Is There a Reverse Network Effect with Scale?
The Internet economy has been built on the network effect (i.e. the effect that one user of a good or service has on the value of that product for other people). Investors and entrepreneurs have treated this like Moore's Law. But just as Moore's Law hits physical constraints, network effects have a limit in many types of online communities. Indeed, in some cases, a reverse network effect may exist: as new people join, others are motivated to leave. This dramatically affects the length of the competitive advantage enjoyed by these ventures. In this post, we'll look at which ventures suffer from reverse network effects, which don't, and which may suffer depending on the strategy they choose to adopt.
Signs of Reverse Network Effect
Real human social networks (as opposed to the tools that facilitate online communication between people in a social network) have an obvious reverse network effect. If I have too many people in my social network, I cannot pay enough attention to each of them, and without attention, relationships fade.
Back in September 2007, we looked at social motivation in the real world, specifically the two distinct types of motivation. One is, "I want to communicate better with the people I already know and trust". The other is, "I want to increase my visibility so that I can connect with more people."
Both have clear limits. The number of people I can really know and trust is limited, because knowing and trusting take time and attention. Increasing visibility, whether by blogging or tweeting or advertising or PR, is less limited. But when visibility goes beyond a certain number of people, it becomes no more social than broadcast media or spamming. The personal touch is gone. The real community spirit is gone.
As Groucho Marx remarked, "I refuse to join any club that would have me as a member." If it is an exclusive club, the membership has to be limited. If it is not exclusive, is it really "social"?
eBay is the classic example of a network that lost its community spirit after reaching a certain scale, as the comments on this post vehemently demonstrate. This loss opened the market for eBay alternatives, such as Bonanzle. It is unclear whether these alternatives will face the same issues when they get to scale.
Etsy will be an interesting case study. It looks like it may avoid the reverse network effect by being focused entirely on handmade goods. That focus may limit its eventual scale, as not everybody wants to make or buy handmade goods, but it will still be able to build a business more than big enough to satisfy even the most demanding dreams of avarice. That focus on handmade goods will act as its social glue. It will grow as eBay would have had it decided to remain focused on the global garage sale, not getting lured into selling mass consumer goods. I suspect if eBay had done that, its core business today would be smaller but ultimately more profitable and sustainable.
Networks Without Messy Human Interaction Are Immune
eBay the corporation owns two businesses that have almost perfect network effects and do not suffer from any reverse network effects: PayPal and Skype.
PayPal works for consumers because merchants use it, and merchants like it because consumers like it. The fact that everybody likes it won't make me like it any less.
Skype gets more useful with each new user, and each new user promotes Skype, consciously or unconsciously, for his or her own reasons. Even better, the cost of providing the service goes down with each new user, and that is really unusual (a function of Skype's P2P architecture). Google and PayPal also benefit from each new user, but they still have to service that user, and that costs money. In the case of a video service such as YouTube, the servicing cost is significant. So Skype really is in a league of its own when it comes to network effects, and that is why it may become the world's largest telephone company and the biggest economic success story of the Web 2.0 era. (Google Voice, having just thrown its hat in the ring to battle Skype, will be interesting to watch. My bet is on Skype.)
The difference, though, is that we do not look at these services as communities. They are simply enablers of commodity transactions: payments and phone calls.
What About Social Networks?
Does Facebook still feel special now that it has 175 million users and is growing at a rate of 600,000 per day? That is a sincere question for Facebook users. I am one of the few people who do not use Facebook. For whatever reason, I never got into the habit. And I have no compelling reason to start now. This has made me a bear on Facebook for a long time. As a non-user, I miss what makes Facebook special and why it grows so fast.
The network that I use is LinkedIn. I use it to connect to people who my contacts know. As far as I am concerned, it is a utility in the same way that the phone or my email/CRM system is a utility. Do I care that LinkedIn has 7.7 million users now? Does that make it more valuable to me? No. Is Facebook 22 times more valuable to me than LinkedIn because it has 22 times more users? No.
Here is the theory:
In a social network, the value for existing users of a new user joining the network plateaus once users have most of their own contacts in that network.
Of course, the social network grows in value as a business as more users come into it because the network then has more eyeballs to sell to advertisers. But that is different from network effects. As a LinkedIn user, I do not benefit when more strangers join. I already have about 90% of my contacts in there, and the remaining 10% may remain hold-outs; and I don't really care anyway, because I can always reach them outside of LinkedIn. When I meet somebody in business, I look them up on LinkedIn and connect if they are on it (I cannot recall anybody recently who was not on it). I do that to keep my Rolodex updated, which is a very valuable utility for me. But my actions are not growing the network. If I joined a new network, I would spam all my contacts asking them to join, but I have zero motivation to do that.
As a long-time Facebook user, do you care when more strangers join? Does it make any difference to the value you get from Facebook?
So, it is possible that the network effect has a natural plateau.
A Plateau Is Okay, But a Steep Downward Slope?
Whether that plateau turns into a downward slope depends on the monetization strategy adopted by the "owners" of the social network. And in the social networking business, a downward slope can very quickly become a steep slope or even a cliff. Trust tends to be binary; viral can work both ways; and switching costs are minimal. That is why I put "owners" in quotation marks. You can never really own a social network or community. You can provide services and extract rent for only as long as the community wants those services and is willing to pay the rent.
This is where the incredibly high valuations of businesses such as Facebook and LinkedIn may become problematic. If these businesses get too eager to monetize to justify those valuations, they may create the reverse network effect.
There are only two ways to monetize: ask for revenue from users who regard the service as a utility (like paying for the phone company), or ask for revenue from vendors that want to sell something to the people using the service. Thus far, all the major social networks have taken the latter fork in the road. They don't want to become utilities because that wouldn't justify their lofty valuations. So they have to sell more to those who use the service. At that point, the reverse network effects may kick in.
Craigslist
Craigslist chose a different path by not taking on external investors. It has no valuation to justify. It can leave masses of money on the table without any worries. So Craigslist won't suffer the reverse network effects that come from over-eager monetization. Its model of allowing lots of free listings will sustain high growth and is clearly impacting eBay's business.
Twitter an Interesting Case Study
Once again, Twitter is the interesting one to watch. The ease with which one can add and delete who one follows makes its size self-regulating. As a real-time search tool, its value goes up with each new user. As a communication tool, it goes up as new people join who might be interesting to follow. Its openness may prevent the reverse network effect.
The other reason Twitter is an interesting case study is that it has not yet disclosed its revenue model. If the revenue model it does adopt involves selling to its users, the reverse network effect may kick in. Twitter would become classic MBA case study material, a fact of which management must be well aware!
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I agree that for the case of "more effectively communicate with people I already know and trust" the total size of the network does not matter much once it is established. I established my network on LinkedIn long ago and rarely invite people or receive invites because the people I know and trust in a business context are already my connections.
However, as you mention, for people starting out, it is much easier to build their network now since most of their connections are already on LinkedIn. A large overall network tends to attract people who want to use it for the same purpose (business, in the case of LinkedIn) because there is less risk.
In addition, as you also point out, in business you often want to contact people who have certain expertise you need to get business done, so in that context I care that LinkedIn has 37 million members (http://www.linkedin.com/companies/linkedin).
In many of my searches, I'm not looking for a person by name, but I know I'm looking for people who have in the past or are currently working at a certain company, in a certain industry or who have certain functional expertise (perhaps at specific seniority levels and at specific locations). Here, the number of people matters along with the quality of people, the kind of information they have in their profile and whether or not I can approach a busy professional in a way that will make her take the time to consider my proposal to talk/meet (I prefer to use introductions to get in touch with people my contacts know).
Reminds me of a great article I read called love doesn't scale, which compares similar companies to the ones you've listed with Communism and Socialism.
"Socialism's and Communism's failure was it's attempt to scale brotherhood."
I strongly recommend you (Bernard, or anyone else who enjoyed this article) read it, it's quite concise.
As for your comments on Facebook above: For me, 90% of my connections are real life friends, and this just enhances our connection. To me, the more people spend on Facebook the more value I get from it, even without having to make new connections. For example, 6 months ago everyone started getting the hang of uploading and tagging pictures, which made Facebook more enjoyable for me. These days people are starting to get the hang of posting & sharing cool/funny/interesting links, which once again enhances the utility I get from Facebook.
I completely agree with your opinion. I am not a big fan of MySpace or FaceBook either. It is unlikely to have 1000 friends in real life. It is even harder to have 10 genuine friends.
So I am always surprised when I hear people saying they have 10000 virtual friends on the Net. Personally, 2 real friends is not a substitute for 1000 virtual friends.
This is just my 2 cent.
Kiki,
GossipMojo.com
I think that the claim that you don't get any more value from new members joining a social network is not true.
As new people join, the circle of people you are able to reach grows. You have more professionals to answer your questions, more people you can get introduced to and so on.
It doesn't matter that you do not know them at the moment they join the network. The important thing is that they will be there in case you'll need their help.
I agree with the article.
The key question for any web service provider has to be: how do we add value to our users/customers? If they figure this out, they do not need to worry about the monetization.
Going the opposite way (asking how to justify our valuation) might lead to the reverse network effect.
In regards to the Facebook question:
It doesn't make that much more of a difference to me if more people join. And I don't really care either. I haven't been one to spam my friend requests, and only keep my connections to most people that I have either met personally, or have had significant interaction with online. Now I use the term connection to describe the range of my contacts. 20% are the close, personal friends that I communicate with 80% of the time, and vice versa.
Interesting article. Networking is not an aim in itself, but a means to an end. Sheer numbers on any network are only useful if they help me in my objective. I couldn't care less that Facebook has 175 million members, because I use it to keep up with a close friends. I am interested in Skype's growth, however, as it means a greater chance of a cheap or free phone call to people I do business with.
I don't think the volumes of users matter as much as what the net does to enable you to achieve your goals faster and easier.
Ian Hendry
CEO, WeCanDo.BIZ
http://www.wecando.biz
I guess your argumentation is partly missing an important point : Facebook is more valueable to me than Linkedin, because the mass of users attract application developers who make Facebook more useful to me. That is a typical crossed network effect of that kind of platforms.
Network effects are based on growth and growth is
everywhere in nature limited.
Why should it be different in the web?
As application gain more and more attraction and
people following, the constraints like information
overflow, speed decrease, difficulty finding relevant
information will surely kick in.
Growing of just one community such as Facebook,
LinkedIn, XING, or others will just not happen as
people will adapt and inevitably change the system.
New networks will emerge where people will find their
specific needs fulfilled and moving away of followers
will "force" the "established" communities to find new
ways to run their services more smoothly in order to
attract new ones.
It is a game that goes on in waves and as a surfer we
should appreciate the changes in see the benefits that
arise from new tools, communities and applications:-)
Let's surf the web 2.0 and find the ways that suit our
personal needs, habits and work demands best.
Cheers,
Ralf
PS.: Thanks to @jenshoffmann for posting the link on Twitter:-)
I think what is comes down to is picking the right social network for you. You have to disregard numbers and statistics because those will not help you. If you're looking to increase your work network, LinkedIn is your best bet. Your friend network? MySpace or Facebook. Dating life? Join a dating network. The statistics shouldn't influence your individual choices - only you can do that.
Very insightful article. However, I completely disagree w/ your example of Craigslist not being affected by a reverse network affect. Unfortunately, when a community reaches that scale it becomes very attractive to "the dark underbelly of the Internet" (this has already happened). Sor far, Craigslist failed to successfully adapt to this new dynamic. In many areas, their community is completely overrun with spammers and scammers, and unsuspecting users are left vulnerable. Because of this, users are driven to seek alternatives. Its this situation that has opened up the opportunity for companies such as iList, and others in the space.
This article discusses the value of social networking from the point of view of the owners of or investors in the network.
Let's consider the point of view of the user. In this case, I am thinking of the point of view of entrepreneurs and small business owners who might use social networking to promote their businesses. When people use online social networking to make business connections, they are expecting to be able to develop relationships with people that will ultimately provide them with referrals to their business or business from the online connections themselves. In this sense, online networking, at least at the outset, follows the model of many in-person networking groups. The exception is that in-person networking groups are inherently geographically local in scope, whereas online social networking is, or can be, national and international in scope.
So far, I see plenty of oppportunities to have a large number of people in various online networks. I do not readily see the opportunity to develop productive relationships, particularly business relationships, when the business owner depends on a brick and mortar location in which to receive new customers. One example might be the case of an attorney or a financial planner who is licensed to do business in one or a few states, and who typically need to sit down with prospective clients to discuss their needs. Often, compliance parameters for their industry or their company restrict them in their online representation. Further, even if they obtain prospective client leads or referrals online, how can they best transition to an in-person relationship with these people?
Lots of baby boomers are in this situation. Many are in second careers or pursuing their dreams with businesses that are still brick and mortar. A good portion are internet savvy, but their businesses are not necessarily internet-based businesses.
Comments? Discussion?
Interesting observation! Is there other discussions about this topic?
-Andrey
This law has a name : Laffer curve.
It was designed to establish a relationship between tax growth and tax ratio. It's based (like often for economic model) on a closed economy.
If we translate this law to facebook or myspace it just means that the more connections you have the less you will be "tax" by the closed network you are in. It's called noise.
If you stay with a small number of "friends" their are no network effect. If you have a network effect then at one point the curve of the implicit value will decline.
I do love economy ;-D
Analysis like this is what separates ReadWriteWeb from other early adopter blogs! This post organized the scattered pieces of thoughts that have been floating in my mind :)
Thanks Bernard!
Thanks Bernard for the nice post & topic. However u got me thinking about "As a LinkedIn user, I do not benefit when more strangers join." I actualy think LinkedIn is also very useful beyond my direct contacts in activating my second and third degree network. In that light I think that more members certainly can create more value to me.
I think in the end it comes down to your own responsibility as a user to keep your network relevant. Organize and maintain it with care and attention. On the other hand "owners" from social networks should know their role and responsibility to keep their users satisfied and not get lost in an unfriendly businessmodel
Vincent (#16). That is an interesting question. My personal experience is that 3 degree contacts are useless on LinkedIn. In the early days of LinkedIn when it was a small network filled with enthusiasts interested in the media, people would pass on requests. No more. So its only 2 degrees and most of my 2 degrees are in there. So it is leveling off, plateauing. don't get me wrong, still very valuable, just not growing.
Bernard, thanks for the insightful piece; you've captured much of what I believe is the fundamental dynamic of social networks. You do, however, peter out and skip the biggest problem with the network effect: additional users can detract from my experience (regardless of the network monetization scheme).
This "reverse network effect" (which leafar correctly identifies as a Laffer curve-style dynamic) comes in several different flavors:
1. Increased hassle from new users: Today on Facebook I get friend requests from people I went to high school with on almost a daily basis, people I would prefer to never hear from again. This dynamic will push people to new networks where they can reassemble their "real" network in private.
2. Decreased freedom within a social network: Because of social pressure I am connected to my parents, aunts, uncles, cousins, business contacts, and many others. While Facebook does allow me to segregate these uses into groups, most people do not bother and instead simply do not share
oliver, thanks. Probably just petered out from fear of over long post or some pressing biz got my attention! But yes, there is a change of behavior on Facebook that a few people have noted, most publicly and eloquently Fred Wilson:
http://www.avc.com/a_vc/2009/03/a-new-approach-to-facebook.html
Bernard, as you briefly mention, I think that as a mostly open, asymmetrical network, Twitter has very different properties than mostly closed symmetrical networks like LinkedIn and Facebook.
I strongly suspect that people will cap their participation at some augmented Dunbar limit of the number of people they can follow with social attention and time. But in Twitter, retweets, searches, and visible replies mean that the more people who join the network, the more interesting information will be amplified through it, and the more potentially interesting people you may discover.
Once you have your existing contacts on the networks, it is easy and to make new contacts if you wish. The level of context is fairly high - you can see what someone else has been Twittering, and see if they are interesting and relevant to you. And the level of obligation is low (you can follow someone without giving them the burden of accepting or rejecting you).
I've got some more thoughts on the topic here:
http://www.alevin.com/?p=1402
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Appreciate your deep analysis Bernard. Its implication is vast across many platforms, tools and situations.
As a power user in both Facebook and Twitter in my community, I gain more values when more people join in Facebook and Twitter.This is partly because I turn my Facebook into a hybrid utility in addition to my LinkedIn.
1. The new comers automatically follow/add me
2. If they don't, their friends who know me introduce me to them
3. Ultimately my influence is extended over new comers. Network externality works: the more people know the contents I publish, the easier for them to discuss those topics.
So in sum, it depends on your usage.
Regards
Thanks Bernard for the great post! In addition to risking turning off users when trying to monetize, there is always a risk of becoming completely obsolete when a new "buzz" service comes along. The risk is especially significant with a low cost of switching. But on other hand trying to "close clients in" doesn't work either. I think that long term answer is in genuinely caring about customers. Best!
Very intuitive system. However, it may yet be a little confusing. I will keep visiting this blog very often. After this I will read all your posts thankful.
I could never understand the hype about Twitter. What good is this service? A limited number of symbols, language support poorly developed. Perhaps in the English-speaking Internet Twitter and popular, but to attract Russian users, Twitter is not enough support for the Russian language.
I could never understand the hype about Twitter. What good is this service? A limited number of symbols, language support poorly developed. Perhaps in the English-speaking Internet Twitter and popular, but to attract Russian users, Twitter is not enough support for the Russian language. By Sergio