Business Strategy

Subsidizing Your Network

Written by James Garvin for Gaebler Ventures

Network effects have been a successfully utilized strategy for building durable competitive advantages, but are often the most difficult strategy to successfully implement. Understanding the critical components of building your network will help you achieve stronger network effects in the long run.

Network effects are a powerful strategy to building and sustaining your business strategy for the long-run.

In a previous article, I discussed how to incorporate network effects into your business and provided some examples of firms that have created powerful, long lasting network effects. Network effects often face a chicken and the egg problem. As an example, eBay is only valuable to a seller if buyers are already searching on eBay and valuable to a buyer if there are sellers selling their merchandise online. How do you get either side of the network into eBay first with out having the other side of the network present.

For pure two-sided networks like eBay, it can often times be a challenge to incentivize one side of your network to start using your product if the only value they derive from it is by interacting with the other side of the network. The general rule of thumb, when starting a two-sided network is to subsidize the side that values quality and charge the side that values quantity.

In eBay's case, sellers obviously value the quantity of buyers coming to the site, while buyers value quality of the products being sold rather than the quantity. eBay has followed a pricing strategy that enables consumers to search for products, free of charge, while charging sellers a fee for creating an online store and a commission for each product sale. The initial incentive for eBay sellers was that posting merchandise on eBay was free at first; they only paid if they sold their product.

While products that create value through network effects can be powerful, they also face the challenge of described above. A strategy to counter the difficulties of attracting each side of the network to your product is to create a product that has enough value as a stand alone product to attract early adopters. eBay is an example of a pure two-sided network that has almost no stand alone value, but they benefit from the "I have nothing to lose" mentality of sellers who can post their merchandise online for free, and only pay a fee if their product sells.

Flickr, the online photo sharing site is a service benefiting from strong network effects, but one that also has high stand alone value of enabling users to upload, view, and share digital photos. Flickr becomes more valuable as more and more people upload and share their photos, however they provided enough stand alone value to attract initial users to their site thus creating the snowball effect that attracted the millions of users it has today through its strong viral effect and word-of-mouth marketing.

The total value of your network is the sum of the value of your product as a stand alone plus the value of your network. In eBay's case, the value of eBay is strictly the value of the network, since they have no stand alone benefits to its users. Flickr's value is a combination of the value of its service as a standalone product plus the value of the entire network of Flickr users.

If you are in a business where network effects are critical to your strategy, focus on how you can incentivize early adopters to your product or service by either subsidizing the side that will value the quality or by creating a product or service that has enough stand alone value to attract early users.

James Garvin began his education studying biotechnology. In recent years he has turned his interest in technology to helping two internet startup companies. The first business was an online personal financial network and the second was an e-marketing platform created to help entrepreneurs demo their web sites. Currently a student at University of California Davis, James is spending his summer incubating two new online businesses and writing about his entrepreneur experiences.

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