Jun 152017
 
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Startup Growth – What Is The Network Effect?

If you’ve been in the startup game for a while, I assume you’ve heard the term “Network Effect,” but what is it? And does it apply to your startup and your company’s offering(s)?

Simply put, the term Network Effect is typically used to refer to a product or service that becomes more valuable as more people use it.

Note that the Network Effect is not the same as “viral growth,” which occurs when the rate of adoption (product or service adoption) increases with each additional user. Both can lead to increases in the value of the company and the product or service, and they can both be present at the same company, even for the same offering, but they are not the same thing.

Examples of the Network Effect (and sometimes viral growth as well) are numerous and include:

  • Telephones
  • Email
  • Internet
  • Instant messaging

This list, as you can see, could go on an on.

Realize too, that in some cases, there can be negative Network Effects if, for example, there are too many users for the system to handle. In such a case, the system may experience congestion, which would slow it down and make the experience for each user – and the value to each user – worse, instead of better.

Social networks are another classic example of the Network Effect. If you’re on a social network and only a few other people are using it, then typically it will have less value to you than if a large number of people are using it. The same can be said of the negative Network Effect mentioned above, though; if too many people are using it, it may become congested and slow down or just overwhelm the user with the number of potential interactions with other users.

So, the Network Effect can cut both ways.

How then is the Network Effect relevant to your startup or to products or services that you sell, or wish to sell, to your client base?

It will only be relevant if what you sell, like the examples mentioned above, becomes more valuable to each user as more users come online.

If it does become more valuable to each user as more people use it, and the negative Network Effects are not significant, then as you gain more users, you will likely see a jump in the value of your offering, and usually correspondingly, of your business.

This article is meant to be an introduction to the concept, rather than an exhaustive treatment of the Network Effect, but if you’d like to dig into the math and other related details further, do a quick web search on the Network Effect, Metcalfe’s Law, Sarnoff’s Law, and Reed’s Law. Suffice it to say that the growth can be very impressive, especially when both the Network Effect and viral growth are present, as they were with the likes (pun intended) of Facebook, Twitter and YouTube.

What can you do to try to take advantage of the Network Effect?

First, you need to determine if your product or service becomes (or can become) more valuable to each user as more users are added.

If the answer is yes, then you need to experiment with ways to get more users as quickly as possible, while maintaining the quality of the customer/user experience. You’re trying to get to “critical mass,” which is a term used to describe the point at which you have enough users for the Network Effect to really kick into gear.

There is not a set number of users for “critical mass,” but it’s likely to be accompanied by users using the product or service more (usage time) and more consistently (frequency), commenting more positively on it, and if you’re lucky, kicking viral growth into action as well, by inviting more and more of their friends to join/buy in.

You will want to use every method you can think of to get users to engage more with your product and service, stay engaged, and invite their friends and peers to do the same, knowing that if there truly is a Network Effect associated with your offering, users will get more and more (to some natural limit) value out of it as the user base grows. The increased value in the user experience will then tend to continue to feed the growth.

Does your product or service offering have a potential Network Effect?

If yes, let this article serve as an introduction, but by all means scour the web and all other sources you can find to get yourself as informed as possible about the Network Effect.

If possible, do this as early as you can in the process of designing your offering, as the initial (and evolving) design can have a major effect on the probability that you will reach “critical mass” and enjoy the benefits of the Network Effect.

I look forward to your thoughts and questions.

 

Paul Morin

paul@companyfounder.com

www.companyfounder.com

 

 

 

 

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Apr 042011
 
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If you are like many entrepreneurs, you probably have at least ten ideas each day for potential businesses, products and services. You’re constantly seeing things and processes that can be improved and you’re probably very interested in and aware of trends in a variety of marketplaces. So are you rich yet? Has your ability to come up with ideas gotten you where you want to be?

Unless you constantly force yourself to differentiate between ideas and opportunities, chances are that your ability to brainstorm new solutions for just about anything has not yet made you as wealthy as you’d like to be. So what is the difference between ideas and opportunities? How can you determine whether this one is just another idea, or a real opportunity that can be turned into a profitable business?

In another article I wrote on a similar topic – idea screening – I provided a series of criteria to help you determine whether a particular idea could provide you with a business that suited you well. Those criteria included:

Does the business have high gross margins?

Are there a lot of employee headaches associated with the business?

What potential does the business have to reach break-even cash flow within 12 months?

What is the startup capital investment required relative to what you are able/prepared to spend?

Do the strengths necessary to be successful in the business suit those of the founder(s)?

What is the founder(s)’ level of enthusiasm for the industry?

What is the founder(s)’ level of enthusiasm for the idea?

Does the business have potential for residual income?

What is the market growth rate for the market/niche you want to go after? How is it expected to behave in the future?

What is the number and strength of the competitors you’ll be going up against? Competition is not necessarily bad, but you’ll want to understand what you’l l be up against.

What will be your ability to take a vacation in this business? Retail, for example, can be tough.

What is the potential for “significant” (to you, based on what you consider “significant”) upside in the business, if you are successful?

Will there be a lot of liability risk in the business? Anything that deals with products or services for young children, for example, can carry a high level of liability risk.

This is certainly not an exhaustive list to measure your potential venture against, however looking at it against these criteria will help you determine whether it’s “just another idea” or a true opportunity that you would like to pursue. Also, and very importantly, what may look like just another idea to some people, may look like a great opportunity to others. It depends very much on your perspective and where you’re coming from. It also depends on what type of business you are trying to create. In another article, I described five broad categories of businesses that you could consider pursuing. These categories included:

Hobby Businesses: for example, if you were to try to turn your love for collecting antique toy trains into a business.

Lifestyle Businesses: an example here would be if you were trying to capitalize on specialized knowledge you had developed and use it to become an independent consultant to businesses on that topic. Rather than a career, you’d be seeking a business that allowed you time and geographic flexibility, while at the same time allowing you to earn a comfortable living.

Franchise Businesses: This would be where, for example, you’d open up a Subway or McDonald’s franchise, with the desire to take advantage of the strong brands and systems they have created and provide to their franchisees.

Self-Funded Growth Businesses: In this category, you invest your own financial resources and “blood, sweat, and tears,” with the objective of creating a growth business. Here you’re not looking at hobbies usually and you’re not just looking at creating a comfortable lifestyle with time and geographic flexibility. Rather, you are “putting the pedal to the medal” and trying to build a “real” growth business, with multi-millions in sales and most likely, a decent number of employees.

Outside-funded Growth Businesses: Here is where you try to do pretty much the same thing as in the Self-Funded Growth Business model, but you try to do it more quickly and/or on a greater scale. In this case, you would typically take equity investment from “angel” and/or venture capital investors.

There is no wrong type of business to start, of course – it is an individual and personal decision, based on your biases and where you happen to be in life when you decide to start a business. Even though there is no wrong type of business to start though, as you can see, your mentality with regard to which type of business you’re trying to create will have a significant impact on how much weight you put on the various screening criteria discussed above. If you’re trying to start a Hobby or Lifestyle Business for example and you determine that the startup costs will be $10 million, that may be an extreme negative. If you’re looking to start an Outside-funded Growth Business, on the other hand, then startup costs of $10 million may be very much in the realm of reason.

So, in conclusion, work hard first to understand what type of business you would like to create. This doesn’t need to be cast in stone, but depending on where you are in life, you may gravitate strongly toward one of the categories mentioned above. Once you’ve thought that through, when you get your normal flow of business/service/product ideas, likely on a daily basis, consider them in light of the type of business you’d like to create.

Once you’ve considered your ideas in the context of the type of business you are trying to create, and discarded those that don’t match with your objectives and vision, you are now in a position to apply the idea screening criteria mentioned above, as well as any others you may like to add. You can find an Excel (or PDF, if you’d prefer) screening worksheet here to help you with this process.

I hope you have found this post helpful as you work to differentiate between ideas and true opportunities, in the context of the type of business you’re trying to create. If you have questions or comments, don’t hesitate to contact us or to leave a question or comment below or in the top right corner of this post. Either way, we’d love to hear from you as you look to turn your ideas into opportunities and profitable businesses.

Paul Morin
CompanyFounder.com
paul@companyfounder.com.

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Apr 032011
 
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If you are starting or already have an early-stage business, you may have come up with an idea and just decided to go for it. While that works for some, I have found that it is always a good idea to get very clear in your head the objectives you have for a business, before you start it, or at the very least, before you try to grow it too much.

There’s probably an infinite number of categories of businesses you could create, particularly if you want to get very specific about the venture’s characteristics. Rather than try to take on the world here, we’re going to focus on five broader categories of businesses that I have found encompass the vast majority of companies out there.

1.) The first category is what I call Hobby Businesses. An example of a business that falls into this category would be one where you collect antique trains, so you decide to go into business buying and selling them. The beauty of a business like this is that typically you won’t lack for passion for the subject matter, as it’s something that you’re already willing to do in your spare time for free. Another positive about this type of business is that no matter how much time and resources you invest, within reason, with deference to your relationship with your family, you can hardly lose. You love the subject matter and would probably be spending money on it anyway. The downside to a business like this is that it’s hard to keep your hobby and love of the merchandise separate from the commercial interests of the enterprise. In the end therefore, while there are exceptions, a business such as this typically remains in the hobby realm and does not develop into a larger, more profitable enterprise.

2.) The second category is Lifestyle Businesses. This is the kind of business that allows you to have flexible hours and maybe even flexible geography, yet pays you well enough to make it worth doing. An example of a lifestyle business would be working as a business coach. There’s no doubt that there are some coaching businesses that are large, have several partners and various administrative staff and are extremely profitable, but on average, these are one- or two-person Lifestyle Businesses. They take advantage of the background and capabilities of the owner and allow that owner to make a good wage with a lot of flexibility; however they are highly unlikely to become fast growth companies with many employees. There is nothing wrong with Lifestyle Businesses, in fact, they can be great! It is important though that you understand their limitations and realize that if you are trying to create a fast growth business, then that is a different animal, with different lifestyle, investment, risk and upside expectations.

3.) The next category is Franchise Businesses. This one does not require too much explanation, since as consumers, we’re all familiar with a large number of very successful food franchises, such as Subway, McDonalds, etc. Franchise Businesses do not appeal to all entrepreneurs, but they do appeal to a good number, particularly those who have come from jobs in corporate America and are accustomed to a structured environment. Franchises can be great businesses, with excellent profitability. Also, on average, given the proven system they usually provide to their franchisees, Franchise Businesses fail at a much lower rate than the overall startup population. On the downside, Franchise Businesses can require a significant initial investment that is outside the reach of many entrepreneurs. They also require ongoing royalty payments to the Franchisor. That said, they can be an excellent alternative for the aspiring entrepreneur who has very little experience in startups and who has some funds available to dedicate to the franchise startup costs.

4.) The fourth category is Self-funded Growth Businesses. These are not hobbies, they are not Lifestyle Businesses and they are not Franchises. Rather, they are businesses that you start with the intention of growing them into large enterprises with many employees and many millions of dollars in revenues. In this category, you are funding the startup costs yourself, from your own assets and available credit. You are not seeking outside investors, most likely because you want to retain control of the business and you do not want to have to answer to equity investors, whether they be friends and family, angel investors, or venture capitalists. Since you typically need significant funds to start a growth business (let’s say $250k plus), this type of business is usually started by someone who is either independently wealthy from other sources, or has started and been successful with other businesses and wants to pursue their next great idea. Just because businesses in this category are self-funded at the outset, does not mean that they will not take growth funding down the road, rather it means that in the startup phase, the company founder(s) do not want the complications of having outside investors. Businesses in this category can fall into a number of industries and business types, depending on the background of the founder(s).

5.) The fifth and final category on this list is Outside-funded Growth Businesses. Such businesses often fall in the technology space, as this is an area of great interest for angel and venture capital investors, two of the most common types of equity investors in early-stage companies. Because they are “Outside-funded” does not mean that none of the founder(s)’ money goes into the business; it just means that a significant portion of the funding comes from outside sources and a good portion of the control of the venture is ceded to those outside investors. For many types of true growth companies, given the startup costs required relative to the net worth of the company founders, there is no choice but to take outside capital [investor pitch template, here]. This is not all negative, of course, as having the participation of the right investors can help the founders accomplish many of the early partnering and customer seeking activities necessary to achieve success. On the other hand, most any entrepreneur who has worked with outside investors will tell you that they would much rather be able to drive the business in the direction they want, without having to answer to outsiders. So taking equity investment from outsiders is a doubled-edged sword, but the reality is that, particularly in the tech space, very few of the great companies that you would know by name were started and grown without the benefit of outside equity capital.

This list of startup business types is not exhaustive, but it gives you an idea of the five broad categories of businesses that you may consider starting. Before you invest the first dime in your business, I strongly suggest that you come to terms with the type of business you are trying to start. If you find that you want to start a business that you simply cannot afford to fund from the resources of the founder(s), you will need to seek outside capital. In that case, there’s a wide variety of funding sources that you can consider. In any case, you will want to make sure you do a good job of screening your ideas to ensure that they truly represent the types of opportunities you want to spend your time, money and other resources pursuing.

I hope you have found this helpful in gaining perspective on the types of ventures you may start up and grow. If you have any questions with regard to how to apply these ideas to your particular venture, don’t hesitate to contact us. In any case, we’d love to hear your thoughts/comments/questions/ideas. Please enter them below or in the top right corner of this post.

Paul Morin
CompanyFounder.com
paul@CompanyFounder.com.

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