native creature of the newglobal network.
Unlike fiat currencies, it isn't constrained bygeography or by time.
This is a huge difference.
Bitcoin's product is a currency and Morganspecifically, a store of value.
Its currency doubles as, let's say, shares, andwe can all buy and sell the coins as we would
(13:25):
traditional stock.
And in this view, Bitcoin's market cap wouldput it in the top few most valuable companies
in the world, like other network effectbusinesses.
So Bitcoin has core defensibilities.
And of course, there are only 4 defensibilitiesnative to the digital age that Bitcoin might
use.
There's network effects, there's brand, there'sscale, and there's embedding.
(13:47):
Network effects are, of course, the greatest ofthese.
So let's focus on the network effects map.
You can see the various network effects typesand categories, organized by Beller with the
strongest network effects at the center of themap.
Bitcoin's first and primary network effect is abelief network effect.
It's the same mechanism you see with gold andwith religions.
The more people believe it's valuable, the morevaluable it gets for everyone.
(14:10):
The more times its price crashes and thenbounces back, the more people will believe it
has lasting value.
Yes.
Bitcoin is a bit like sand.
It's not solid.
But if you get a lot of sand and then layersome Ethereum sand on top of it and then the
sand of the thousands of other cryptocurrenciesin existence, The Bitcoin sand gets
progressively more solid as a result of growingbelief network effects, but was once fluid and
(14:33):
intangible transforms into something closer torock.
The Bitcoin second network effect is a protocolnetwork effect.
Protocol arises when a computational standardis declared, and all the nodes can plug into
the network using protocol.
Traditional examples are ethernet and faxmachines as the number of nodes that connect to
the protocol increases the network effect getsstronger.
(14:56):
Bitcoin's 3rd network effect is a 2 sidedmarketplace network effect, and this is the 2nd
most powerful effect for Bitcoin.
And Bitcoin creates 2 form of marketplacenetwork effects.
1st, a speculation between buyers and sellersof its store of value.
Number 2, a payments marketplace.
The more nodes on the network buying, selling,and holding, the better for everyone.
Bitcoin's 4th network effect is a 2 sidedplatform network This is where there are
(15:21):
developers adding their products to the Bitcoinplatform.
The developers receive distribution to users ascompensation for building and adding value to
Bitcoin.
Bitcoin also has a data network effect, a datanetwork effect occurs when as the data in the
network grows, the value of the data for eachuser grows.
If Bitcoin's case transaction data is accretingon the blockchain in a way so that the amount
(15:45):
of computation required to hijack the networkincreases.
To increase the security for everyone and thusvalue for everyone.
Bitcoin 6 network effect is a tribal networkeffect.
Now the main mechanism for tribal networkeffects is the creation of an in group and an
out group so that the in group can know who tohelp and to be loyal to the outgroup typically
(16:05):
turns into the enemy.
There are now Bitcoin maximalists who believethat Bitcoin should be the only digital asset
we'll need in the future and they activelydenounce all other coins.
So within the 5 years, Bitcoin will have 99% ofthe hashing power and 99% of the market cap.
Finally, Bitcoin 7th network effect is abandwagon network effect.
(16:26):
Now these bandwagon effects typically arisewhen people are jumping on early and not
wanting to be left out.
In Bitcoin's case, these early supporters werefinancially and ideologically rewarded for
joining early.
And as the value of the token has grown, peoplehave been wanting to jump on and not be left
out.
Because Bitcoin has the biggest worldwide brandin crypto and is the biggest market cap, the
bandwagon effect is strongest compared tolesser crypto brands.
(16:49):
Moving on to other forms of defensibility,Bitcoin has a strong embedding effect already
because they are listed on all the exchangeswhere people trade crypto They benefit
initially by being listed at all so that theycan attract more users.
But more importantly, because of where they'relisted on the exchanges, at the number one
spot.
For preferred attachment, this will tend tokeep them number 1.
(17:10):
Another key defense ability of the digital ageis brand.
Most people tend to be risk averse and avoidthe unknown, so they are less likely to switch
to an unknown or lesser known brand.
Bitcoin is regularly conflated with the entirecryptocurrency face.
Given its size, Bitcoin has competitors comingat it from all directions.
First, the fiat currencies issued by nations,such as the US dollar and the Chinese yuan.
(17:32):
Incumbents.
Number 2, they've got other digital currencieslike Ethereum Cardano who are trying to take it
down.
And number 3, gold, traditional gold.
Of course, there are some external shocks thatmight negatively impact Bitcoin's network
effects.
We see 3.
First, fake trans 2nd risk is responsiveness ofthe Bitcoin Dow.
The 3rd risk is government intervention.
(17:54):
They are the winners.
They're the incumbents.
They're the winners of the old regime.
Our opinion, it's too late for governments tostop Bitcoin.
The network math protects it.
To sum up, cryptos here to stay The reinventionof money is underway.
Bitcoin will continue to be a big part of thatstory.
Bitcoin created and is now embedded into thecrypto ecosystem and the world's consciousness.
(18:19):
You're now listening to the network effects ofUber.
Companies build their value throughdefensibility in the long term, and there's
only a few ways of doing it well in the digitalworld and through scale, through brand, through
embedding, but the most important one isnetwork effects.
So we see network effects as the number onefactor in defensibility, and there are at least
(18:41):
13 different types.
The strongest ones are in the center of theMorgan, and they generally get less strong as
you go out from the center.
Of the examples where it really matters is acompany like Uber.
So when Uber first got going, they thought thatthey had a real 2 sided marketplace network
effect.
But what it turns out if you look closer isactually have an asymptotic through side of
marketplace network effect, which is not nearlyas strong.
(19:02):
To be clear, there are actually 3 differenttypes of 2 sided marketplace network effect.
One is like Craigslist or eBay where the morepeople you have on both the sellers and the
buyer sides, the more defensible the businessbecomes.
Then there are places like OpenTable is wherethey had to collect a supply of restaurants for
7 years before they had enough to open up themarketplace.
And then the 3rd type is the weakest type,which is an asymptotic one.
(19:25):
So after a certain point, more drivers don'tsignificantly benefit the pesticide and perhaps
your wait times drop from 4 minutes to 3 or to2, the demand side value doesn't keep
increasing as you move towards 0.
Some other company like Lyft can come in, andthey can provide a few hundred cars and can
pick someone up in 4 minutes, they can alsocompete.
(19:46):
Compounding the asymptotic problem for Uber isthat there's multitenanting on both the supply
and the demand side.
The drivers, it's costless for them to switchbetween Uber and Lyft.
And same for the demand side, the thepassengers.
So because of the asymptotic nature of thenetwork effect, Uber has had to get pretty
creative in how they actually increase theirdefense ability.
I mean, the first thing they tried was to growtheir brain.
(20:08):
I mean, they've done an amazing Jaho staying inthe press for all sorts of reasons, so everyone
knows Uber, everyone talks about Uber.
The other thing is they just raise incrediblequantities of money, which allowed them to
scale up and be everywhere.
The other thing they've done is they've theytry to embed Uber into things like Messenger
and Google Maps.
So by embedding, they're also getting anadvantage to get on that demand side or or
(20:28):
maybe even on the supply side.
The other thing they've done is is they'vereally worked on language.
If you can get someone saying your name, like,I googled something or I took an Uber, that is
giving you, social reason for people tocontinue to use that particular service.
All these things have, I think, been very smartand they've effectively executed on it to try
to make up for the fact that their core Peteeffect just isn't that strong.
(20:49):
You know, going forward, we'd wanna take Uberinto a direction where you have much stronger
network effects.
So getting into some of these more personaldirect network effects, perhaps with Uber mute.
Hoover's a great example of how you can use thenetwork effects map to really tease out the
differences between business element to thelast 25 years, over 70 percent of value that's
been created in technology has been created bycompanies with a network effect at their core.
(21:13):
And so for founders, understanding this stuff,the the nuances here is a critical importance.
Stay tuned to the podcast as we'll post 1episode per week until we complete the course.
You can also watch this entire Masterclassonline atnfx.com/masterclass.
Where you can log in, track your progress, andwatch full videos, retranscripts, and find
(21:36):
other related material.
Thanks for listening to the NFX podcast.
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